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Socially Responsible Investing Portfolios Methodology

See the methodology for our Socially Responsible Investing (SRI) portfolios.

By Betterment Editors

Published Oct. 22, 2020 | Updated Oct. 27, 2022

Socially Responsible Investing Portfolios Methodology Oct 27, 2022 12:00:00 AM See the methodology for our Socially Responsible Investing (SRI) portfolios. Table of Contents Introduction How do we define SRI? The Challenges of SRI Portfolio Construction How is Betterment’s Broad Impact portfolio constructed? How is Betterment’s Climate Impact portfolio constructed? How is Betterment’s Social Impact portfolio constructed? Conclusion Introduction Betterment first made a values-driven portfolio available to our customers in 2017, under the Socially Responsible Investing (SRI) label, and has maintained SRI as the umbrella term for the category in subsequent expansions and updates to that offering. Betterment’s portfolios represent a diversified, relatively low-cost solution that will be continually improved upon as costs decline, more data emerges, and as a result, the availability of SRI funds broadens (in this paper, “funds” refer to ETFs, and “SRI funds” refer to either ETFs screened for some form of ESG criteria or ETFs with an SRI-focused shareholder engagement strategy). Within Betterment’s SRI options, we offer a Broad Impact portfolio and two additional, more focused SRI portfolio options, a Social Impact SRI portfolio (focused on social governance criteria) and a Climate Impact SRI portfolio (focused on climate-conscious investments). How do we define SRI? Our approach to SRI has three fundamental dimensions: Reducing exposure to companies involved in unsustainable activities and environmental, social, or governmental controversies. Increasing investments in companies that work to address solutions for core environmental and social challenges in measurable ways. Allocating to investments that use shareholder engagement tools, such as shareholder proposals and proxy voting, to incentivize socially responsible corporate behavior. We first define our SRI approach using a set of industry criteria known as “ESG”, which stands for Environmental, Social and Governance, and then expand upon the ESG-investing framework with complementary shareholder engagement tools. SRI is the traditional name for the broad concept of values-driven investing (many experts now favor “sustainable investing” as the name for the entire category). ESG refers specifically to the quantifiable dimensions of a company’s standing along each of its three components. In our SRI portfolios, we use ESG factors to define and score the degree to which our portfolios incorporate socially responsible ETFs. We also complement our ESG factor-scored socially responsible ETFs with engagement-based socially responsible ETFs, where a fund manager uses shareholder engagement tools to express a socially responsible preference. Using ESG Factors In An SRI Approach A significant and obvious aspect of improving a portfolio’s ESG score is reducing exposure to companies that engage in unsustainable activities in your investment portfolio. Companies can be considered undesirable because their businesses do not align with specific values—e.g. selling tobacco, military weapons, or civilian firearms. Other companies may be undesirable because they have been involved in recent and ongoing ESG controversies and have yet to make amends in a meaningful way. SRI is about more than just adjusting your portfolio to minimize companies with a poor social impact. Based on the framework of MSCI, an industry-leading provider of financial data and ESG analytics that has served the financial industry for more than 40 years, a socially responsible investment approach also emphasizes the inclusion of companies that have a high overall ESG score, which represents an aggregation of scores for multiple thematic issues across E, S, and G pillars as shown in Table 1 below. Table 1. A Broad Set of Criteria Across E, S and G pillars 3 Pillars 10 Themes 35 Key ESG Issues Environment Climate Change Carbon Emissions Product Carbon Footprint Financing Environmental Impact Climate Change Vulnerability Natural Resources Water Stress Biodiversity & Land Use Raw Material Sourcing Pollution & Waste Toxic Emissions & Waste Electronic Waste Packaging Material & Waste Environmental Opportunities Opportunities in Clean Technology Opportunities in Renewable Energy Opportunities in Green Building Social Human Capital Labor Management Human Capital Development Health & Safety Supply Chain Labor Standards Product Liability Product Safety & Quality Privacy & Data Security Chemical Safety Responsible Investment Consumer Financial Protection Health & Demographic Risk Stakeholder Opposition Controversial Sourcing Community Relations Social Opportunities Access to Communications Access to Health Care Access to Finance Opportunities in Nutrition & Health Governance Corporate Governance Board Ownership Pay Accounting Corporate Behavior Business Ethics Tax Transparency Source: MSCI Ratings Methodology Shareholder Engagement The most direct ways a shareholder can influence a company’s decision making is through shareholder proposals and proxy voting. Publicly traded companies have annual meetings where they report on the business’ activities to shareholders. As a part of these meetings, shareholders can vote on a number of topics such as share ownership, the composition of the board of directors, and executive level compensation. Investors receive information on the topics to be voted on prior to the meeting in the form of a proxy statement, and can vote on these topics through a proxy card. A shareholder proposal is an explicit recommendation from an investor for the company to take a specific course of action. Shareholders can also propose their own nominees to the company’s board of directors. Once a shareholder proposal is submitted, the proposal or nominee is included in the company’s proxy information and is voted on at the next annual shareholders meeting. ETF shareholders themselves do not vote in the proxy voting process of underlying companies, but rather the ETF fund issuer participates in the proxy voting process on behalf of their shareholders. As investors signal increasing interest in ESG engagement, more ETF fund issuers have emerged that play a more active role engaging with underlying companies through proxy voting to advocate for more socially responsible corporate practices. These issuers use engagement-based strategies, such as shareholder proposals and director nominees, to engage with companies to bring about ESG change and allow investors in the ETF to express a socially responsible preference. The Challenges of SRI Portfolio Construction For Betterment, three limitations had a large influence on our overall approach to building an SRI portfolio: 1. Poor quality data underlying ESG scoring. Because SRI is still gaining traction, data for constructing ESG scores are at a nascent stage of development. There are no uniform standards for data quality yet. In order to standardize the process of assessing companies’ social responsibility practices, Betterment uses ESG factor scores from MSCI, who collects data from multiple sources, company disclosures, and over 1,600 media sources monitored daily. They also employ a robust monitoring and data quality review process. See the MSCI ESG Fund Ratings Executive Summary for more detail. 2. Many existing SRI offerings in the market have serious shortcomings. Many SRI offerings today sacrifice sufficient diversification appropriate for investors who seek market returns, allocate based on competing ESG issues and themes that reduce a portfolio’s effectiveness, and do not provide investors an avenue to use collective action to bring about ESG change. Betterment’s SRI portfolios do not sacrifice global diversification and all three portfolios include a partial allocation to an engagement-based socially responsible ETF using shareholder advocacy as a means to bring about ESG-change in corporate behavior. These approaches allow Betterment investors to take a diversified approach to sustainable investing and use their investments to bring about ESG-change. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly, even if particular shareholder campaigns are unsuccessful. The Broad Impact portfolio seeks to balance each of the three dimensions of ESG without diluting different dimensions of social responsibility. With our Social Impact portfolio, we sharpen the focus on social equity with partial allocations to gender and racial diversity focused funds. With our Climate Impact portfolio, we sharpen the focus on controlling carbon emissions and fostering green solutions. 3. Integrating values into an ETF portfolio may not always meet every investor’s expectations, though it offers unique advantage For investors who prioritize an absolute exclusion of specific types of companies above all else, the ESG Scoring approach will inevitably fall short of expectations. For example, many of the largest ESG funds focused on US Large Cap stocks include some energy companies that engage in oil and natural gas exploration, like Hess. While Hess might rate relatively poorly along the “E” pillar of ESG, it could still rate highly in terms of the “S” and the “G.” Furthermore, maintaining our core principle of global diversification, to ensure both domestic and international bond exposure, we’re still allocating to some funds without an ESG mandate, until satisfactory solutions are available within those asset classes. We expect that increased asset flows across the industry into such funds would continue to drive down expense ratios and increase liquidity. Since the original offering, which was the predecessor to what is now our Broad Impact portfolio, we’ve been able to expand the ESG exposure to now also cover Developed Market stocks, Emerging Market stocks, and US High Quality Bonds. We also now include ESG exposure to an engagement-based fund. Sufficient options also exist for us to branch out in two different areas of focus—Climate Impact, and Social Impact. 4. Most available SRI-oriented ETFs present liquidity limitations. In an effort to control the overall cost for SRI investors, a large portion of our research focused on low-cost exchange-traded funds (ETFs) oriented toward SRI. While SRI-oriented ETFs indeed have relatively low expense ratios compared to SRI mutual funds, our analysis revealed insufficient liquidity in many ETFs currently on the market. Without sufficient liquidity, every execution becomes more expensive, creating a drag on returns. Median daily dollar volume is one way of estimating liquidity. Higher volume on a given asset means that you can quickly buy (sell) more of that asset in the market without driving the price up (down).The degree to which you can drive the price up or down with your buying or selling must be treated as a cost that can drag down on your returns. In balancing cost and value for the Broad Impact portfolio, the options were limited to funds that focus on US stocks , Developed Market stocks, Emerging Market stocks, US Investment Grade Corporate Bonds, and US High Quality bonds. How is Betterment’s Broad Impact portfolio constructed? In 2017, we launched our original SRI portfolio offering, which we’ve been steadily improving over the years. In 2020, we released two additional Impact portfolios and improved our original SRI portfolio, the improved iteration now called our “Broad Impact” portfolio to distinguish it from the new specific focus options, Climate Impact and Social Impact, and the legacy SRI portfolio for those investors who elected not to upgrade their historical version of the SRI portfolio (“legacy SRI portfolio”). For more information about the differences between our Broad Impact portfolio and the legacy SRI portfolio, please see our disclosures. As we’ve done since 2017, we continue to iterate on our SRI offerings, even if not all the fund products for an ideal portfolio are currently available. Figure 2 shows that we have increased the allocation to ESG focused funds each year since we launched our initial offering. Today all primary stock ETFs used in our Broad Impact, Climate Impact, and Social Impact portfolios have an ESG focus. 100% Stock Allocation in the Broad Impact Portfolio Over Time Figure 2. Calculations by Betterment. Portfolios from 2017-2019 represent Betterment’s original SRI portfolio. The 2020 portfolio represents a 100% stock allocation of Betterment’s Broad Impact portfolio. As additional SRI portfolios were introduced in 2020, Betterment’s SRI portfolio became known as the Broad Impact portfolio. As your portfolio allocation shifts to higher bond allocations, the percentage of your portfolio attributable to SRI funds decreases. Additionally, a 100% stock allocation of the Broad Impact portfolio in a taxable goal with tax loss harvesting enabled may not be comprised of all SRI funds because of the lack of suitable secondary and tertiary SRI tickers in the developed and emerging market stock asset classes. Betterment has built a Broad Impact portfolio, which focuses on ETFs that rate highly on a scale that considers all three ESG pillars, and includes an allocation to an engagement-based SRI ETF. Broad ESG investing solutions are currently the most liquid, highlighting their popularity amongst investors. Due to this, we will first examine how we created Betterment’s Broad Impact portfolio. In order to maintain geographic and asset class diversification and to meet our requirements for lower cost and higher liquidity in all SRI portfolios, we continue to allocate to some funds that do not have SRI mandates, particularly in bond asset classes. How does the Broad Impact portfolio compare to Betterment’s Core portfolio? Based on the primary ticker holdings, the following are the main differences between Betterment’s Broad Impact portfolio and Core portfolio: Replacement of market cap-based US stock exposure and value style US stock exposure in the Core portfolio, with SRI-focused US stock market funds, ESGU and VOTE, in the Broad Impact portfolio. Replacement of market cap-based developed market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGD, in the Broad Impact portfolio. Replacement of market cap-based emerging market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGE, in the Broad Impact portfolio. Replacement of market cap-based US high quality bond fund exposure in the Core portfolio, with SRI-focused US high quality bond funds, EAGG and SUSC, in the Broad Impact portfolio. ESGU, ESGV, SUSA, ESGD, ESGE, SUSC, and EAGG each track a benchmark index that screens out companies involved in specific activities and selectively includes companies that score relatively highly across a broad set of ESG metrics. ESGU, ESGD, ESGE, SUSC, and EAGG exclude tobacco companies, thermal coal companies, oil sands companies, certain weapons companies (such as those producing landmines and bioweapons), and companies undergoing severe business controversies. The benchmark index for ESGV explicitly filters out companies involved in adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power. SUSA benchmark index screens out tobacco companies and companies that have run into recent ESG controversies. VOTE tracks a benchmark index that invests in 500 of the largest companies in the U.S. weighted according to their size, or market capitalization. This is different from the other indexes tracked by SRI funds in the Broad Impact portfolio, because the index does not take into account a company’s ESG factors when weighting different companies. Rather than invest more in good companies and less in bad companies, VOTE invests in the broader market and focuses on improving these companies’ social and environmental impact through shareholder engagement. Some of our allocations to bonds continue to be expressed using non-SRI focused ETFs since either the corresponding SRI alternatives do not exist or may lack sufficient liquidity. These non-SRI funds continue to be part of the portfolios for diversification purposes. As of September 2022, the Broad Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.12-0.18%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Broad Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%. SRI portfolios are also able to support our core tax products, Tax-loss Harvesting+ (TLH) and Tax-coordinated portfolios (TCP). In the Broad Impact portfolio, because of limited fund availability in the developed and emerging market SRI spaces, we use non-SRI market cap-based funds, like VWO, SPEM, VEA, and IEFA as secondary and tertiary funds for ESGE and ESGD when TLH is enabled. How socially responsible is the Broad Impact portfolio? As mentioned earlier, we first use the ESG data and analytics from MSCI to quantify how SRI-oriented our portfolios are. For each company that they cover, MSCI calculates a large number of ESG metrics across multiple environmental (E), social (S), and governance (G) pillars and themes (recall Table 1 above). All these metrics are first aggregated at the company level to calculate individual company scores. At the fund level, an overall MSCI ESG Quality score is calculated based on an aggregation of the relevant company scores. As defined by MSCI, this fund level ESG Quality score reflects “the ability of the underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors”. These fund scores can be better understood given the MSCI ESG Quality Score scale shown below. See MSCI's ESG Fund Ratings for more detail. Table 2. The MSCI ESG Quality Score Scale The ESG Quality Score measures the ability of underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors. Fund ESG Letter Rating Leader/ Laggard Fund ESG Quality Score (0-10 score) AAA Leader - Funds that invest in companies leading its industry in managing the most significant ESG risks and opportunities 8.6-10.0 AA 7.1-8.6 A Average- Funds that invest in companies with a mixed or unexceptional track record of managing the most significant ESG risks and opportunities relative to industry peers 5.7-7.1 BBB 4.3-5.7 BB 2.9-4.3 B Laggard- Funds that invest in companies lagging its industry based on its high exposure and failure to manage significant ESG risks 1.4-2.9 CCC 0.0-1.4 Source: MSCI *Appearance of overlap in the score ranges is due to rounding imprecisions. The 0-to-10 scale is divided into seven equal parts, each corresponding to a letter rating. Based on data from MSCI, which the organization has made publicly available for funds to drive greater ESG transparency, and sourced by fund courtesy of etf.com, Betterment’s 100% stock Broad Impact portfolio has a weighted MSCI ESG Quality score that is approximately 19% greater than Betterment’s 100% stock Core portfolio. MSCI ESG Quality Scores U.S. Stocks Betterment Core Portfolio: 8.2 Betterment Broad Impact Portfolio: 9.3 Emerging Markets Stocks Betterment Core Portfolio: 5.2 Betterment Broad Impact Portfolio: 8.6 Developed Markets Stocks Betterment Core Portfolio: 8.7 Betterment Broad Impact Portfolio: 9.7 US High Quality Bonds Betterment Core Portfolio: 6.6 Betterment Broad Impact Portfolio: 9.5 Sources: MSCI ESG Quality Scores courtesy of etf.com, values accurate as of September 30, 2022 and are subject to change. In order to present the most broadly applicable comparison, scores are with respect to each portfolio’s primary tickers exposure, and exclude any secondary or tertiary tickers that may be purchased in connection with tax loss harvesting. Another way we can measure how socially responsible a fund is by monitoring their shareholder engagement with companies on environmental, social and governance issues. Engagement-based socially responsible ETFs use shareholder proposals and proxy voting strategies to advocate for ESG change. We can review the votes of particular shareholder campaigns and evaluate whether those campaigns are successful. That review however does not capture the impact that the presence of engagement-based socially responsible ETFs may have on corporate behavior simply by existing in the market. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly. These aspects of sustainable investing are more challenging to measure in a catch-all metric, however that does not diminish their importance. A Note On ESG Risks And Opportunities An ESG risk captures the negative externalities that a company in a given industry generates that may become unanticipated costs for that company in the medium- to long-term. An ESG opportunity for a given industry is considered to be material if companies will capitalize over a medium- to long-term time horizon. See MSCI ESG Ratings Methodology (June 2022 ) for more detail. For a company to score well on a key ESG issue (see Table 1 above), both the exposure to and management of ESG risks are taken into account. The extent to which an ESG risk exposure is managed needs to be commensurate with the level of the exposure. If a company has high exposure to an ESG risk, it must also have strong ESG risk management in order to score well on the relevant ESG key issue. A company that has limited exposure to the same ESG risk, only needs to have moderate risk management practices in order to score as highly. The converse is true as well. If a company that is highly exposed to an ESG risk also has poor risk management, it will score more poorly in terms of ESG quality than a company with the same risk management practices, but lower risk exposure. For example, water stress is a key ESG issue. Electric utility companies are highly dependent on water with each company more or less exposed depending on the location of its plants. Plants located in the desert are highly exposed to water stress risk while those located in areas with more plentiful water supplies present lower risk. If a company is operating in a location where water is scarce, it needs to take much more extensive measures to manage this risk than a company that has access to abundant water supply. Should we expect any difference in an SRI portfolio’s performance? One might expect that a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio. The notion behind this reasoning is that somehow there is a premium to be paid for investing based on your social ideals and values. A white paper written in partnership between Rockefeller Asset Management and NYU Stern Center for Sustainable Business, studied 1000+ research papers published from 2015-2020 which analyzed the relationship between ESG investing and performance. The primary takeaway from this research was that they found “positive correlations between ESG performance and operational efficiencies, stock performance, and lower cost of capital.” When ESG factors are considered, there seems to be improved performance potential over longer time periods and potential to also provide downside protection during periods of crisis. Dividend Yields Could Be Lower Dividend yields calculated over the past year (ending September 30, 2022) indicate that income returns coming from Broad Impact portfolios have been lower than those of Core portfolios. Oil and gas companies like BP, Chevron, and Exxon, for example, currently have relatively high dividend yields and excluding them from a given portfolio can cause its income return to be lower. Of course, future dividend yields are random variables and past data may not provide accurate forecasts. Nevertheless, lower dividend yields can be a factor in driving total returns for SRI portfolios to be lower than those of Core portfolios. Comparison of Dividend Yields Source: Bloomberg, Calculations by Betterment for one year period ending September 30, 2022. Dividend yields for each portfolio are calculated using the dividend yields of the primary ETFs used for taxable allocations of Betterment’s portfolios as of September 2022. How is Betterment’s Climate Impact portfolio constructed? Betterment offers a Climate Impact portfolio for investors that want to invest in an SRI strategy more focused on being climate-conscious rather than focusing on all ESG dimensions equally. The Climate Impact portfolio was designed to give investors exposure to climate-conscious investments, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio, as we seek to incorporate broad based climate-focused ETFs with sufficient liquidity relative to their size in the portfolio. How does the Climate Impact portfolio more positively affect climate change? The Climate Impact portfolio is allocated to iShares MSCI ACWI Low Carbon Target ETF (CRBN), an ETF which seeks to track the global stock market, but with a bias towards companies with a lower carbon footprint. By investing in CRBN, investors are actively supporting companies with a lower carbon footprint, because CRBN overweights these stocks relative to their high-carbon emitting peers. One way we can measure the carbon impact a fund has is by looking at its weighted average carbon intensity, which measures the weighted average of tons of CO2 emissions per million dollars in sales, based on the fund's underlying holdings. Based on weighted average carbon intensity data from MSCI (courtesy of etf.com), Betterment’s 100% stock Climate Impact portfolio has carbon emissions per unit sales more than 50% lower than Betterment’s 100% stock Core portfolio as of September 30, 2022. International Developed and Emerging Markets stocks in the Climate Impact portfolio are also allocated to fossil fuel reserve free funds, EFAX and EEMX. U.S. stocks in the Climate Impact portfolio are allocated to a fossil fuel reserve free fund, SPYX, and an engagement-based ESG fund, VOTE. Rather than ranking and weighting funds based on a certain climate metric like CRBN, fossil fuel reserve free funds instead exclude companies that own fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in fossil fuel reserve free funds investors are actively divesting from companies with some of the most negative impact on climate change, including oil producers, refineries, and coal miners such as Chevron, ExxonMobile, BP, and Peabody Energy. Another