How to Invest Ethically and Save Fees


During Q4 2015, I attended a Benefits and Pensions Monitor conference on ethical investing. Through a series of individual presentations and then a Q&A session, a panel of ethical investing experts provided the audience with their views on incorporating Environmental, Social and Governance (ESG) considerations into a portfolio. For each question, all panelists provided an answer based upon their opinions and experiences. One question, however, found the panelists without an answer. The panel's collective response was "I'm sorry. I have no experience in that area."

To me, unanswered questions are usually the most interesting. Here’s the question that went unanswered:

Everything I've heard so far seems to relate solely to incorporating ESG into an active portfolio. How can ESG be incorporated into a passive mandate?

Sitting in the audience that day, I knew there was an answer to that question. After all, we had just tailored a passive and ethical solution for a client which we deliver at roughly half the cost of competing products. In this article, I examine the topic of incorporating ESG or ethical constraints into a passive portfolio. However, before doing so, allow me to provide the reader with two essential pieces of background information:

  1. 18 AM's credibility in being able to satisfactorily answer this question (and deliver on the execution of our solution to the passive and ethical question), and
  2. A brief scan of the ethical investing landscape.

18 AM's Credibility

As a founder and the CIO of a prior firm, I custom built our first ethical portfolio to satisfy a client’s request in 2003. The use of the term "custom built" was purposeful for a number of reasons. First, ethics are client dependent. No two people, nor any two clients, have precisely the same definition of what it means to invest ethically. Consequently, we prefer to tailor mandates to adhere to each client's Statement of Investment Policies and Guidelines (SIP&G). Second, I used the word "built" to connote the idea of having some tangible output from the building process. Specifically, here I am referring to a quantitative model that incorporates ethical considerations by scoring, ranking and/or screening client-specified ESG criteria. Quant firms are well suited to manage ESG mandates because:

  • Quant models are an ideal way to capture a client's investment requirements into an actionable and consistently repeatable investment process.
  • Most ESG notions can be illustrated as either a score on a gradient scale (indicating where a company ranks relative to others) or as a binary score (indicating whether a company does or doesn't meet certain criteria).
  • Quant firms have industry-leading skills in the area of transaction cost analysis and transaction cost management.

These are essential ingredients of an institutional quality investment process and necessities in the building of a passive solution.

In 2015, we continued our long-standing practice of tailoring solutions for clients when we used our considerable ESG and quantitative skill and experience to custom build a passive and ethical solution for a client. This mandate provides exposure to a specific benchmark (of the client’s choosing) while maintaining adherence to our client's ethical requirements as defined by their SIP&G. Hence, our answer to the above-stated passive and ethical question is based on years of practical experience.

A Brief Scan of the Ethical Investing Landscape

Ethical investing has existed for decades under many banners. It has enjoyed considerable momentum in recent years. In fact, according to a Xerox HR Consulting ‘ESG Flash survey’, 98% of investment managers incorporate ESG factors as part of their decision-making process1. This trend toward greater use of ESG considerations has been propelled by:

  • A generational value shift where institutional clients and their stakeholders put more emphasis on ESG;
  • Legislation and regulatory shifts, such as the January 1, 2016 implementation of a requirement by the Financial Services Commission of Ontario for pension plans to disclose if ESG factors are incorporated into the plan’s investment policies; and
  • The expanding availability of ESG data, allowing investment managers the ability to score, rank and screen stocks on ESG factors. This prevalence of data also provides clients with the ability to monitor the ESG levels of their portfolios.

The most prevalent form of ESG investing, over the past 25 years, has followed an exclusionary approach. That is, clients allowed their investment managers the freedom to build a portfolio from a given universe of stocks except for expressed prohibitions. Generally, these prohibited stocks have been the so-called “sin” stocks, such as alcohol, tobacco and gambling. This form of taking ESG into consideration by excluding known stocks or sectors is likely to remain a prevalent form of ESG investing.

Nonetheless, we see two interesting trends developing in the demand for ESG investing solutions. First, clients and their stakeholders are raising their level of ESG sophistication. Consequently, there is a continued movement toward favouring companies for their ‘good’ ESG characteristics versus simply excluding those stocks with ‘bad’ ESG characteristics. The data and expertise are now available to enable making an investment decision utilizing ESG inputs. Second, passive investing is increasing in popularity. For certain asset classes, the ability of managers to consistently beat the benchmark is particularly limited, especially after taking all fees into consideration. This lack of added value is one of the driving forces behind the demand for passive investing2. As the popularity of ESG investing and passive investing grow concurrently, the demand for passive and ethical solutions will continue to grow, evidencing the relevance and timeliness of the conference question.

Without a doubt, the market has responded and a small number of passive and ethical solutions do exist for clients to consider. However, we feel that many more clients will follow down the passive and ethical path, especially when more suitable (ie. client-centric) solutions become available. As there are far fewer dollars in passive ESG strategies than there are in their active counterparts, we feel the need for client education will be high and remain so for some time. It is our hope that this article contributes to that education process if for no other reason than it begins a dialogue aimed at fostering greater understanding of the marketplace options for passive and ethical solutions.

The Passive and Ethical Solution

The large index providers do provide a limited number of passive and ethical products. These products have been built with the fund manager’s desire for scale firmly in mind. I say this for two main reasons:

  • There are more products available in asset classes that have high client demand. That is, there are more options for passive and ethical in US Equities than there are for Canadian Small Cap. Simply put, in a global marketplace there is greater demand for US Equities.
  • Passive fund providers have created ethical products that exclude all the stocks most often prohibited by institutional clients. These are one-size-fits-all solutions. By keeping the exclusion list all-encompassing, fund providers can use one product to cater to as many people who have an interest in exclusionary approaches.

How can ESG be Incorporated into a Passive Mandate?

Our answer is: Through tailored solutions.

18 AM set out to devise a solution not based upon a need for scale but rather with a desire to build something that meets a specific client’s need. In fact, we think the investment industry has tilted too far away from craftsmanship in favour of scale. Clients haven't always benefited from this tilt. It's time for investment professionals to get back to crafting products for their client's needs rather than the firm's.

Given our thinking, we devised a solution that can be:

  • Employed against a number of different benchmarks, and
  • Tailored to meet a client’s specific ethical prohibitions.

Advantages of 18 AM’s approach include:

  • A cost efficient total solution.
  • A fee schedule that decrements based on AUM.
  • The ability for a client to utilize a separate account.
  • An investment approach that is easy to understand and explain to stakeholders.
  • Face-to-face customer service with the people who manage the company and the portfolio.

Upon request, we would be happy to provide further details of our passive and ethical approach.


  1. Benefits and Pensions Monitor Daily Alerts, February 18, 2016.
  2. SPIVA US Scorecard: Based on data as of Dec. 31, 2014, 86.44% of large-cap fund managers underperformed the benchmark over a one-year period. This figure is equally unfavorable when viewed over longer-term investment horizons. Over 5- and 10-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark.