ETF Expert Corner

Transcript

You can listen to our interview with Ethan Powell by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: We're now very pleased to be joined by Ethan Powell, Founder and President of Impact Shares. Impact Shares has a really unique concept in the ETF space. They are going to build ETFs for nonprofit organizations and direct the profits from those ETFs back to support the nonprofit causes. There's no other ETF provider doing this right now. This is a really innovative approach to socially responsible investing which, of course, is an area that continues to garner a lot more attention, especially among younger investors. Ethan is joining us via phone today from Atlanta. Ethan, our pleasure to have you on the program.

Ethan Powell: Well guys, it's my pleasure to be with you.

Nate Geraci: Ethan, before we talk about the Impact Shares platform itself, since we haven't had you on the program previously, tell us a little bit about your background and how you ultimately became involved with ETFs.

Ethan Powell: I've been in the asset management business for over 20 years, the last 10 of which was with Highland Capital Management out of Dallas. They were running up to $45 billion in hedge fund assets and, among other things, I helped them build their ETF platform, which today has about $650 million in it. I still sit on their retail fund board. They've got around $4.5 billion in retail fund assets. We started that in about 2007, so it's been a while.

Nate Geraci: What led to the founding of Impact shares? Where did that idea come from?

Ethan Powell: If you look at sort of post-crisis, a lot of investors really getting, well they were disappointed with their investment results that sort of a traditional stock-picking equity portfolio brought. In fact, 85% of actively managed funds failed to beat their index over the last 15 years. If you look at sort of that backdrop with $1.5 trillion going from active to passive, and if you think about asset management as the effective and efficient allocation of capital to sort of society’s priorities, and if you give up on achieving alpha through stock selection, what else can you do with your capital that's meaningful to an investor? A lot of people are moving towards ESG investing – environmental, social, governance - because of that. There's currently $8 trillion in the United States that track ESG mandates, and that represents a 70% growth rate for the two years ending 2015. A lot of interest, as you pointed out, 85% of millennials want social considerations in their portfolio, and there's $30 trillion of wealth transferring from baby boomers to millennials over the next two decades. There's a lot of tailwind for ESG. The challenge is the E and the G are pretty well spoken for in that everyone knows generally what a low carbon portfolio looks like, and everyone generally agrees on what good corporate governance is, but that S, that social responsibility aspect is sometimes called the messy middle. That's because everyone has different social priorities, and understanding your own priorities, let alone effectively communicating that to your financial advisor and then constructing a portfolio around those social priorities, is very challenging. Generally, in the market today you've got either exclusionary portfolios, which screen out alcohol, tobacco, firearms, porn, or the asset manager becomes the arbiter of what a good corporate citizen is and they're not necessarily in the best position to do that. What we're doing is we're partnering with leading non-profits, so we've got in registration a strategy with the NAACP for minority empowerment and then another one with the YWCA for women's empowerment. We say effectively, "Okay NAACP, what does a good corporate citizen look like through the lens of the NAACP, specifically as it relates to minority rights in the United States? How do we measure that? What are our desired corporate outcomes relative to minority rights?" Then we identify the top 200 to 300 performing companies based on that social metric, and we put them in what's called an equity market proxy portfolio. The idea is that you're still getting your financial beta, but you're getting what we call social alpha or superior social outcomes relative to your specific cause that you're interested in. Then Nate, as you pointed out, we are ourselves a 501(c)(3) - so we're a nonprofit and all of the net advisory proceeds, which would have otherwise gone to an asset manager, goes back to the collaborating nonprofit.

Nate Geraci: Ethan, to be clear for our listeners, you haven't yet launched an ETF yet correct? I know you're getting pretty close.

Ethan Powell: Yes that's right, that's right. I was hoping we would have our initial registration statement for those two strategies in with the SEC before this interview, but we should have it in the next day or two.

Nate Geraci: Now, as I understand it, all of the ETFs that will be launching under Impact Shares will be passively managed – right? They'll be index based. Can you talk a little bit about the backend process for constructing a new index? How does that work?

Ethan Powell: Yes, and it's interesting because it's really a case-by-case basis. You think of somebody like an NAACP. They've already got a corporate scorecard. They have this economic reciprocity initiative that they've been running since the late 80s, so they already have a good idea of who's the sort of good actors and bad actors on a sector-by-sector basis. It's really just a matter of leveraging that information and putting that in an index methodology. We're working closely with Wilshire and S&P right now. That's pretty straightforward, but some of the others we're working on - access to affordable housing with Habitat for Humanity in Atlanta, and then we're working with the National Association of Community Hospitals for access to affordable healthcare. Those are a little bit different in that, really, you're identifying preferred vendors that are used by those nonprofits to deliver reasonably priced housing, reasonably priced healthcare. It's really more of just a way to encourage vendors, specifically within the healthcare and housing sectors to more actively participate with these nonprofits initiatives. It's a case-by-case basis.

Nate Geraci: That actually brings up an interesting question. I'm curious what will be the driver of the types of nonprofits you work with? Will these be causes that are near and dear to your heart or do you view Impact Shares as a platform for any nonprofit? Or is it sort of a combination of the two?

