Introduction
Illuminate aims to deliver a service that simplifies and automates sustainable investing. Illuminate offers recommended portfolios constructed using Modern Portfolio Theory ("MPT") principles and optimized for your risk tolerance. From there, you can customize your portfolio and Illuminate will take care of the rest by reinvesting dividends, rebalancing the portfolio in a tax-efficient way, and performing daily automated Tax-Loss Harvesting, as needed.
Illuminate's recommended portfolios are designed to provide an attractive tradeoff between risk and long-term, after-tax, net-of-fee return through a diversified set of global asset classes, each of which is represented by low-cost exchange traded funds (ETF) and individual stocks. This methodology describes the process Illuminate uses to construct its recommended Core portfolios, as well as the ongoing monitoring and rebalancing process, so that all portfolios remain close to their target allocations while seeking to minimize taxes from realized gains.
At Illuminate, we evaluate potential investments against the Paris-aligned benchmark that support limiting global warming to well below 2°C, with efforts to limit it to 1.5°C above pre-industrial levels. This framework requires carbon reduction targets and year-on-year decarbonization trajectories, allowing us to select companies that demonstrate both financial and sustainable performance. We believe that the risks caused by climate change are not adequately priced into the market.
We regularly monitor and rebalance portfolios to maintain their diversification. In addition, we aim to reduce potential tax liabilities by evaluating the tax impact of each asset class and adjusting allocations accordingly for taxable and non-taxable (retirement) accounts.
Our investment methodology employs five steps:
Identify a diverse set of asset classes
Select the most appropriate funds to represent each asset class analyzing both financial and sustainable performance
Apply Modern Portfolio Theory principles to develop asset allocations that seek to maximize the expected return for each level of portfolio risk
Determine your risk tolerance to select the allocation that is most appropriate for you
Monitor and periodically rebalance your portfolio, taking advantage of dividend reinvestment
Modern Portfolio Theory is one of the most widely accepted frameworks for managing diversified portfolios. The economists who developed MPT, Harry Markowitz and William Sharpe, received the Nobel Prize in Economics in 1990 for their groundbreaking research. While MPT has its limitations, especially in the area of extreme downside scenarios, we believe it is the best framework on which to build an investment management service.
Sophisticated investment management services were once available only to wealthy investors through financial advisors. Many of those advisors charge average annual management fees of 1%, and have account minimums of at least $1 million. By implementing a completely software-based solution, informed by decades of academic research, Illuminate is able to deliver its automated investment management service at much lower cost than traditional investment management services.
Finding Asset Classes
Research consistently has found the best way to potentially maximize returns across every level of risk is to combine asset classes rather than individual securities (Markowitz, 1952; Sharpe, 1964; Brinson, Hood & Beebower, 1986; Brinson, Singer & Beebower, 1991; Ibbotson & Kaplan, 2000). The first step in our methodology is to identify a broad set of diversified publicly accessible asset classes to serve as the building blocks for our portfolios. We consider each asset class's long-term historical behavior, risk-return relationship, and expected behavior based on long-term trends and the macroeconomic environment. We also evaluate each asset class's correlation with the other asset classes, resistance to inflation, cost to implement via ETF (expense ratio), and tax efficiency.
Asset classes typically fall under three broad categories: stocks, bonds, and inflation assets. Stocks, despite their high volatility, provide investors with exposure to economic growth and the potential for long-term capital appreciation. Stocks can be relatively tax efficient due to favorable tax treatment on long-term capital gains and qualified dividends, though individual circumstances may vary. Bonds and bond-like securities are commonly used for income generation. While bonds generally offer lower return expectations, they may help reduce risk for stock-heavy portfolios during periods of economic uncertainty due to their historically lower volatility and lower correlation with stocks. However, bond interest income is typically taxed at ordinary income tax rates, which can result in lower tax efficiency for some investors. Bonds may also face risks, such as interest rate changes or credit risk. Assets that help protect investors from inflation in both moderate and high inflation environments include treasury inflation-protected securities (TIPS) and real estate. Their prices tend to be highly correlated with inflation.
Based on a thorough analysis, our investment team currently considers the following asset classes:
US stocks represent an ownership share in US-based corporations. The US has the largest economy and stock market in the world.
Foreign developed market stocks represent an ownership share in companies headquartered in developed economies like Europe, Australia, and Japan.
Emerging market stocks represent an ownership share in foreign companies in developing economies such as Brazil, China, India, South Africa, and Taiwan. Compared with developed countries, developing countries have younger demographics, expanding middle classes and faster economic growth.
Dividend growth stocks represent an ownership share in US companies that have increased their dividend payout each year for the last ten or more consecutive years. They tend to be large-cap companies in less cyclical industries and thus are less volatile than stocks generally.
US bonds are high-quality debt issued by the US Treasury, government agencies, and US corporations. US bonds provide steady income, low historical volatility and low correlation with stocks.
US corporate bonds are debt issued by US corporations with investment-grade credit ratings to fund business activities.
International market bonds are debt issued by governments and quasi-government organizations from non-U.S. countries.
Municipal bonds are debt issued by US state and local governments. Unlike most other bonds, municipal bonds' interest is exempt from federal income taxes.
Treasury inflation-protected securities (TIPS) are inflation-indexed bonds issued by the US federal government. Unlike bonds with no added inflation protection, TIPS' principal and coupons are adjusted periodically based on the Consumer Price Index (CPI).
Real estate is accessed through publicly traded US real estate investment trusts (REITs) that own commercial properties, apartment complexes and retail space. They pay out their rents as dividends to investors.
There is no definitive answer to the question "how many asset classes should investors hold?" It is relatively easy to improve the risk-return tradeoff of a two- or three- asset class portfolio. It gets increasingly difficult to improve the returns of a portfolio already diversified across seven or eight asset classes. Going beyond a certain level of complexity generally reaches diminishing marginal benefit, especially when you incorporate ETF costs into your decision-making. Having said that, we will continue to evaluate new relatively uncorrelated asset classes that can be implemented using low-cost liquid ETFs, to improve our asset allocation.
Once we decide on our asset classes, our next step is to select the investments.
Selecting Investments
Illuminate uses low cost, index-based ETFs and individual stocks to represent each asset class. In contrast, many financial advisors have historically recommended actively managed mutual funds. A significant amount of research has been published that shows active mutual funds not only underperform the market (Bogle, 2009; Malkiel, 2012), but those that outperform in one period are unlikely to outperform in subsequent periods. In fact, the semi-annual review of active funds by S&P Dow Jones Indices published at the end of 2024 (SPIVA US Scorecard), indicates that 90% of US domestic active funds have underperformed their benchmarks over the last 10-year period. As a result, index funds and, more specifically, passive index ETF offerings have exploded over the past 10 years. As of the end of 2023, there are more than 3,000 US ETFs and in aggregate, ETFs have accumulated assets of more than $8 trillion (ICI 2024 Fact Book). Simultaneously, flows out of active mutual funds have accelerated.
The table below illustrates the average asset-weighted expense ratios of active mutual funds, and Illuminate-selected ETFs. Although fund fees may vary over time, we observe a consistent fee gap between active mutual funds and ETFs. Aggregate industry statistics for actively managed mutual funds are from the Morningstar Fund Fee Study. Data for Illuminate reflect the expense ratios of the target asset allocations for taxable and retirement accounts weighted by the amount of client assets in each target allocation as of April 2025. The table illustrates the annual savings available simply from avoiding actively managed mutual funds.
For the U.S. stock allocation, we replicate the composition of a leading ETF through direct stock ownership, enabling our clients to retain shareholder voting rights while eliminating the expense ratio typically associated with fund management.
Asset Class | Industry Average Active Fund Expense Ratio | Illuminate Fund Expense Ratio |
US Stocks | 0.66% | 0.00% |
Foreign Developed Stocks | 0.73% | 0.12% |
Emerging Market Stocks | 0.90% | 0.15% |
Illuminate periodically reviews the entire population of ETFs to identify the most appropriate ones for use in our portfolio construction. When choosing ETFs, we consider the following criteria:
Sustainable Performance: Our research team evaluates potential investment securities against Paris-aligned benchmark, which are designed to support the global objective of limiting global warming to well below 2°C above pre-industrial levels, and pursuing efforts to limit warming to 1.5°C. These benchmarks require significant carbon reduction targets and incorporate a year-on-year decarbonization trajectory. Additionally, we believe that the risks caused by climate change are not adequately priced into the market.
Cost: All things being equal, we attempt to choose the ETFs with the lowest expense ratios. Unfortunately, all things are not equal so we have to trade off cost for the other four characteristics.
Tracking error: Most investors are surprised to learn that ETFs do not exactly track the indices they were created to mimic. The higher the variance from its selected benchmark (tracking error), the less appropriate an ETF is to represent its asset class.
Liquidity: We choose ETFs that are expected to have sufficient liquidity to allow purchases and sales at any time. Newly issued ETFs usually take a while before they are appropriate for recommendation, even if they offer lower fees because the lack of liquidity may cause trading costs that more than offset their lower fees.
Securities lending: ETF issuers generate income from lending out their underlying securities to hedge funds to enable short sales; the more prevalent the lending, the higher the risk to the ETF buyer. We prefer ETFs that either minimize lending or share the lending revenue with their investors through lower management fees.
The Paris-Aligned Benchmark
As part of our alignment with sustainable investing principles, Illuminate conducted extensive research on a broad universe of frameworks and securities to determine their alignment with the Paris Agreement objectives. This research was key in shaping our investment methodology.
We believe the Paris Aligned Benchmark provides the optimal investment framework to meet our sustainable investment goals. Our research team evaluated potential investment securities against the Paris-aligned benchmark, which are designed to support the global objective of limiting global warming to well below 2°C above pre-industrial levels, and pursuing efforts to limit warming to 1.5°C.
The Paris-aligned benchmark has several distinguishing characteristics:
Requires a 50% reduction in carbon intensity compared to the investable universe
Excludes companies involved in fossil fuels (coal at 1%+ revenue, oil at 10%+ revenue, natural gas at 50%+ revenue) and electricity producers with high greenhouse gas emissions
Requires at least 7% year-on-year carbon reduction, aligned with or exceeding the decarbonization trajectory of a 1.5°C scenario
Maintains a stronger ratio of green to brown investments (factor of 4) compared to the investable universe
Allocation increases are prioritized for companies that set science-based targets to avoid greenwashing
Excludes companies involved in controversial weapons and those that violate societal norms such as UN Global Compact Principles
Disqualifies companies from the portfolio after 2 consecutive years of misalignment with the required decarbonization trajectory
Illuminate portfolios are diversified across global regions including U.S., developed markets and emerging markets and we allocate our bond portion of the portfolio exclusively to Green Bonds.
We analyzed hundreds of securities across multiple asset classes, examining:
Current carbon footprint metrics (Scope 1, 2, and where available, Scope 3 emissions)
Published decarbonization targets and their credibility
Climate transition strategies and implementation progress
Alignment with sector-specific Paris-aligned pathways
Climate risk exposure and management strategies
Asset Allocation
Having identified the funds we will use in our portfolio, we now need to determine how much to invest in each one.
Understand the Expected Behavior of Each Asset
We begin by analyzing how each fund is likely to perform in the future. For each fund, we estimate:
How much return we expect it to generate on average
How volatile it might be (how much its value might fluctuate)
How it tends to move in relation to our other funds (whether they tend to rise and fall together or move independently)
Set Up Portfolio Goals for Different Risk Levels
We create eight different risk levels, ranging from very conservative (Level 1) to very aggressive (Level 8). Each level corresponds to a specific balance between stocks and bonds:
Level 1: 20% stocks, 80% bonds
Level 2: 35% stocks, 65% bonds
Level 3: 50% stocks, 50% bonds
Level 4: 60% stocks, 40% bonds
Level 5: 70% stocks, 30% bonds
Level 6: 80% stocks, 20% bonds
Level 7: 90% stocks, 10% bonds
Level 8: 100% stocks, 0% bonds
Find the Optimal Allocation Within Each Category
For each risk level, we determine the ideal allocation between different types of stocks (US, Developed Markets, and Emerging Markets) and bonds. We use portfolio optimization techniques to identify the mix that offers the highest expected return for that level of risk.
For example, in a Level 5 portfolio (70% stocks, 30% bonds), we might allocate:
52.5% to US stocks
10.5% to Developed Market stocks
7% to Emerging Market stocks
30% to Corporate bonds
This exact breakdown is determined by carefully analyzing how these assets work together, not just individually.
Consider Additional Constraints
We apply additional constraints to ensure the portfolios remain practical and aligned with our principles:
Maintaining sufficient diversification (never putting too much in any single asset class)
Ensuring the portfolio can be implemented efficiently, even for smaller accounts
Incorporating our Paris-aligned benchmark criteria to ensure sustainability performance
Create the Final Portfolio Models
The result is eight distinct portfolio models, each optimized for its specific risk level. These models serve as the foundation for all client portfolios. Each model offers the highest expected return for its level of risk, provides appropriate diversification across asset classes, balances growth potential with stability based on risk tolerance, and incorporates sustainability performance through our Paris-aligned benchmark approach
For any of these risk levels, clients can customize their portfolios by selecting from available thematic investment options including Climate Technology, Women's Empowerment, Carbon Credits, Water Solutions, and Clean Energy.
Determining Risk Tolerance
It is necessary to determine your risk tolerance in order to identify the ideal asset allocation for your needs. Rather than asking the typical 25 questions asked by many financial advisors to identify an individual's risk tolerance, Illuminate combed behavioral economics research to simplify our risk identification process to only a few questions. We ask you questions to evaluate both your objective capacity to take risk and subjective willingness to take risk.
The questionnaire is used to determine your preferences and risk profile, using a point-based system designed to determine a your risk score:
What do you want from your investments?
I want to keep my money safe and avoid losses. (2 Points)
I aim to grow my savings without taking on too much risk. (4 Points)
I seek steady growth and am comfortable with some risk. (6 Points)
I want to grow my money as much as possible, even if i take on more risk. (9 Points)
How soon do you think you’ll need the money you’re investing?
Very soon (1-3 years), I'll need to access it in the near future. (2 Points)
Somewhat soon (3-5 years), I'm saving for something in the next few years. (4 points)
In a while (5-10 years), I don't plan to use it for several years. (6 Points)
Not anytime soon (10+ years), I won't need it for a long time. (9 points)
How much experience do you have with investing?
I'm new to investing and have little to no experience. (2 Points)
I have some experience and have made a few investments. (4 Points)
I'm fairly experienced and understand how markets work. (6 Points)
I'm very experienced and confident in making investment decisions. (9 Points)
Imagine you started with $10,000. One month later, your investment loses $2,000. What would you do next?
I would sell everything because I can't handle that kind of loss. (2 Points)
I would feel worried but wait and hope it recovers. (4 Points)
I wouldn't be too concerned and might consider buying more. (6 Points)
I would see it as an opportunity to invest even more. (9 Points)
Suppose a relative left you an inheritance of $100,000, stipulating in the will that you invest ALL the money in ONE of the following choices. Which one would you select?
A savings account (2 Points)
A mutual fund that owns stocks and bonds (4 Points)
A portfolio of 15 common stocks (6 Points)
Commodities like gold, silver, and oil (9 Points)
What is your age range?
18 - 30 (9 points)
31 - 40 (6 points)
41 - 50 (4 points)
Over 50 (2 points)
Portfolio Risk Level | Allocation (Stock/Bond) | Point Range |
1 | 20/80 | 0-13 |
2 | 35/65 | 14-21 |
3 | 50/50 | 22-28 |
4 | 60/40 | 29-32 |
5 | 70/30 | 33-35 |
6 | 80/20 | 36-41 |
7 | 90/10 | 42-50 |
8 | 100/0 | 51-54 |
The Risk Levels range from 1 (most risk averse) to 8 (most risk tolerant) in 1 level increments. In turn, each Risk Level corresponds to one of the 8 asset allocations described in the previous section.
We inform our customers about the impacts of changing their Risk Level frequently, and that it might not be appropriate for their ultimate goals. This is because we believe attempting to time the market is one of the most serious mistakes investors can make, and changing Risk Levels frequently should not be used as a tool to try to time the market. We recommend that you review their Risk Score annually and only consider updating it every three years or so, or if you experience a significant change in financial circumstances.
Rebalancing and Ongoing Monitoring
The composition of any investment portfolio will naturally drift as capital markets move and certain holdings outperform others. This typically results in two outcomes in our experience: 1. Portfolio risk increases as higher-risk portions of the portfolio grow beyond their original allocations, and 2. Allocations become sub-optimally mixed. To maintain the intended risk level and asset allocations, a portfolio must be periodically rebalanced.
Illuminate monitors our clients' portfolios and periodically rebalances each portfolio when dividends from ETFs accrue, a deposit or withdrawal has been made, or if movements in their relative allocations justify a change. Our rebalancing algorithms trade off deviations from the target portfolio with the tax consequences of selling appreciated assets. We use cash inflows to buy underweight asset classes and threshold-based rebalancing instead of time-based rebalancing in an effort to reduce turnover, taxes, and trading costs. Rebalancing will usually reduce risk over time, but not necessarily increase returns.
Specifically for the U.S. stock allocation, we conduct scheduled rebalances twice yearly (June and December) to align with the underlying MSCI Paris-Aligned Climate Benchmark methodology. These semi-annual updates ensure your portfolio reflects the latest assessment of companies meeting or exceeding Paris Aligned Benchmark (PAB) requirements. Companies may be added or removed from the benchmark as their climate commitments and performance evolve, keeping your investments aligned with leading energy transition standards.
It is important to note that your asset allocation will typically need to be adjusted over time as your investment goals and risk tolerance may change. Illuminate recommends you review your investment plans in detail every three to five years to determine whether your risk tolerance and target allocation should be updated. We also remind you on a quarterly basis to keep us informed of any such changes.
Conclusion
At Illuminate, we combine our investment team's judgment with advanced optimization tools to identify efficient portfolios that incorporate the Paris-aligned benchmark. We aim to deliver maximum net-of-fee, after-tax returns within each client's risk tolerance while selecting companies that demonstrate both financial and sustainable performance. By continuously monitoring and periodically rebalancing portfolios, we maximize returns while maintaining calculated risk tolerance. We believe companies that effectively manage climate risks will deliver better long-term performance while contributing to a sustainable future.