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Beyond Reproach
Ethics, Integrity and Trust
by David B. Loeper, CIMA®. CIMC®

ACTUALIZING A CLIENT'S DEEPEST SOCIAL VALUES

Take for example a client with $10 million in assets. He has extreme disdain for oil companies. More than 20 years ago he flew to Prince William Sound to help save the wildlife threatened by the Exxon Valdez spill. Now, his younger brother who is a shrimp fisherman in the gulf has been effectively put out of business by the massive BP oil spill. The typical way the financial industry deals with such personal goals is to simply exclude stocks of oil companies from the portfolio. But, is this really the BEST way to make a material and meaningful difference, or is it merely a means of psychologically appeasing our client? If there was a more effective way for our client to make a difference against oil companies, considering his deep seated passion, shouldn’t we truly help him actualize his goals? Does Eliminating Offensive Companies from the Portfolio Achieve the Client’s Goal? The allocation model for this client’s Wealthcare plan targets 53% domestic stocks, 7% foreign stocks, 37% government bonds and 3% cash (our balanced allocation). The largest market capitalization domestic stock is Exxon Mobil, representing 2.45% of the total domestic equity market. With his $10 million balanced portfolio fully indexed, this means he would own about 2,000 shares of Exxon Mobil that cost around $130,000. This represents 0.007% of the average daily trading volume of Exxon. The typical bid/ask spread for Exxon is about a penny. Though unlikely, let’s say his one 2,000 share trade (or lack thereof) impacts the stock price by a full penny a share at the moment of the trade. The net impact of a penny a share on 2,000 shares is about $20, or less than the cost of filling his Prius with one tank of gas. Is this the meaningful
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n our role as financial advisors (financial actualizers?) some of the greatest value we can deliver is helping clients to truly make a material and meaningful difference in the social issues they personally value. Such social issues are often deeply personal and emotional, with clients having either extreme passion or outright disdain, depending on the issue. Our role is not to judge what a client is passionate about, instead it is to help them truly understand how to accomplish and actualize that goal to make a meaningful difference.

