Portfolio Investing 101: R. Paul Herman

R. Paul Herman has built a new model for socially responsible  investing. One aimed at market-beating performance.

Herman credits his guiding interest in truth and justice  to his childhood growing up in Chicago . “My parents both instilled in me in my DNA and upbringing, values of trust and fairness. That really led to my views on the world.”

After graduating from Wharton with a finance degree, Herman went to work at consulting giant McKinsey & Co. where he worked on incentive regulation of utilities including nuclear power plants.  He describes the experience as an education in “measurement systems as a way to get monopolistic companies to act like profit- driven companies.” It was during this time that Herman started thinking in-depth about how measures like safety, customer satisfaction and employee satisfaction can be tied to return on equity.   “That drove home to me using a business discipline and a measurement discipline in combination with human and environmental goals,” Herman says.

After McKinsey, Herman launched a successful online financial management service, and after selling that went to work at social entrepreneur incubator Ashoka.org and at Omidyar Network, advising the founder of eBay Pierre Omidyar on investments seeking both higher sustainability and financial performance.

Over the years, Herman has come to question the belief Milton Friedman so successfully ingrained in the business community that the only goal of any public business was to maximize shareholder value. “That has really squeezed most companies down to a very short-term focus,” he says.

Herman decided to research if companies with “higher” purposes did better than those with a singular profit motive. Could you do well financially by doing right?  The United Nations puts out a Human Development Index that rates countries based on their human, social and environmental records.  But there was no equivalent for corporations.

So Herman began to evaluate and rate companies based on their “HIP” score, a rating of “Human Impact plus Profit”.

Unlike traditional social investing practitioners who simply knock out companies in damaging industries or with some business blemish, Herman simply lowers their HIP score.  That’s why a company like Walmart is still in the HIP mix. The discount retailer gets dinged for falling behind competitors on employee benefits, but management’s goal of getting to zero waste has had quantifiable results.   A push for sustainable improvement in environmental impact and transparent report at its 60,000 suppliers gets it positive points.

Ranking the S&P 100 according to their HIP score, Herman created “The HIP 100” an index that has beaten the S&P 100 quite handily in its first year.  He doesn’t exclude less HIP companies. Instead he’s weighted the entire index, putting more money with the good guys, less with the bad.

For the 12 months ended July 31, 2010, net of fees, the HIP 100 was up 13.41%, compared to a 9.37% return for the S&P 100 weighting of the same stocks. (Full description and disclosures here including that past performance is not indicative of future results.)

Herman’s conclusion:  the traditional discounted cash flow model of analyzing companies is incomplete. Forward-thinking companies are building an advantage that the market takes time to recognize and reward, he says, which usually leads to positive earnings surprises in the future, and can yield a stronger portfolio performance for investors.

And, he notes, he’s not the first to find this pattern. Wharton Professor Alex Edmans found that the companies on Fortune’s Best Companies to Work For list enjoyed a similar bump in value several months after that list was published. JD Power has established that companies with good customer service follow the same route. And Catalyst, a non-profit focused on women’s advancement in business, found the same for companies with a high proportion of female board members.

In his new book, The HIP Investor: Make Bigger Profits by Building a Better World (John Wiley & Sons) Herman outlines how an individual investor can build a portfolio that includes a HIP evaluation.  There are 20 different factors discussed in the book.

Some of the questions an investor needs to answer include:

1. Do a company’s products and services solve a human need?

And what percentage of its revenue derive from products with a positive net impact? Not all companies report this but some do. Pepsi (30% of revenue from “good-for-you” or “better-for-you”) and GE (10% of revenue from Ecomagination Products) are two examples.

2. What is the company’s human impact?  How does is affect: health, wealth, the earth, equality, and trust and transparency? (Measures inspired by Maslow’s Hierarchy of Needs.)

Some of this information will come from its own annual and quarterly reports but other sources should be checked too, like the Carbon Disclosure Project. The University of Michigan publishes an important customer satisfaction study. SEC filings like a company’s proxy statement include important information about the makeup of the board of directors. The EPA and OSHA also keep public records of company track records too.

3. Does Management talk about and embed positive decision making and accountability? United Technologies scores well on this in part for its focus on sustainability including energy efficiency at its Pratt and Whitney jet engine division, and helping its staff build their skills through education reimbursement. Apple on the other hand, suffers for its management team’s  high level of secrecy. Even if they are doing good, who would know?

Once you’ve evaluated your individual investments, Herman argues for weighting your portfolio based on your HIP analysis. You don’t have to sell Altria just because it makes a product, cigarettes, that are deadly.  But doesn’t it make sense to underweight that, he’d argue, and  overweight companies like Procter & Gamble and IBM which seem to be focused on more sustainable markets, products and practices?

Once you’ve weighted your equity holdings according to HIP, Herman says the next step is to take a similar look at your Cash, Fixed Income, Real Estate and other investments – even your tax deductible charitable giving.

“Anybody can do this,” says Herman. “We call it the new fundamentals of investing, but it is really the fundamentals of investing period. Understand how a company operates and makes money and how a company can do good in the world. Charity is a one-way donation. Business is a two-way exchange. Today, forward-looking Investors put in money expecting a return and a positive impact.

The more businesses take control of problems in a comprehensive way, the less burden [society has] of serving them over time. Business is an effective attracter of great people and capital, and can be the leading sector that can address those problems, sometimes before they even occur.”

Companies currently with the highest HIP scores:

  1. Procter & Gamble (PG)   71.0 (out of 100)
  2. General Electric Co. (GE)   70.8
  3. Intel Corp. (INTC)   70.0
  4. United Parcel Service (UPS)   69.5
  5. H.J.Heinz Co. (HNZ)   68.8
  6. Hewlett-Packard Co. (HPQ)   68.8
  7. PepsiCo Inc. (PEP)   68.8
  8. Cisco Systems (CSCO)   68.6
  9. International Business Machines (IBM)   65.6
  10. Nike Inc. (NKE)   64.2

Source: HIP Investor

3 thoughts on “Portfolio Investing 101: R. Paul Herman

  1. Pingback: HIP Investor | HIP Investor

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