White Brook Capital Ethical S&P 500 Index
Over the past month, White Brook has put the finishing touches on White Brook’s first ethical index strategy based on the S&P 500.
Many investors seek diversified index funds that tax efficiently track the largest corporations in the country. For moral investors, this diversification can be problematic as most diversified funds include companies they would otherwise find objectionable. Historically, investors have either accepted the drawback or offset their investment in these companies by donating to charities.
For many investors, investing in an ETF or fund that invests in companies committing actions they view as immoral is immoral itself. The ETF or Fund is a thin structural veil, and by buying those funds the investor is actively partnering with companies through their share ownership. Today, technology has advanced and proliferated such that it's possible to own a large number of stocks and personalize a diversified index. The difficulty now is not a problem of technology or execution, but in aggregating the right companies.
Fundamentally, I did not want to start our own strategy. I wanted to find a fund or ETF for interested clients and be able to place capital there. In my role as fiduciary, however, after analyzing the underlying holdings, I determined that in many cases the purported purposes of the funds/ETFs did not reflect what it was composed of. Greater zealousness was required.
White Brook’s principles are clear as is our identification of a grey area. Given the ability for customization, we believe clients may have an opinion about every stock, but probably should have an opinion about the identified gray area - should they have interest in an ethical strategy.
Broadly the fund excludes companies that provide significant and substantive support to killing, vice, and exploiting people (defense, tobacco, alcohol, subprime lending, gambling). We evaluate for these activities based on it being a substantial portion of both the current business and future growth.
Management matters. Leadership can change a company relatively quickly and in the case of public markets, with a good amount of opacity. An evaluation of the CEO’s tendencies is part of the evaluation process.
Experts matter. When it comes to the morality of a company’s operations, the question isn’t what a layman can prove, but what a professional making reasonable assumptions with available evidence and likely supposition believes to be true.
De minimis activity exempts. If abuse of the product or service is rare when the product is used in an excluded activity, the product or service is ok. If it is uncommon, but not rare, then it is not.
Multipurpose exempts. If the company sells a product that finds its way into an offending product or service, it’s ok. If it customizes the product for an excluded activity, it is not.
Clients decide on their comfort with regional and money center banks.
It’s important to be principles based as some of the religiously minded ethical funds have unresolved tensions. A notable religious committee ruled that “substantive” is 5% of income, but the SEC doesn’t require disclosure unless a business activity is over 10% of revenue. A large ETF provider states that it uses a 5% revenue hurdle, but excluded activities notoriously have higher than average margins, and would likely trip the 5% of income threshold at even lower levels of revenue.
For instance, multiple ethical funds reviewed own Cadence Design Systems. The Company seems innocuous - it helps companies design semiconductor chips. But Cadence acquired a company in 2023 with the stated goal of accelerating sales to the Aerospace and Defense industry. They helped Northrup Grumman accelerate ASIC development schedules by over two years. The work they did here, and sought to do more of as reflected in their acquisition is customized and illicit and White Brook excludes them. Other funds include Cognizant Technology Solutions, an IT consultant and outsourcer - with a robust Aerospace and Defense practice. White Brook excludes the company, others don’t.
The financial company exclusion framework requires client input. We exclude companies like Carmax, given the subprime loan concentration and relatively high delinquency rate, but prefer clients to have an opinion about the money center banks where opacity makes it difficult for an expert to understand underlying exposure. We also know some would prefer to not have any exposure to interest income and would exclude financial firms altogether. Once understood those preferences can be zealously executed.
The index is market weighted at the time of its rebalancing, and rebalances annually or when companies enter or exit the index (at most quarterly). The charge for a diversified, passively managed ethical strategy in the marketplace is between .30-.60%, White Brook will charge .45%. It will launch on April 1st and is expected to more or less track the performance of the S&P 500.
Sincerely,
Basil F. Alsikafi
Portfolio Manager
White Brook Capital, LLC
All investments involve risk, including loss of principal. This document provides information not intended to meet objectives or suitability requirements of any specific individual. This information is provided for educational or discussion purposes only and should not be considered investment advice or a solicitation to buy or sell securities. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. This report is not to be construed as an offer, solicitation or recommendation to buy or sell any of the securities herein named. We may or may not continue to hold any of the securities mentioned. White Brook Capital LLC and/or their respective officers, directors, partners or employees may from time to time acquire, hold or sell securities named in this report. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein