Last week HIP Investor celebrated the 3rd anniversary of its HIP (Human Impact + Profit) 100 Index. Part of the growing Social Responsible Investing (SRI) market, this index implements HIP’s approach of quantifying the human, social, and environmental impact of each investment. In the three years from July 30, 2009 to July 30, 2012, it generated a cumulative return of 46.80 percent (before fees), very similar to the return on the S&P100 during that period (47.56%). To learn more about the index, its performance and the approach behind it, I talked with R. Paul Herman, founder and CEO of HIP Investor.
Triple Pundit: Three years ago you launched the HIP 100 Index – what were your expectations back then?
Paul Herman: In 2009, we launched the HIP100 index to show that current models of valuation done by Wall Street and most investors were incomplete. Traditional investors were not proactively valuing the human, social and environmental factors deeply embedded in their portfolio of investments, so they were exposed to the downside of undiscovered and undervalued risks, and not necessarily positioned for the potential upside of untapped opportunities, and the cash flows associated with both of these factors.
The HIP 100 takes the same S&P100 firms, and instead of weighting by market value, allocates percentage weights based on sustainability scores, specifically the HIP Score. We see this as a more comprehensive analysis of a company’s financial valuation, and thus potentially less risky and higher return than the old method of valuation.
3P: What’s unique about the HIP 100 Index comparing to other SRI indices?
PH: HIP is unique and innovative in several ways. First, we are inclusive by rating all companies on their actual results, and do not purposely exclude rating companies as many SRI funds do for “negative” companies in tobacco, alcohol, gaming and nuclear. We actually score EVERY company, even ExxonMobil and Halliburton. This then creates the opportunity for a “race to the top” and an “aversion to the bottom.” Also, like other positive criteria investment funds, like Portfolio 21’s mutual fund, HIP more comprehensively assesses risk in a systematic and thorough way based on results data.
HIP also analyzes and values all forms for capital. Human capital value is a driver of innovation and service. But since people are not valued as an asset on the financials, but rather as an expense or liability, most companies are managing their firms without complete data. In fact, since 80 percent of the S&P500′s stock market value is not on the balance sheet, and there are very few non-financial metrics used by CEOs, CFOs, Boards and managers – that’s like driving your car with 80 percent of the windshield blocked, cracked or fogged up – it’s a bad idea.
3P: Are you satisfied with your 3-year results?
PH: At HIP overall, we are satisfied with our 3-year performance. In year 1, we were delighted to significantly outperform the S&P benchmark before and after fees. During this period, high HIP-scoring companies avoided risks and captured new opportunities. We valued this ahead of the market – and our index delivered benchmark-beating returns for that time period. In year two, some higher HIP-scored companies did some un-HIP things, like Hewlett Packard’s CEO continuing to cut R&D from 7 percent to 1 percent of revenues, as well as his personal shenanigans. Johnson and Johnson suffered multiple product recalls. Overall, HIP performed similarly to the S&P benchmark.
Year three was more challenging, as the HIP100 index calculations overestimated the banks’ resilience in the 2011 Fall tumult. But one key valuation approach has hampered us significantly this year: Apple Computer, which is nearly 20 percent of the Nasdaq market value, and one of the highest stock market values overall, HIP has weighted much lower than its market value weight. While HIP sees risks in Apple’s supply chain and overseas manufacturing, customers continue to buy the products at high prices and margins, and not equally see the impacts of the low sustainability of Apple’s supply chain. Thus, as Apple’s growth at large scale is so massive, that has hindered HIP’s year three performance. Over 3 years, we are running close to even with the S&P benchmark before fees; after fees, depends on the amount invested and timing of entry by investors.
3P: Are you going to make any changes in your approach regarding companies like Apple, where the market seems to evaluate differently the company’s risks?
PH: At HIP, we continually look for ways to evolve our methodology. The first version of HIP only had four categories of impact – Health, Wealth, Earth and Equality. As we did more analysis, we added Trust as a fifth category of impact. In addition, HIP examines each of 30 operating metrics driven by sustainability factors for how they link to financial value. Those weights have been pretty consistent over time, from our initial fundamental connection between impact and potential profit.
While the HIP scoring has worked consistently in most sectors, the tech sector’s valuations seem to be driven more by intellectual property and product innovations. Some of these are tied to sustainability, but as we see in Apple, sustainability risks are not always valued by the customer accurately, and businesses continue to thrive by selling those products. Thus, we will likely test some new innovation metrics, which may strengthen all industries. The tech industry tends to have the highest HIP scores relative to other industries.
3P: What’s the most important lesson you have learned in these three years?
PH: Be patient and flexible. Day-to-day stock price movements can be noisy, especially when emotion drives the equity markets many times. Bond markets are more fundamentally based since they tend to be focused on generating sufficient income to pay dividends and interest, and the principal needs to be repaid. You will see HIP ratings on fixed income soon.
3P: Finally, do you think your results strengthen or weaken the business case for sustainability? In what way?
PH: Overall, we see the HIP approach reinforcing the business case for sustainability, including for investors. A more sustainable portfolio can experience lower risks, or higher returns, or potentially both. This “risk-adjusted return,” also called “alpha,” is the goal of many investors. When we do our job right as investment managers, we can create positive alpha, positive returns, lowered risk, and meet the investor expectations for net positive impact.
[Image credit: Laura Read]
Raz Godelnik is the co-founder of Eco-Libris, a green company working to green up the book industry in the digital age. He is an adjunct faculty at the University of Delaware’s Business School, CUNY SPS and the New School, teaching courses in green business and new product development.