Ethan Powell: That's a great question. Impact Shares, think of it as a utility where we're bridging capital to cause and we're agnostic on who we're doing that with effectively. We kind of have to have a good business case. Then our sort of guide post as it relates to the issues is we've got to be able to tie them back to one of the United Nations sustainable development goals. So last year, the United Nations published 17 sustainable development goals called the SDGs, and that's kind of our guide post. If we can't tie it back into one of those - so like arms proliferation is probably not going to be an ETF strategy, or some sort of discriminatory organization is not going to be an ETF strategy because we can't tie it back to one of the 17 SDGs.

Nate Geraci: Our guest today is Ethan Powell, Founder and President of Impact Shares. Ethan, I know back in August, Impact Shares was awarded a $300,000 grant from the renowned Rockefeller Foundation. I'd love to hear the backstory on this. How did you get involved with Rockefeller?

Ethan Powell: A lot of these endowments have groups called innovative finance groups and their entire purpose is to bridge private capital into social issues. As you can imagine getting sort of VC financing for a 501(c)(3) is challenging or traditional private equity financing is challenging. Those innovative finance groups are doing a lot of great work and Ford Foundation has one, the MacArthur Foundation, Gates, Bloomberg obviously. That's really the best way to get financing for a nonprofit is through their grant system. We're going back out to market for sort of post-launch grant funding as well, and it was really just a matter of cold calling. As any sort of entrepreneur would try and raise capital from the PE or VC shop, you do the same thing just with these large endowments.

Nate Geraci: Ethan, just as we're talking today, as I look at the Impact Shares platform, what stands out to me is that theoretically everyone wins. Companies included in the ETF are recognized for their support of a particular social cause. Of course, the nonprofits themselves benefit from awareness and funding, and investors who want to support a specific cause win as well - they feel good about their investment and they know they're directly, financially supporting a cause. What about performance though because ultimately investors do expect performance from their investments? So how should investors think about performance from Impact Shares ETFs?

Ethan Powell: Well through portfolio construction, you're really trying to minimize tracking error to the broader market. But I'm sure you've spoken on your show previously about factor based ETFs and factor investing. You can almost look at the social aspect as the one potential pivot point from a performance standpoint in that, for example, the NAACP, all things being equal, you would expect them to outperform if you believe an appropriately sort of ethnically diverse company outperforms a less fair labor practice company. While our sort of stated investment objective is to minimize tracking error to the broader market, you can easily see a situation where an investor – they want this kind of financial exposure because they believe the underlying companies will outperform simply through superior corporate business practices.

Nate Geraci: I'm sure as you were looking to launch Impact Shares you obviously did your homework and looked at the existing ESG or socially responsible ETFs that are out there. I'm curious, what did you see or what do you think about some of the other ESG ETF options that currently exist? You mentioned earlier that perhaps the social is lacking a little bit, but how do you view the overall ESG ETF landscape?

Ethan Powell: I think it's really bifurcated. If you look at that $8 trillion in ESG mandates in the United States, the majority of it is with institutions. Part of that is, particularly on the S side, part of that is because they can create sort of bespoke portfolios with their consultants that are reflective of their organizational values. The retail investor doesn't necessarily have that. That's really where a lot of the communication gap happens when you see these socially responsible investment strategies and you look at any given company and their reflection of their people - people are good at some things and they're bad at others. Take Walmart, for example. If you're interested in green energy, you may like Walmart because they've got solar panels on every distribution center. But if you are all about fair labor practices or wage growth, then they probably wouldn't be in the AFL-CIO ETF. I think the challenge with those investment options out there is that the asset managers are really creating an unattainable situation in that you can't paint companies with a broad brush - that they are an A-plus corporate citizen, or a D minus because they are good at some things and bad at others. Depending on your perspective, you may want them in and out and that's where a lot of the existing strategies get into trouble because investors will look at their portfolio and they say this is socially responsible - I can't believe you have XYZ company in there because they run counter to something that I believe in. That's the real challenge. I do know ETFs are low cost trading options that are almost infinitely divisible. So with a $10,000 portfolio, with an Impact Shares solution, you can have 10 different causes represented that you actually feel passionately about and you feel confident that those companies are in there for the reasons you've identified because the steward of that capital ultimately is that nonprofit that has 150 plus years of experience in fighting for minority rights in the United States for the NAACP. I think that's where the challenge is, trying to be all things to all people when it comes to social responsibility. Really focusing I think will help draw more capital into that market.

Nate Geraci: Ethan, we have about a minute left here and you mentioned the low cost of ETFs. Obviously, you could have launched your platform using the mutual fund structure if you so wished. Instead, you did choose ETFs. Why was that? Was cost one of the bigger drivers?

Ethan Powell: Oh yes, so you save 20 basis points or something like that on transfer agency fees. ETFs are the great democratization vehicle for financial markets these days. If you look at what we're trying to accomplish with Impact Shares, with that bridging capital to cause, it really is the most efficient and effective way to access investment solutions. That's really in keeping with our broader mission at Impact Shares: democratizing impact investing and making it accessible to the masses, not just the institutions. ETFs are perfect for that.

Nate Geraci: Well, Ethan, with that we'll have to leave it there. Really appreciate your time today. Fascinating concept with Impact Shares and we certainly wish you all the best. We'll be looking forward to those future ETF launches. Thank you.

Ethan Powell: My pleasure guys. Thank you for having me.

Nate Geraci: That was Ethan Powell, Founder and President of Impact Shares and you can learn more about the Impact Shares ETF platform by visiting ImpactShares.org, that's ImpactShares.org.