way that the Climate Impact portfolio promotes a positive environmental impact is by investing in bonds that fund green projects. The Climate Impact portfolio invests in iShares Global Green Bond ETF (BGRN), which tracks the global market of investment-grade bonds linked to environmentally beneficial projects, as determined by MSCI. These bonds are called “green bonds”. The green bonds held by BGRN fund projects in a number of environmental categories defined by MSCI including alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation. How does the Climate Impact portfolio compare to Betterment’s Core portfolio? When compared to the Betterment Core portfolio allocation, there are three main changes. First, in both taxable and tax-deferred portfolios,our Core portfolio’s Total Stock exposure is replaced with an allocation to a broad global low-carbon stock ETF (CRBN) in the Climate Impact portfolio. Currently, there are not any viable alternative tickers for the global low-carbon stock asset class so this component of the portfolio cannot be tax-loss harvested. Second, we allocate Core portfolio’s International Stock exposure, and a portion of our Core portfolio’s US Total Stock Market exposure to three broad region-specific stock ETFs that screen out companies that hold fossil-fuel reserves in the Climate Impact portfolio. US Total Stock Market exposure is replaced with an allocation to SPYX, International Developed Stock Market exposure is replaced by EFAX, and Emerging Markets Stock Market exposure is replaced by EEMX. In the Climate Impact portfolio, SPYX, EFAX, and EEMX will use ESG secondary tickers ESGU, ESGD, and ESGE respectively for tax loss harvesting. Third, we also allocate a portion of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any comparable alternative tickers for VOTE so this component of the portfolio will not be tax-loss harvested. Lastly, for both taxable and tax-deferred portfolios we replace both our Core portfolio’s US High Quality Bond and International Developed Market Bond exposure with an allocation to a global green bond ETF (BGRN) in the Climate Impact portfolio. Some of our allocations to bonds continue to be expressed using non-climate focused ETFs since either the corresponding alternatives do not exist or may lack sufficient liquidity. These non-climate-conscious funds continue to be part of the portfolios for diversification purposes. As of September 2022, the Climate Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.13-0.20%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Climate Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%. How do performance expectations compare to the Core portfolio? When some first consider ESG investing, they assume that they must pay a heavy premium in order to have their investments aligned with their values. However, as previously noted above, the data suggests that the performance between sustainable funds versus traditional funds is not significantly different, although there can be differences over shorter periods. How is Betterment’s Social Impact portfolio constructed? Betterment offers a Social Impact portfolio for investors that want to invest in a strategy more focused on the social pillar of ESG investing (the S in ESG). The Social Impact portfolio was designed to give investors exposure to investments which promote social equity, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio discussed above, as we seek to incorporate broad based ETFs that focus on social equity with sufficient liquidity relative to their size in the portfolio. How does the Social Impact portfolio promote social equity? The Social Impact portfolio shares many of the same holdings as Betterment’s Broad Impact portfolio, which means the portfolio holds funds which rank strongly with respect to broad ESG factors. The Social Impact portfolio looks to further promote the social pillar of ESG investing, by also allocating to two ETFs that specifically focus on diversity and inclusion -- Impact Shares NAACP Minority Empowerment ETF (NACP) and SPDR SSGA Gender Diversity Index ETF (SHE). NACP is a US stock ETF offered by Impact Shares that tracks the Morningstar Minority Empowerment Index. The National Association for the Advancement of Colored People (NAACP) has developed a methodology for scoring companies based on a number of minority empowerment criteria. These scores are used to create the Morningstar Minority Empowerment Index, an index which seeks to maximize the minority empowerment score while maintaining market-like risk and strong diversification. The end result is an index which provides greater exposure to US companies with strong diversity policies that empower employees irrespective of race or nationality. By investing in NACP, investors are allocating more of their money to companies with a track record of social equity as defined by the NAACP. SHE is a US Stock ETF that allows investors to invest in more female-led companies compared to the broader market. In order to achieve this objective, companies are ranked within each sector according to their ratio of women in senior leadership positions. Only companies that rank highly within each sector are eligible for inclusion in the fund. By investing in SHE, investors are allocating more of their money to companies that have demonstrated greater gender diversity within senior leadership than other firms in their sector. For more information about these social impact ETFs, including any associated risks, please see our disclosures. How does the Social Impact portfolio compare to Betterment’s Core portfolio? The Social Impact portfolio builds off of the ESG exposure from funds used in the Broad Impact portfolio and makes the following additional changes. First, we replace a portion of our US Total Stock Market exposure with an allocation to a US Stock ETF, NACP, which provides exposure to US companies with strong racial and ethnic diversity policies in place. Second, another portion of our US Total Stock Market exposure is allocated to a US Stock ETF, SHE, which provides exposure to companies with a relatively high proportion of women in high-level positions. As with the Broad Impact and Climate Impact portfolios, we allocate the remainder of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any viable alternative tickers for NACP, SHE, or VOTE, so these components of the portfolio will not be tax-loss harvested. As of September 2022, the Social Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.13-0.20%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Social Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%. How do performance expectations compare to the Core portfolio? When some first consider ESG investing, they assume that they must pay a heavy premium in order to have their investments aligned with their values. However, as previously noted above, the data suggests that the performance between sustainable funds versus traditional funds is not significantly different, although there can be differences over shorter periods. Conclusion Despite the various limitations that all SRI implementations face today, Betterment will continue to support its customers in further aligning their values to their investments. Betterment may add additional socially responsible funds to the SRI portfolios and replace other ETFs as more socially responsible products become available. How does the legacy SRI portfolio compare to the current SRI portfolios? There are certain differences between the legacy SRI portfolio and the current SRI portfolios. If you invested in the legacy SRI portfolio prior to October 2020 and chose not to update to one of the SRI portfolios, your legacy SRI portfolio does not include the above described enhancements to the Broad Impact portfolio. The legacy SRI portfolio may have different portfolio weights, meaning as we introduce new asset classes and adjust the percentage any one particular asset class contributes to a current SRI portfolio, the percentage an asset class contributes to the legacy SRI portfolio will deviate from the makeup of the current SRI portfolios and Betterment Core portfolio. The legacy SRI portfolio may also have different funds, ETFs, as compared to both the current versions of the SRI portfolios and the Betterment Core portfolio. Lastly, the legacy SRI portfolio may also have higher exposure to broad market ETFs that do not currently use social responsibility screens or engagement based tools and retain exposure to companies and industries based on previous socially responsible benchmark measures that have since been changed. Future updates to the Broad, Climate, and Social Impact portfolios will not be reflected in the legacy SRI portfolio.

Table of Contents

Introduction
How do we define SRI?
The Challenges of SRI Portfolio Construction
How is Betterment’s Broad Impact portfolio constructed?
How is Betterment’s Climate Impact portfolio constructed?
How is Betterment’s Social Impact portfolio constructed?
Conclusion

Introduction

Betterment first made a values-driven portfolio available to our customers in 2017, under the Socially Responsible Investing (SRI) label, and has maintained SRI as the umbrella term for the category in subsequent expansions and updates to that offering. Betterment’s portfolios represent a diversified, relatively low-cost solution that will be continually improved upon as costs decline, more data emerges, and as a result, the availability of SRI funds broadens (in this paper, “funds” refer to ETFs, and “SRI funds” refer to either ETFs screened for some form of ESG criteria or ETFs with an SRI-focused shareholder engagement strategy).

Within Betterment’s SRI options, we offer a Broad Impact portfolio and two additional, more focused SRI portfolio options, a Social Impact SRI portfolio (focused on social governance criteria) and a Climate Impact SRI portfolio (focused on climate-conscious investments).

How do we define SRI?

Our approach to SRI has three fundamental dimensions:

Reducing exposure to companies involved in unsustainable activities and environmental, social, or governmental controversies.
Increasing investments in companies that work to address solutions for core environmental and social challenges in measurable ways.
Allocating to investments that use shareholder engagement tools, such as shareholder proposals and proxy voting, to incentivize socially responsible corporate behavior.

We first define our SRI approach using a set of industry criteria known as “ESG”, which stands for Environmental, Social and Governance, and then expand upon the ESG-investing framework with complementary shareholder engagement tools.

SRI is the traditional name for the broad concept of values-driven investing (many experts now favor “sustainable investing” as the name for the entire category). ESG refers specifically to the quantifiable dimensions of a company’s standing along each of its three components. In our SRI portfolios, we use ESG factors to define and score the degree to which our portfolios incorporate socially responsible ETFs. We also complement our ESG factor-scored socially responsible ETFs with engagement-based socially responsible ETFs, where a fund manager uses shareholder engagement tools to express a socially responsible preference.

Using ESG Factors In An SRI Approach

A significant and obvious aspect of improving a portfolio’s ESG score is reducing exposure to companies that engage in unsustainable activities in your investment portfolio. Companies can be considered undesirable because their businesses do not align with specific values—e.g. selling tobacco, military weapons, or civilian firearms.

Other companies may be undesirable because they have been involved in recent and ongoing ESG controversies and have yet to make amends in a meaningful way.

SRI is about more than just adjusting your portfolio to minimize companies with a poor social impact. Based on the framework of MSCI, an industry-leading provider of financial data and ESG analytics that has served the financial industry for more than 40 years, a socially responsible investment approach also emphasizes the inclusion of companies that have a high overall ESG score, which represents an aggregation of scores for multiple thematic issues across E, S, and G pillars as shown in Table 1 below.

Table 1. A Broad Set of Criteria Across E, S and G pillars

3 Pillars	10 Themes	35 Key ESG Issues
Environment	Climate Change	Carbon Emissions Product Carbon Footprint Financing Environmental Impact Climate Change Vulnerability
	Natural Resources	Water Stress Biodiversity & Land Use Raw Material Sourcing
	Pollution & Waste	Toxic Emissions & Waste Electronic Waste Packaging Material & Waste
	Environmental Opportunities	Opportunities in Clean Technology Opportunities in Renewable Energy Opportunities in Green Building
Social	Human Capital	Labor Management Human Capital Development Health & Safety Supply Chain Labor Standards
	Product Liability	Product Safety & Quality Privacy & Data Security Chemical Safety Responsible Investment Consumer Financial Protection Health & Demographic Risk
	Stakeholder Opposition	Controversial Sourcing Community Relations
	Social Opportunities	Access to Communications Access to Health Care Access to Finance Opportunities in Nutrition & Health
Governance	Corporate Governance	Board Ownership Pay Accounting
Governance	Corporate Behavior	Business Ethics Tax Transparency

Source: MSCI Ratings Methodology

Shareholder Engagement

The most direct ways a shareholder can influence a company’s decision making is through shareholder proposals and proxy voting. Publicly traded companies have annual meetings where they report on the business’ activities to shareholders. As a part of these meetings, shareholders can vote on a number of topics such as share ownership, the composition of the board of directors, and executive level compensation. Investors receive information on the topics to be voted on prior to the meeting in the form of a proxy statement, and can vote on these topics through a proxy card.

A shareholder proposal is an explicit recommendation from an investor for the company to take a specific course of action. Shareholders can also propose their own nominees to the company’s board of directors. Once a shareholder proposal is submitted, the proposal or nominee is included in the company’s proxy information and is voted on at the next annual shareholders meeting.

ETF shareholders themselves do not vote in the proxy voting process of underlying companies, but rather the ETF fund issuer participates in the proxy voting process on behalf of their shareholders.

As investors signal increasing interest in ESG engagement, more ETF fund issuers have emerged that play a more active role engaging with underlying companies through proxy voting to advocate for more socially responsible corporate practices. These issuers use engagement-based strategies, such as shareholder proposals and director nominees, to engage with companies to bring about ESG change and allow investors in the ETF to express a socially responsible preference.

The Challenges of SRI Portfolio Construction

For Betterment, three limitations had a large influence on our overall approach to building an SRI portfolio:

1. Poor quality data underlying ESG scoring.

Because SRI is still gaining traction, data for constructing ESG scores are at a nascent stage of development. There are no uniform standards for data quality yet.

In order to standardize the process of assessing companies’ social responsibility practices, Betterment uses ESG factor scores from MSCI, who collects data from multiple sources, company disclosures, and over 1,600 media sources monitored daily. They also employ a robust monitoring and data quality review process. See the MSCI ESG Fund Ratings Executive Summary for more detail.

2. Many existing SRI offerings in the market have serious shortcomings.

Many SRI offerings today sacrifice sufficient diversification appropriate for investors who seek market returns, allocate based on competing ESG issues and themes that reduce a portfolio’s effectiveness, and do not provide investors an avenue to use collective action to bring about ESG change.

Betterment’s SRI portfolios do not sacrifice global diversification and all three portfolios include a partial allocation to an engagement-based socially responsible ETF using shareholder advocacy as a means to bring about ESG-change in corporate behavior. These approaches allow Betterment investors to take a diversified approach to sustainable investing and use their investments to bring about ESG-change. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly, even if particular shareholder campaigns are unsuccessful.

The Broad Impact portfolio seeks to balance each of the three dimensions of ESG without diluting different dimensions of social responsibility. With our Social Impact portfolio, we sharpen the focus on social equity with partial allocations to gender and racial diversity focused funds. With our Climate Impact portfolio, we sharpen the focus on controlling carbon emissions and fostering green solutions.

