Family offices

Calvin: Hey Mark, I just got an e-mail from a family foundation where they want to learn more about mission-aligned investing, but they don’t know where to start. Could we catch up over coffee?

Mark: Happy to.

Calvin: So we have a family foundation that wants to invest to support its mission. So, how does Aperio help with these types of investors?

Mark: Let me share a client story with you.

We worked with the board of a family foundation that included a father and his grown daughters. 

We started by sharing Aperio’s portfolio construction approach. We use a multi-factor optimization process seeking to match the performance of the client’s selected benchmark index, while aligning the portfolio more closely to the client’s values.

Then we had a conversation primarily to listen to the family. Imagine listening in on a father and his grown daughters talking about what they believe. There was a lot of agreement--but there were also some issues where they didn’t agree.

Calvin: It almost sounds like family therapy.

Mark: It can feel that way. The father later said that having that conversation with his daughters was one of the most meaningful conversations he’d ever had.

Calvin: What criteria did they end up applying to the family foundation’s portfolio?

Mark: They were very concerned with world peace issues, so they chose criteria including an exclusion of military weapons and a tilt toward companies that scored better on environment, corporate governance, diversity, human rights, and labor relations. We built a custom score for the client based on these client-selected criteria. All of these were criteria that the family chose themselves. 

Calvin: And when you say that you tilted the portfolio, what does that mean?

Mark: Let me show you. 

We create a score for each company within each index based on various factors and values, such as the client-selected criteria like we just discussed. Once that’s done, we make a score which can range from 0 to 100.

What we see here is the aggregated weight of companies in the benchmark within each scoring quintile. We also take the company scores and calculate the weighted average score of the benchmark as a whole. When we tilt a portfolio, we construct a portfolio that has a higher weighted average score than the benchmark—frequently about 20 percent higher score, although there’s a range depending on different aspects of a portfolio. 

This graph now shows a comparison of the weight in each scoring quintile for the portfolio compared to the benchmark. The portfolio construction process seeks to track the benchmark performance as closely as possible while meeting the client-selected criteria. You can see that the portfolio still has some low scoring companies since tilts don’t automatically exclude companies. But you can also see that the tilts tends to underweight the group of lower scoring companies and overweight the group of higher scoring companies.

Calvin: You said the tilt level is frequently 20 percent. So how much variation is there in the tilt level across accounts?

Mark: Our starting tilt level for many of our standard strategies is 20 percent but tilt levels will vary based on tax management and other issues within a specific client portfolio, depending on the criteria they select. When we’re creating a customized score, we can also customize the target tilt level. 

We treat the customized score as a factor in the portfolio construction process. For each increase in the tilt level based on the customized score, we predict a larger potential deviation from the benchmark index. This deviation is called tracking error. Our clients can use this concept to consider the tradeoff between tracking error and the intensity they want to apply for their own specific values and preferences. We call this the Social Efficient Frontier.

Calvin: What’s your current relationship with the foundation client. And how has the relationship evolved?

Mark: Our first conversations with this client were in 2007 and they implemented a portfolio for the family foundation that year. The family then added personal, taxable accounts using the same criteria where we also apply our tax loss harvesting capabilities.

Over the years, we’ve worked with the father as new issues emerged for him. He’s very concerned about climate change and chose to add a low carbon tilt to the portfolio.

A couple years ago, the father asked to have another Social Conversation. It had been such a meaningful experience with his daughters he wanted to do it again. So, we did. And they’re still a client today.

Calvin: Any significant changes out of that second Social Conversation?

Mark: They increased the relative importance of diversity within the scoring profile and added some additional exclusions, including private prisons and predatory lending. We look to implement the client’s evolving values over time and continuing conversations are important to do that.

Calvin: So, do you work with all your values-aligned clients at this level of detail?

Mark: We really work to right-size the conversation for the client, but yes, we’ll work with each of our clients to make sure they understand what we can and can’t do to better align their portfolio with their values or mission.

Calvin: That’s great. So let’s meet with this client and see how we can help customize their portfolio to better support its mission.

Mark: Thanks, we’d be happy to work together and help this client.

THE INFORMATION CONTAINED HEREIN MAY BE PROPRIETARY IN NATURE AND MAY NOT BE REPRODUCED, COPIED OR DISTRIBUTED WITHOUT THE PRIOR CONSENT OF BLACKROCK, INC. (“BLACKROCK”). These materials are not an advertisement and are not intended for public use or dissemination.

IMPORTANT NOTES

Aperio Group, LLC, provides this material for informational purposes only and for the sole use of the recipient. The information contained herein is provided with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in these areas. The strategies and/or investments referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities. The fees and expenses Aperio charges may be higher than the fees and expenses of other investment advisors and may offset profits. Additional information about the firm, and our fees and expenses, is included in our Form ADV.

Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that any investment strategy discussed herein will work under all market conditions. Many factors affect performance, including changes in market conditions and interest rates, as well as other economic, political, or financial developments.

You should not assume that investment decisions we make in the future will be profitable or will equal the investment performance of the past. With respect to the description of any investment strategies, simulations, or investment recommendations, we cannot provide any assurances that they will perform as expected and as described in our materials. Past performance is not indicative of future results.