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and material impact he is passionately trying to achieve? Would there be a more effective way of actualizing his goal? If he is truly passionate and deeply emotional on this issue, wouldn’t he want to have the biggest impact he could? What does it cost to avoid owning Exxon? Generally, socially responsible funds are going to cost a lot more than the 7 basis point expense ratio of Vanguard’s Total Domestic Equity ETF or Fidelity’s 10 basis point cost for their retail Total Domestic Equity Fund. Say it costs 50 basis points more on this client’s $10 million, which means the client is paying an additional $50,000 a year. Is the client really paying $50,000 annually to have a onetime $20 impact on Exxon? No, Exxon is just the largest company. Many other offensive companies will be in the index fund albeit in far smaller proportions but with potentially larger per share impacts on the stock price. Chevron, for example, is the next largest oil company in the index with a weighting of 1.17%. The $62,000 of Chevron he’d beneficially own through the fund would be about 800 shares, and with only 12 million shares traded daily, in theory that trade could impact the price by two cents … at least in theory. That’s a $16 impact. By the time you get past the largest 25 positions (Exxon and Chevron are the only oil companies in the top 25) all positions are less than 0.66% of the portfolio. The bottom line is that to have a market value impact in one year to make up for the additional $50,000 every year in expense going to a socially responsible money manager (who may be driving around in a Hummer) you would have to avoid buying AT LEAST 2,500 companies. There aren’t that many publicly traded oil companies. So instead of psychologically appeasing a client by increasing his expenses, which accomplishes very little of what he is deeply passionate about, why not add a goal to his Wealthcare plan to make charitable donations that are specifically targeted to our client’s passionate goal? All other things being equal, instead of paying $50,000
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to fund manager he could make donations of $50,000 a year to a direct charitable/educational effort on the issues he is so passionate about. Wouldn’t $50,000 a year in donations to Greenpeace or the Sierra Club have a greater impact than the $20 or $16 of stock price impact he’d have by not owning Exxon or Chevron? Bringing Emotions to Life to Make a Difference There are a lot of personal and emotional issues involved in this reality. It is our job as advisors (or actualizers) to educate clients about the reality behind the misconceptions. Those misconceptions get in the way of achieving the very goals they are passionate about, but this provides an opportunity for you to add significant value. For example, there are a lot of clients who mistakenly believe that when they purchase stock, the company gets the money. Of course, in the case of an IPO that is true, but IPOs generally aren’t in index funds. In reality, the proceeds from a stock purchase go to the previous holder of the stock. Thus, the proceeds from the purchase of BP made in an index fund might very well be going to the Greenpeace Foundation that may have held it based on BPs “Beyond Petroleum” alternative fuel ad campaign… until the recent spill. Conversely, the proceeds from the extra purchase of Whole Foods (the organic/ health food grocery chain) that is over-weighted in the socially responsible portfolio to make up for the missing oil companies might go directly to BP’s pension. The reality is that where your purchase proceeds ultimately go is completely unknowable, so this is not a means of accomplishing your deepest most valued social goals. Some clients feel as though owning a stock, or deciding not to own it, is a “vote” for or against a company. The stock market though is not an election, it is an auction. While millions of people all “voting with their dollars” by not buying a stock might add up with each $20 impact they’d have, it still doesn’t add up to something very significant and, more importantly, would have much less impact than they could otherwise have in actualizing a targeted charitable goal.
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Ethics, Integrity and Trust
Some clients can’t stand the notion of “profiting” from what some of these evil companies do in the form of the dividends they receive or in price appreciation. Here again though, with the addition of a meaningful charitable goal to the Wealthcare plan targeted to the client’s passion, one could view it as the client is taking the profits from those companies and redirecting those company profits to a charity that is on a mission to clean the company up. Isn’t this better than paying a money manager a bunch of fees to avoid buying certain stocks? Why not use those ill- gotten profits of such offensive companies to get those companies to clean up their act? Would you rather those “ill-gotten” profits on those shares go to an uncaring indifferent money monger? Think about it. There are a number of other issues where emotions get in the way of reason, and get in the way of achieving the goals a client values. For example, if you just can’t stomach owning the stock of some of these companies (and using the profits they generate to clean them up) where do you draw the line? What about all of the other companies that profit from the oil company’s business? The oil company buys all kinds of services. So, are you going to eliminate from the portfolio the hotel chain that hosts annual meetings for some oil companies? Clearly some of the hotel chain’s profits are coming from oil. How about the tractor company that profits from selling oil companies bull dozers? What about the office supply store the oil company uses? What about the waste and recycling program company that services the oil company’s offices? This ‘voting with your dollars’ thing appeases an emotion but, in reality, accomplishes little else. If it is okay to have some of these other non-oil companies in your portfolio that profit from the oil company’s business, how much is too much? And, even if you could draw the line at, say, no more than 2.45% of a company’s business, how could you even uncover how much it really is? Finally, what about the additional uncertainty being
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introduced by not being as diversified? Additional uncertainty will impact the confidence level of what a client’s Wealthcare plan can incorporate in goals. So even if there is no additional expense to construct a socially responsible portfolio, the added uncertainty could cost our client significantly in the goals that would otherwise be funded. (For a 50 year plan with a balanced allocation, increasing the standard deviation by just 1% due to the lesser amount of diversification would cost this client $40,000 a year in distributions he could otherwise make.) When combined with the certainty of avoiding additional expense, our client could confidently fund $90,000 a year in donations for his cause when compared to a socially responsible portfolio. Despite Reality, I Just Can’t Do It What if, after educating a client about these realities, he still insists on a socially responsible portfolio despite it doing very little to actualize the goal he values? Here is where this ties to ethics. If you represent that you help clients make the most of their life, their goals and what they personally value, are you willing to accept an advisory fee from a client knowing that you aren’t able to deliver the value you represent? Is appeasing an emotion with an illusion the ethical thing to do? Go back to our New Year’s resolution and remind yourself of how that is a contradiction to building a practice that is beyond reproach.
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David B. Loeper is the CEO of Financeware, Inc. which does business as Wealthcare Capital Management. An SEC Registered Investment Adviser with nearly 25 years experience, Loeper has appeared on CNBC and has been a featured contributor on Bloomberg TV and CNN. Loeper joined Wheat First Securities as vice president of investment consulting in 1988, where he
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served for 10 years. He was promoted to managing director of investment consulting, and then eventually to managing director of strategic planning for the retail brokerage division. He left his position at Wheat First Securities in 1999 to found Financeware. Active in industry associations throughout his career, Loeper has been a member of the Investment Management Consultants Association (IMCA) for over 20 years, serving on the advisory council for more than 5 years, most recently as chairman. Loeper was also appointed by the governor of Virginia to serve on the Investment Advisory Committee of the nearly $30 billion Virginia Retirement System. He received his CIMA® designation in 1990 by completing a program offered through Wharton Business School, in conjunction with IMCA. Drawing on years of experience in financial services including serving as a fiduciary for all types of ERISA plans, Loeper has authored numerous whitepapers and books including the top selling book, Stop the 401k Rip-off! as well as The Four Pillars of Retirement Plans, Stop the Retirement Ripoff and Stop the Investing Rip-off

Ethics, Integrity and Trust

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