Independent Thinking^®

Q&A with Dimensional Fund Advisors

Editor’s note: Evercore Wealth Management supplements its core investment capabilities with carefully selected outside funds across the range of the firm’s asset classes. The firm has invested in Dimensional Fund Advisors’ DFA International Core Equity Portfolio since September 2014, during which time the fund has outperformed its benchmark. ¹ Here, we interview Joseph Chi, Co-Head of Portfolio Management at Dimensional Fund Advisors and the chairman of the firm’s investment committee, about two of the firm’s newer funds, the U.S. Sustainability Core 1 Portfolio and the International Sustainability Core 1 Portfolio.
 
Q: Dimensional is a pioneer in what is now widely known as factor investing, in which securities are chosen based on attributes that are associated with higher returns. Please tell us about your approach to your sustainability-based investment strategies.
A: We use a systematic process to efficiently provide low-cost, broadly diversified portfolios that focus on securities with higher expected returns, as identified by rigorous academic research. Differences in expected returns among securities are observed along the dimensions of expected returns. In equity markets, these dimensions define: (i) the small cap premium, with smaller capitalization companies having higher expected returns than larger capitalization companies, (ii) the value premium, with companies trading at a low price relative to their book equity having higher expected returns than companies with high prices relative to their equity, and (iii) the profitability premium, with companies with higher profitability having higher expected returns than companies with lower profitability trading at a similar relative price.
 
The Dimensional sustainability funds provide well-diversified investment solutions focused on higher expected return securities in U.S. and international developed markets, respectively, while taking into account sustainability considerations.
 
Q: How have investors’ views of sustainable investing evolved? How about the investors themselves?
A: In recent years, we have found that investors are increasingly concerned about the potential environmental effects of certain business practices, and many individuals and institutions are asking how they can align their environmental views and personal values with their investment decisions. Scientists, industries, governments, and society in general are now looking for ways to manage the tradeoffs between improving people’s standard of living in the short and medium term and, in the long term, avoiding environmental damage that may inhibit humanity’s standard of living.
 
With investors increasingly concerned about the potential environmental effects of certain business practices, institutions and individuals can embrace these concerns through their behavior and consumption decisions and can become effective agents of change. Investors are also choosing to express their preferences through their participation in global capital markets.
 
Q: How are pensions and endowments engaging in sustainable investing?
A: Industry stakeholders appear to be increasingly interested in ESG, or environmental, social, governance investing. In particular, a number of institutional investors, including pensions, endowments, and foundations, have recently considered the outright divestment of companies involved or associated with fossil fuels. Concerns over land use/biodiversity, toxic spills/releases, operational waste, water management, cluster munitions, factory farming, child labor, tobacco, and other topics have also been included in conversations around ESG investing.
 
Q: How have DFA’s strategies changed?
A: The investment strategy of the U.S. Sustainability Core 1 Portfolio and the International Sustainability Core 1 Portfolio is to add value over conventional benchmarks by providing low-cost, well-diversified portfolios that focus on securities with higher expected returns. This investment strategy has not changed; however, the sustainability considerations that we use have evolved with the increasing availability of reliable data about the impact of companies on our planet and our society, and with evolutions in science and technology.
 
We recently implemented enhancements in the portfolios to more directly reduce exposure to companies that have substantial greenhouse gas emissions or potential emissions from reserves.
 
Q: How does your sustainability-scoring framework operate?
A: Dimensional’s approach emphasizes environmental sustainability at both the portfolio and industry level. We believe this dual approach to be more comprehensive, as some industries do not produce emissions but are consumers to industries that produce emissions and have the option to select what to consume. The best example is the financial industry, which consumes, say, electricity, and has a choice to purchase from green sources. Our approach attempts to focus on both demand and supply, not just on utilities. At the industry level, we have a patented process that emphasizes companies operating with more environmental responsibility relative to their peers while preserving diversification among industries.²
 
All companies in our investment universe receive a sustainability score based on five industry-level variables: greenhouse gas emissions intensity, land use/biodiversity, toxic spills/releases, operational waste, and water management. Within each industry, weightings are adjusted to emphasize investment in companies with higher scores and minimize or exclude investment in companies with lower scores relative to their peers.
 
In addition to addressing greenhouse gas emissions as a primary component of the industry-based scoring system, we focus on greenhouse gas emissions at the strategy portfolio level by excluding or underweighting the top contributors to greenhouse gas emissions as well as potential emissions from reserves.
 
The approach also limits investment in companies that use particularly intensive factory farming methods, companies identified as manufacturers of cluster munitions and mines that indiscriminately affect humans and the productive use of land, companies cited for child labor practices, and those linked to the production of tobacco.
 
The sustainability portfolios also vote proxies in a manner that we believe to be consistent with the underlying sustainability goals of investors in the portfolios.

 
For further information on Dimensional Fund Advisors’ sustainability funds and on the Evercore Wealth Management approach to sustainable investing, please contact Iain Silverthorne at [email protected].

¹ The DFA International Core Equity Portfolio returned -3.91 from 9/30/2014 to 6/30/2016. The MSCI World ex-US returned -5.54 over the same period.
² Dimensional’s approach to sustainability investing is protected by U.S. Patent Nos. 7,596,525 B1, 7,599,874 B1 and 8,438,092 B2.