3. Integrating values into an ETF portfolio may not always meet every investor’s expectations, though it offers unique advantage

For investors who prioritize an absolute exclusion of specific types of companies above all else, the ESG Scoring approach will inevitably fall short of expectations. For example, many of the largest ESG funds focused on US Large Cap stocks include some energy companies that engage in oil and natural gas exploration, like Hess. While Hess might rate relatively poorly along the “E” pillar of ESG, it could still rate highly in terms of the “S” and the “G.” Furthermore, maintaining our core principle of global diversification, to ensure both domestic and international bond exposure, we’re still allocating to some funds without an ESG mandate, until satisfactory solutions are available within those asset classes.

We expect that increased asset flows across the industry into such funds would continue to drive down expense ratios and increase liquidity. Since the original offering, which was the predecessor to what is now our Broad Impact portfolio, we’ve been able to expand the ESG exposure to now also cover Developed Market stocks, Emerging Market stocks, and US High Quality Bonds. We also now include ESG exposure to an engagement-based fund. Sufficient options also exist for us to branch out in two different areas of focus—Climate Impact, and Social Impact.

4. Most available SRI-oriented ETFs present liquidity limitations.

In an effort to control the overall cost for SRI investors, a large portion of our research focused on low-cost exchange-traded funds (ETFs) oriented toward SRI. While SRI-oriented ETFs indeed have relatively low expense ratios compared to SRI mutual funds, our analysis revealed insufficient liquidity in many ETFs currently on the market. Without sufficient liquidity, every execution becomes more expensive, creating a drag on returns. Median daily dollar volume is one way of estimating liquidity. Higher volume on a given asset means that you can quickly buy (sell) more of that asset in the market without driving the price up (down).The degree to which you can drive the price up or down with your buying or selling must be treated as a cost that can drag down on your returns.

In balancing cost and value for the Broad Impact portfolio, the options were limited to funds that focus on US stocks , Developed Market stocks, Emerging Market stocks, US Investment Grade Corporate Bonds, and US High Quality bonds.

How is Betterment’s Broad Impact portfolio constructed?

In 2017, we launched our original SRI portfolio offering, which we’ve been steadily improving over the years. In 2020, we released two additional Impact portfolios and improved our original SRI portfolio, the improved iteration now called our “Broad Impact” portfolio to distinguish it from the new specific focus options, Climate Impact and Social Impact, and the legacy SRI portfolio for those investors who elected not to upgrade their historical version of the SRI portfolio (“legacy SRI portfolio”). For more information about the differences between our Broad Impact portfolio and the legacy SRI portfolio, please see our disclosures.

As we’ve done since 2017, we continue to iterate on our SRI offerings, even if not all the fund products for an ideal portfolio are currently available. Figure 2 shows that we have increased the allocation to ESG focused funds each year since we launched our initial offering. Today all primary stock ETFs used in our Broad Impact, Climate Impact, and Social Impact portfolios have an ESG focus.

100% Stock Allocation in the Broad Impact Portfolio Over Time

image4-600x507

Figure 2. Calculations by Betterment. Portfolios from 2017-2019 represent Betterment’s original SRI portfolio. The 2020 portfolio represents a 100% stock allocation of Betterment’s Broad Impact portfolio. As additional SRI portfolios were introduced in 2020, Betterment’s SRI portfolio became known as the Broad Impact portfolio. As your portfolio allocation shifts to higher bond allocations, the percentage of your portfolio attributable to SRI funds decreases. Additionally, a 100% stock allocation of the Broad Impact portfolio in a taxable goal with tax loss harvesting enabled may not be comprised of all SRI funds because of the lack of suitable secondary and tertiary SRI tickers in the developed and emerging market stock asset classes.

Betterment has built a Broad Impact portfolio, which focuses on ETFs that rate highly on a scale that considers all three ESG pillars, and includes an allocation to an engagement-based SRI ETF. Broad ESG investing solutions are currently the most liquid, highlighting their popularity amongst investors. Due to this, we will first examine how we created Betterment’s Broad Impact portfolio. In order to maintain geographic and asset class diversification and to meet our requirements for lower cost and higher liquidity in all SRI portfolios, we continue to allocate to some funds that do not have SRI mandates, particularly in bond asset classes.

How does the Broad Impact portfolio compare to Betterment’s Core portfolio?

Based on the primary ticker holdings, the following are the main differences between Betterment’s Broad Impact portfolio and Core portfolio:

Replacement of market cap-based US stock exposure and value style US stock exposure in the Core portfolio, with SRI-focused US stock market funds, ESGU and VOTE, in the Broad Impact portfolio.
Replacement of market cap-based developed market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGD, in the Broad Impact portfolio.
Replacement of market cap-based emerging market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGE, in the Broad Impact portfolio.
Replacement of market cap-based US high quality bond fund exposure in the Core portfolio, with SRI-focused US high quality bond funds, EAGG and SUSC, in the Broad Impact portfolio.

ESGU, ESGV, SUSA, ESGD, ESGE, SUSC, and EAGG each track a benchmark index that screens out companies involved in specific activities and selectively includes companies that score relatively highly across a broad set of ESG metrics. ESGU, ESGD, ESGE, SUSC, and EAGG exclude tobacco companies, thermal coal companies, oil sands companies, certain weapons companies (such as those producing landmines and bioweapons), and companies undergoing severe business controversies. The benchmark index for ESGV explicitly filters out companies involved in adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power. SUSA benchmark index screens out tobacco companies and companies that have run into recent ESG controversies.

VOTE tracks a benchmark index that invests in 500 of the largest companies in the U.S. weighted according to their size, or market capitalization. This is different from the other indexes tracked by SRI funds in the Broad Impact portfolio, because the index does not take into account a company’s ESG factors when weighting different companies. Rather than invest more in good companies and less in bad companies, VOTE invests in the broader market and focuses on improving these companies’ social and environmental impact through shareholder engagement.

Some of our allocations to bonds continue to be expressed using non-SRI focused ETFs since either the corresponding SRI alternatives do not exist or may lack sufficient liquidity. These non-SRI funds continue to be part of the portfolios for diversification purposes.

As of September 2022, the Broad Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.12-0.18%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Broad Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%.

SRI portfolios are also able to support our core tax products, Tax-loss Harvesting+ (TLH) and Tax-coordinated portfolios (TCP). In the Broad Impact portfolio, because of limited fund availability in the developed and emerging market SRI spaces, we use non-SRI market cap-based funds, like VWO, SPEM, VEA, and IEFA as secondary and tertiary funds for ESGE and ESGD when TLH is enabled.

How socially responsible is the Broad Impact portfolio?

As mentioned earlier, we first use the ESG data and analytics from MSCI to quantify how SRI-oriented our portfolios are. For each company that they cover, MSCI calculates a large number of ESG metrics across multiple environmental (E), social (S), and governance (G) pillars and themes (recall Table 1 above). All these metrics are first aggregated at the company level to calculate individual company scores. At the fund level, an overall MSCI ESG Quality score is calculated based on an aggregation of the relevant company scores. As defined by MSCI, this fund level ESG Quality score reflects “the ability of the underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors”. These fund scores can be better understood given the MSCI ESG Quality Score scale shown below. See MSCI's ESG Fund Ratings for more detail.

