ESG Robo Advisors: Present & Future

Robo advisors have been around for well over a decade. Jack Bogle (RIP) – founder and longtime CEO of Vanguard – is widely credited with investing the concept of an “index fund”. Technology, namely the rise of platform-based investing and machine learning in portfolio allocation, has since enabled robo advisors like Betterment and Wealthfront to aggregate index funds, pools of bonds, and other assets to present retail investors (like you and me) a plug-and-play, ready-made portfolio with built-in diversification and broad exposure to the market.

All well and good! But what if you are a moral human, you are skeptical of the idea that “the market” is monolithically benevolent. You like the idea of attaining broad exposure to various sectors of the economy; and someone else (or a machine) optimizing risk-adjusted returns for you over time, consistent with your goals; but you don’t like the idea of owning Philip Morris, or Smith & Wesson, or fossil fuels. Enter: ESG robo advisors.

ESG Robo Advisors: The Basics

Like any robo advisor, ESG robo advisors will be buying a broad basket of securities across sectors of the economy, mostly via ETFs (exchange-traded funds). They will also purchase corporate or municipal bonds, utilities, or other assets that fit within some ESG mandate (more on that in a bit). Like a standard robo advisor, an ESG robo advisor will tailor an asset allocation to your risk tolerance, age, and objectives.

More risk-averse or older investors will generally be allocated a higher proportion of bonds, treasuries, and other assets that historically reflect lower levels of downside risk. Most robo advisors at least purport to apply some form of machine learning to rebalance and optimize your portfolio over time.

The Actual Impact of ESG Robo Advisors

All ESG robo advisors operate with some form of mandate or standards when it comes to selecting ETFs or individual assets. Marketing copy promulgated by ESG robo advisors will tout some kind of groundbreaking approach to the robo advisor model; a strict standard of selecting assets that align with sustainability and better corporate citizenship. Are these standards valid, or marketing fluff?

In short: maybe, it’s not always easy to tell, and it varies.

The robo advisor model is opaque by design. You specify your goals and set up recurring contributions via a slick web app, the web app invests in a basket of securities on your behalf, and you spend virtually no time examining the movements (or the ESG rating) of individual assets within your robo advisor portfolio. As Jack Bogle famously said “don’t look for the needle in the haystack, just buy the haystack!” This can be a tough pill to swallow for the Righteous Money investor. A healthy yield and low volatility is all well and good, but if investments in fossil fuels and other bad shit are hiding from view in the robo advisor’s mix of assets, we’re not really doing what we set out to do.

So, here are some things to look out for:

Does the ESG robo advisor have clear standards, transparently presented? In my opinion, if you want to be true to the mission of investing your values, you should do the work of understanding your ESG robo advisor’s portfolio makeup and what guides it. In selecting an ESG robo advisor, seek detailed information about asset allocation and be honest with yourself about how comfortable you would be investing given what you can find. Here’s what Aspiration presents in support of their Redwood Fund, for example. There’s plenty of fluff out front, but there’s also a detailed breakdown of asset allocation and you can also find specific FAQs regarding this product.

Will the ESG robo advisor answer questions?

What is the structure of the ESG robo advisor? The Redwood Fund, for example, is technically a fund (duh). It buys a broad swath of assets and sells shares. This may make it easier to evaluate ESG standards and dig into specifics. Other ESG robo advisors will function more like a traditional robo advisor: buying ETFs and other bundles of assets that may require further scrutiny.

How do ESG robo advisors perform?

For the most part, ESG robo advisors are focused on delivering healthy returns while promoting ESG investing, rather than investing solely in companies that are driven by specific sustainability or social impact mission statements. If you are looking to invest exclusively in such companies, you may need to purchase shares directly or look for specific ETFs with more narrow EGS mandates. Part of the overall thesis (aside from not investing in bad shit) is that companies that adopt ESG standards outperform those who don’t, in aggregate, over long time frames (see figure above).

We are still early in the game. A few ESG robo advisors have already gone belly-up, presumably from difficulty standing out or articulating a distinct value proposition (RIP Swell). In my experience, returns have been roughly commensurate with the S&P 500. For more specifics, check out my reviews of Betterment’s ESG product and Aspiration.

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