What is Socially Responsible Investing?

What is Socially Responsible Investing?

by Trailhead Plan… on Oct 2, 2017

ESG, Socially Responsible Investing, Sustainable Investing

One of the questions I get asked most often is “What is socially responsible investing?” My response is that at its core, socially responsible investing (or SRI) is about investing in a manner that is coherent with your personal values and beliefs.

Most investors don’t know what is in their investment accounts, be it an IRA, a 401(k) or an after-tax account. Sure, they own ETFs (exchange traded funds) and mutual funds, and maybe even a few individual stocks, but it takes a lot of extra work to figure out what exactly is inside those investment vehicles.

Many individuals do not feel the need to take it any further than that. That's fine.

However, a growing group of investors want to know what their money is invested in and to ensure that they aren’t supporting companies they don’t believe in. This is the problem that socially responsible investing attempt to solve.

So, easy-squeazy, right? We’ll just exclude a few obvious bad-actors and move on...

Unfortunately, it’s not that simple. In practice, socially responsible often means different things to different individuals. Some individuals are primarily focused on environmental sustainability. Others are concerned about worker’s rights, wanting to ensure that the companies they invest in, and are partial owners of, treat their employees fairly and ethically.

Many investors are even more defined. For example, some mutual funds invest according to Muslim guidelines - usually pertaining to borrowing and lending practices. Others invest according to what they define as Catholic or biblical values. The list, of course, goes on - vegan values, animal-rights, inclusion of women in the C-Suite and Boardroom, etc.

Why does socially-responsible mean different things to different people? Well, everyone’s values and beliefs are different, and that inevitably makes things a bit muddled. That said, the industry is rallying around a new standard for responsible investing, which we'll talk more about below.

The lack of a standard has made SRI seem flimsy

A quick rule of thumb: if you don't define what you mean, others will define it for you.

This is what historically happened to socially responsible investing. Many fund companies, trying to capitalize on people's good intentions, pushed high-risk investments like solar, water, and wind stocks at investors who were concerned about the environment. Unfortunately, a few good-natured bets do not magically create a diversified portfolio and when the inevitable downturn came (like 2008), socially responsible investors got burned.

Due to experiences like this, socially responsible investing has become associated with high risk/low reward investment strategies - never a good investment strategy, and an extremely poor outcome.

That said, we think socially responsible investing is changing for the better and rallying around a new banner.

A New Model For SRI

Attempting to alleviate the inherent flimsiness of a term like socially-responsible, the financial industry has developed a set of standards by which companies can be measured to assess their overall sustainability and social impact. These are:

Environmental: Assesses sustainability factors like carbon usage, production waste, environmental pollution, etc. As well as potential environmental risks that could impact the company.

Social: Assesses factors like how the company treats its workers, its community, its suppliers and other stakeholders. Are workers exposed to unsafe conditions? Are they compensated fairly? Is diversity promoted? Does the company have a positive impact on its community?

Governance: Governance factors assess how transparent the company is with shareholders and other stakeholders as well factors such as board diversity and qualification. Are shareholders respected and allowed to vote on important issues? Does the company have effective controls and disclosures in place? Does the company make political contributions that lead to unfair treatment?

US and international companies alike can now be screened by ESG standards to set a baseline for socially-responsible investment. We now have a set of standards and language for how to define the positive social impact of publicly-traded companies. This is a huge step forward for conscious investors!!

In fact, the industry is now changing SRI from ‘socially responsible investment’ to sustainable, responsible and impact investing. Once again, we think this furthers the cause of what the standards are for conscious investment.

Improving investment risk/reward

This is all well good, but can you actually build an investment portfolio using ESG guidelines that will help individuals reach their long-term goals?

Recent studies and data lead us to conclude that yes, it is possible. Due to the shift toward using ESG standards to optimize investment portfolios, investors can now invest broadly and cost-effectively in a manner that, when done correctly, should roughly track broad market indices over time. This vastly improves the risk/reward dynamic and means investors can do socially responsible investment, well responsibly.

We will write more about recent studies done on ESG performance in later post, but for now, let it be said, investors who want to invest in a manner that doesn’t leave them feeling ethically-compromised just achieved a huge win. It’s called ESG, and we believe it is the template for the future of investing.