Table 2. The MSCI ESG Quality Score Scale

The ESG Quality Score measures the ability of underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors.
Fund ESG Letter Rating	Leader/ Laggard	Fund ESG Quality Score (0-10 score)
AAA	Leader - Funds that invest in companies leading its industry in managing the most significant ESG risks and opportunities	8.6-10.0
AA		7.1-8.6
A	Average- Funds that invest in companies with a mixed or unexceptional track record of managing the most significant ESG risks and opportunities relative to industry peers	5.7-7.1
BBB		4.3-5.7
BB		2.9-4.3
B	Laggard- Funds that invest in companies lagging its industry based on its high exposure and failure to manage significant ESG risks	1.4-2.9
CCC		0.0-1.4

Source: MSCI

*Appearance of overlap in the score ranges is due to rounding imprecisions. The 0-to-10 scale is divided into seven equal parts, each corresponding to a letter rating.

Based on data from MSCI, which the organization has made publicly available for funds to drive greater ESG transparency, and sourced by fund courtesy of etf.com, Betterment’s 100% stock Broad Impact portfolio has a weighted MSCI ESG Quality score that is approximately 19% greater than Betterment’s 100% stock Core portfolio.

MSCI ESG Quality Scores

U.S. Stocks
- Betterment Core Portfolio: 8.2
- Betterment Broad Impact Portfolio: 9.3
Emerging Markets Stocks
- Betterment Core Portfolio: 5.2
- Betterment Broad Impact Portfolio: 8.6
Developed Markets Stocks
- Betterment Core Portfolio: 8.7
- Betterment Broad Impact Portfolio: 9.7
US High Quality Bonds
- Betterment Core Portfolio: 6.6
- Betterment Broad Impact Portfolio: 9.5

Sources: MSCI ESG Quality Scores courtesy of etf.com, values accurate as of September 30, 2022 and are subject to change. In order to present the most broadly applicable comparison, scores are with respect to each portfolio’s primary tickers exposure, and exclude any secondary or tertiary tickers that may be purchased in connection with tax loss harvesting.

Another way we can measure how socially responsible a fund is by monitoring their shareholder engagement with companies on environmental, social and governance issues. Engagement-based socially responsible ETFs use shareholder proposals and proxy voting strategies to advocate for ESG change. We can review the votes of particular shareholder campaigns and evaluate whether those campaigns are successful. That review however does not capture the impact that the presence of engagement-based socially responsible ETFs may have on corporate behavior simply by existing in the market. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly. These aspects of sustainable investing are more challenging to measure in a catch-all metric, however that does not diminish their importance.

A Note On ESG Risks And Opportunities

An ESG risk captures the negative externalities that a company in a given industry generates that may become unanticipated costs for that company in the medium- to long-term. An ESG opportunity for a given industry is considered to be material if companies will capitalize over a medium- to long-term time horizon. See MSCI ESG Ratings Methodology (June 2022 ) for more detail.

For a company to score well on a key ESG issue (see Table 1 above), both the exposure to and management of ESG risks are taken into account. The extent to which an ESG risk exposure is managed needs to be commensurate with the level of the exposure. If a company has high exposure to an ESG risk, it must also have strong ESG risk management in order to score well on the relevant ESG key issue. A company that has limited exposure to the same ESG risk, only needs to have moderate risk management practices in order to score as highly. The converse is true as well. If a company that is highly exposed to an ESG risk also has poor risk management, it will score more poorly in terms of ESG quality than a company with the same risk management practices, but lower risk exposure.

For example, water stress is a key ESG issue. Electric utility companies are highly dependent on water with each company more or less exposed depending on the location of its plants. Plants located in the desert are highly exposed to water stress risk while those located in areas with more plentiful water supplies present lower risk. If a company is operating in a location where water is scarce, it needs to take much more extensive measures to manage this risk than a company that has access to abundant water supply.

Should we expect any difference in an SRI portfolio’s performance?

One might expect that a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio. The notion behind this reasoning is that somehow there is a premium to be paid for investing based on your social ideals and values.

A white paper written in partnership between Rockefeller Asset Management and NYU Stern Center for Sustainable Business, studied 1000+ research papers published from 2015-2020 which analyzed the relationship between ESG investing and performance. The primary takeaway from this research was that they found “positive correlations between ESG performance and operational efficiencies, stock performance, and lower cost of capital.” When ESG factors are considered, there seems to be improved performance potential over longer time periods and potential to also provide downside protection during periods of crisis.

Dividend Yields Could Be Lower

Dividend yields calculated over the past year (ending September 30, 2022) indicate that income returns coming from Broad Impact portfolios have been lower than those of Core portfolios. Oil and gas companies like BP, Chevron, and Exxon, for example, currently have relatively high dividend yields and excluding them from a given portfolio can cause its income return to be lower. Of course, future dividend yields are random variables and past data may not provide accurate forecasts. Nevertheless, lower dividend yields can be a factor in driving total returns for SRI portfolios to be lower than those of Core portfolios.

Comparison of Dividend Yields

core-vs-sri-yields

Source: Bloomberg, Calculations by Betterment for one year period ending September 30, 2022. Dividend yields for each portfolio are calculated using the dividend yields of the primary ETFs used for taxable allocations of Betterment’s portfolios as of September 2022.

How is Betterment’s Climate Impact portfolio constructed?

Betterment offers a Climate Impact portfolio for investors that want to invest in an SRI strategy more focused on being climate-conscious rather than focusing on all ESG dimensions equally. The Climate Impact portfolio was designed to give investors exposure to climate-conscious investments, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio, as we seek to incorporate broad based climate-focused ETFs with sufficient liquidity relative to their size in the portfolio.

How does the Climate Impact portfolio more positively affect climate change?

The Climate Impact portfolio is allocated to iShares MSCI ACWI Low Carbon Target ETF (CRBN), an ETF which seeks to track the global stock market, but with a bias towards companies with a lower carbon footprint. By investing in CRBN, investors are actively supporting companies with a lower carbon footprint, because CRBN overweights these stocks relative to their high-carbon emitting peers. One way we can measure the carbon impact a fund has is by looking at its weighted average carbon intensity, which measures the weighted average of tons of CO2 emissions per million dollars in sales, based on the fund's underlying holdings. Based on weighted average carbon intensity data from MSCI (courtesy of etf.com), Betterment’s 100% stock Climate Impact portfolio has carbon emissions per unit sales more than 50% lower than Betterment’s 100% stock Core portfolio as of September 30, 2022.

International Developed and Emerging Markets stocks in the Climate Impact portfolio are also allocated to fossil fuel reserve free funds, EFAX and EEMX. U.S. stocks in the Climate Impact portfolio are allocated to a fossil fuel reserve free fund, SPYX, and an engagement-based ESG fund, VOTE. Rather than ranking and weighting funds based on a certain climate metric like CRBN, fossil fuel reserve free funds instead exclude companies that own fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in fossil fuel reserve free funds investors are actively divesting from companies with some of the most negative impact on climate change, including oil producers, refineries, and coal miners such as Chevron, ExxonMobile, BP, and Peabody Energy.