Indexes represent unmanaged groups of securities. Investing directly in an index is not possible. Past performance is not indicative of future performance.

Aperio Social Scores

Aperio assembles data from ESG (environmental, social, and governance) data vendors and other organizations, generally on an annual basis. This data is used to score companies on a wide range of ESG topics and is the basis for creating values-aligned portfolios. Data Elements are combined into preconfigured, standard Aperio Strategy and Tilt options and are also used to create customized, client-specific scoring profiles. The output from these profiles is generally referred to as “Social Scores” or “ESG Scores.”

To calculate Aperio Social Scores, Data Elements are evaluated (and quantified if needed), z-scored (statistically compared to the average value of other companies), and combined based on assigned weights into issue area Component Scores. Companies have multiple scores, with a different score for each component. Component Scores are aggregated at profile-assigned weights and are used to calculate Company Social Scores. Company scores are calculated across the entire Aperio universe and range from 0 to 100. Higher Company Social Scores reflect a “better” company and lower scores represent a “worse” company, based on the criteria being evaluated. When used as a tilt in the construction of portfolios, higher scores can result in an overweighting of companies and lower scores can result in an underweighting of companies. Strategy scores consist of the weighted average of the relevant Component Scores for each company. Each strategy—whether a standard strategy or client-specific option—generates a different set of company scores. These strategy-specific scores are usually referred to by their strategy name, such as “DEI Score,” “Aperio SRI Score,” etc.

We are happy to provide further details on how Aperio Social Scores are compiled and used.

Sources of Data

Aperio sources of data include MSCI ESG Research, ISS ESG, Bloomberg, GeoPhy. other data providers as relevant, and industry classifications (usually GICS® classifications). In addition, for certain Data Elements, Aperio sources information from other sources, including advocacy organizations.

Each of these data sources relies on a number of original sources for its data gathering. Three primary sources for data gathering are:

Mandatory company disclosures: In certain cases, companies must comply with regulatory requirements for the disclosure of information. This kind of information can range from financial information to information the US Environmental Protection Agency requires company facilities to disclose. The advantage of this information is that it is comprehensive across the universe of companies. Unfortunately, in many issue areas, no mandatory disclosure applies.

Voluntary company disclosures: Much of the information available is voluntarily disclosed by companies, often in corporate sustainability reports or in sustainability or responsibility sections of their websites. This information can be more difficult to incorporate into evaluations and ratings because all companies do not disclose all information, and even when they disclose similar issues, companies are not consistent in how they do so.

Third-party information: In certain instances, third parties may have information about a company that does not rely on the information disclosed by the company. For instance, a regulatory agency that fines a company has that information independent of any disclosures by the company.

Data that Aperio receives from its vendors and other information sources may include metrics constructed as a combination of these concepts. For instance, there is mandatory disclosure of certain kinds of international operations, including registered subsidiaries. When this information is combined with evaluations of countries’ political and civil liberties provided by a nongovernmental organization (NGO), we have a hybrid Data Element. In another example, we use ratings by the Human Rights Campaign (HRC) as an indication of a company’s approach to sexual-orientation issues. HRC gathers information from companies, including by conducting surveys (voluntary disclosure), and then scores the companies. So, this is a combination of voluntary disclosure and evaluation.

NOTE: When assembling data into Aperio scores, Aperio determines how to score missing data based on the reason and context for the missing Data Element value. When the Data Element is based on voluntary disclosure and the data vendor sought to gather the Data Element from the company, but the element is null, the company will receive the lowest available score. When the Data Element was not researched by the vendor because it is not relevant to the company’s industry, and Aperio agrees it is not relevant, then the company is generally assigned the highest possible score. When the vendor did not research the Data Element for the company based on its not being relevant, but Aperio disagrees with this assessment, the company is generally assigned an average score for the sector.

Data Limitations & Update Frequency

Aperio generally updates its ESG data for the Values-Alignment Menu annually. Data Elements may be updated during the year as our data providers receive new data from either the company or publicly available sources, and this will not be captured in our processes until Aperio’s next annual data update. Aperio generally updates all exclusions and scoring profiles annually, usually during the first calendar quarter. As accounts are rebalanced, the updated data will be incorporated, usually during the second calendar quarter.

Because the data sets are not updated in real time, there may be a lag between a change at the company and when the change flows into the data set, and again when it flows into the portfolio during a rebalance. Aperio endeavors to handle all updates consistently and does not override the approved, vendor-/source-provided data sets.

Aperio is dependent upon data and information that may be incomplete, inaccurate, or unavailable, which could adversely affect the assessment of companies based on ESG factors. Aperio cannot guarantee the accuracy of the data disclosed by companies or the estimates made by third-party vendors such as MSCI when data are missing. As a result, Aperio’s Social Scores are based on information with inherent limitations. Scores should be viewed solely as directional, and their accuracy is not guaranteed.

Portfolio Management Implementation Process

The Aperio Portfolio Management team uses data from the Component Scoring described above for the investible universe and integrates the data into the relevant strategies as indicated by our clients’ indicated investment guidelines. ESG strategies, tilts, and exclusions alter Aperio’s ability to track a portfolio’s benchmark. The forecasted deviation is measured using tracking error calculated by the MSCI Barra risk model. This deviation can be significant.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters.

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