Another way that the Climate Impact portfolio promotes a positive environmental impact is by investing in bonds that fund green projects. The Climate Impact portfolio invests in iShares Global Green Bond ETF (BGRN), which tracks the global market of investment-grade bonds linked to environmentally beneficial projects, as determined by MSCI. These bonds are called “green bonds”. The green bonds held by BGRN fund projects in a number of environmental categories defined by MSCI including alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation.

How does the Climate Impact portfolio compare to Betterment’s Core portfolio?

When compared to the Betterment Core portfolio allocation, there are three main changes. First, in both taxable and tax-deferred portfolios,our Core portfolio’s Total Stock exposure is replaced with an allocation to a broad global low-carbon stock ETF (CRBN) in the Climate Impact portfolio. Currently, there are not any viable alternative tickers for the global low-carbon stock asset class so this component of the portfolio cannot be tax-loss harvested.

Second, we allocate Core portfolio’s International Stock exposure, and a portion of our Core portfolio’s US Total Stock Market exposure to three broad region-specific stock ETFs that screen out companies that hold fossil-fuel reserves in the Climate Impact portfolio. US Total Stock Market exposure is replaced with an allocation to SPYX, International Developed Stock Market exposure is replaced by EFAX, and Emerging Markets Stock Market exposure is replaced by EEMX. In the Climate Impact portfolio, SPYX, EFAX, and EEMX will use ESG secondary tickers ESGU, ESGD, and ESGE respectively for tax loss harvesting.

Third, we also allocate a portion of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any comparable alternative tickers for VOTE so this component of the portfolio will not be tax-loss harvested.

Lastly, for both taxable and tax-deferred portfolios we replace both our Core portfolio’s US High Quality Bond and International Developed Market Bond exposure with an allocation to a global green bond ETF (BGRN) in the Climate Impact portfolio.

Some of our allocations to bonds continue to be expressed using non-climate focused ETFs since either the corresponding alternatives do not exist or may lack sufficient liquidity. These non-climate-conscious funds continue to be part of the portfolios for diversification purposes.

As of September 2022, the Climate Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.13-0.20%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Climate Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%.

How do performance expectations compare to the Core portfolio?

When some first consider ESG investing, they assume that they must pay a heavy premium in order to have their investments aligned with their values. However, as previously noted above, the data suggests that the performance between sustainable funds versus traditional funds is not significantly different, although there can be differences over shorter periods.

How is Betterment’s Social Impact portfolio constructed?

Betterment offers a Social Impact portfolio for investors that want to invest in a strategy more focused on the social pillar of ESG investing (the S in ESG). The Social Impact portfolio was designed to give investors exposure to investments which promote social equity, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio discussed above, as we seek to incorporate broad based ETFs that focus on social equity with sufficient liquidity relative to their size in the portfolio.

How does the Social Impact portfolio promote social equity?

The Social Impact portfolio shares many of the same holdings as Betterment’s Broad Impact portfolio, which means the portfolio holds funds which rank strongly with respect to broad ESG factors. The Social Impact portfolio looks to further promote the social pillar of ESG investing, by also allocating to two ETFs that specifically focus on diversity and inclusion -- Impact Shares NAACP Minority Empowerment ETF (NACP) and SPDR SSGA Gender Diversity Index ETF (SHE).

NACP is a US stock ETF offered by Impact Shares that tracks the Morningstar Minority Empowerment Index. The National Association for the Advancement of Colored People (NAACP) has developed a methodology for scoring companies based on a number of minority empowerment criteria. These scores are used to create the Morningstar Minority Empowerment Index, an index which seeks to maximize the minority empowerment score while maintaining market-like risk and strong diversification. The end result is an index which provides greater exposure to US companies with strong diversity policies that empower employees irrespective of race or nationality. By investing in NACP, investors are allocating more of their money to companies with a track record of social equity as defined by the NAACP.

SHE is a US Stock ETF that allows investors to invest in more female-led companies compared to the broader market. In order to achieve this objective, companies are ranked within each sector according to their ratio of women in senior leadership positions. Only companies that rank highly within each sector are eligible for inclusion in the fund. By investing in SHE, investors are allocating more of their money to companies that have demonstrated greater gender diversity within senior leadership than other firms in their sector.

For more information about these social impact ETFs, including any associated risks, please see our disclosures.

How does the Social Impact portfolio compare to Betterment’s Core portfolio?

The Social Impact portfolio builds off of the ESG exposure from funds used in the Broad Impact portfolio and makes the following additional changes.

First, we replace a portion of our US Total Stock Market exposure with an allocation to a US Stock ETF, NACP, which provides exposure to US companies with strong racial and ethnic diversity policies in place.

Second, another portion of our US Total Stock Market exposure is allocated to a US Stock ETF, SHE, which provides exposure to companies with a relatively high proportion of women in high-level positions.

As with the Broad Impact and Climate Impact portfolios, we allocate the remainder of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any viable alternative tickers for NACP, SHE, or VOTE, so these components of the portfolio will not be tax-loss harvested.

As of September 2022, the Social Impact portfolio’s asset weighted expense ratio, while relatively low-cost, has a range of 0.13-0.20%. This is dependent on the risk level (% allocation to stocks vs bonds) that you are invested in. The Social Impact portfolio’s asset weighted expense ratio is higher than the Betterment Core portfolio strategy which has a range of 0.05-0.13%.

How do performance expectations compare to the Core portfolio?

Conclusion

Despite the various limitations that all SRI implementations face today, Betterment will continue to support its customers in further aligning their values to their investments. Betterment may add additional socially responsible funds to the SRI portfolios and replace other ETFs as more socially responsible products become available.

How does the legacy SRI portfolio compare to the current SRI portfolios?

There are certain differences between the legacy SRI portfolio and the current SRI portfolios. If you invested in the legacy SRI portfolio prior to October 2020 and chose not to update to one of the SRI portfolios, your legacy SRI portfolio does not include the above described enhancements to the Broad Impact portfolio. The legacy SRI portfolio may have different portfolio weights, meaning as we introduce new asset classes and adjust the percentage any one particular asset class contributes to a current SRI portfolio, the percentage an asset class contributes to the legacy SRI portfolio will deviate from the makeup of the current SRI portfolios and Betterment Core portfolio. The legacy SRI portfolio may also have different funds, ETFs, as compared to both the current versions of the SRI portfolios and the Betterment Core portfolio. Lastly, the legacy SRI portfolio may also have higher exposure to broad market ETFs that do not currently use social responsibility screens or engagement based tools and retain exposure to companies and industries based on previous socially responsible benchmark measures that have since been changed. Future updates to the Broad, Climate, and Social Impact portfolios will not be reflected in the legacy SRI portfolio.