A Guide to Socially Responsible Investing
Staying on top of the latest investing trends can seem like a learning a new language.
For one thing, there’s an alphabet soup of terms to understand — from alpha to beta to passive investing to socially responsible investing to values-based investing. Even when the individual words make sense, it’s not always clear what they mean.
Yet with $8.7 trillion of professionally managed funds in the U.S. being directed toward socially responsible investing — out of a total of $42 trillion of total professionally managed assets — according to 2016 figures from the Forum For Sustainable And Responsible Investing (US SIF), it’s obviously more than a passing trend.
But what exactly is socially responsible investing and why should you care about it? Equally important, what isn’t it?
Understanding Socially Responsible Investing
Socially responsible investing, SRI for short, goes by a variety of names, each of which contain subtle differences in meaning. Along with SRI, you’ll also hear of sustainable investing, ethical investing, values-based investing, and environmental, social, and corporate governance (ESG).
No matter which name it goes by, socially responsible investing describes an approach that emphasizes your ethical, social/community, political, and/or religious goals when choosing where to invest.
Sometimes this is a requirement. For instance, foundations and endowments are often required by their charters or donor stipulations to invest in or avoid investments in certain industries or companies. Weapons manufacturers, for instance.
Even for individual investors who are free to invest where they want to, the bottom line is they increasingly want their values and their investments to be in sync.
And they expect to do well financially while doing good.
Ethical investing as a concept stretches back centuries — it was practiced by religious groups including the Quakers and Methodists.
Modern SRI has its roots in the social and political movements of the 1960s. Activists and professional investors beginning with institutions such as government pension funds, foundations and university endowments started using their investments as a way to fight apartheid, push for environmental awareness and end military conflicts.
Initially, they focused on divesting from and/or avoiding the most obvious offenders. That meant saying no to investments in “sin sectors,” such as weapons makers, gambling, alcohol, oil and gas, and tobacco manufacturers.
More and more, individuals, especially millennials, are the ones powering the growing drive to sustainable investing.
What’s in a Name?
Since values differ from person to person, terms like “socially responsible” can seem loaded.
Sustainable investing is a somewhat squishy term, too. According to Farzana Hoque, Research And Communications Consultant with US SIF, distinguishing between different types of strategies is more helpful than belaboring shades of meaning between terms.
Regarding strategies, at first, the easiest way to make sure investors weren’t supporting companies and industries at odds with their values was to use negative screening to exclude certain categories of investments. The problem with that approach is that it’s a blunt tool that’s way too simplistic.
Also, by definition, excluding whole categories of the investing universe essentially guarantees inferior performance.
As SRI expanded to include concepts of sustainability, values-based and ESG standards, it became more sophisticated.
Tracking the Evolution
SRI has come to mean not just excluding some parts of the investment market but proactively supporting industries and investments that create positive impact.
Proponents of this style of investing believe that taking into account a range of ESG factors can not only help make sure their investments are in sync with their values, but also give them an edge in identifying companies that are less likely to blow up because of questionable ethics or shady financial practices the way Enron did.
Tuning Out and Tuning in
ESG doesn’t automatically avoid certain industries. It looks at how company management performs on a range of factors including environmental stewardship, how they treat employees and suppliers, and how corporate governance — think management accountability, and the transparency and quality of their financial reporting — in addition to traditional performance and valuation metrics.
There’s still an exclusionary aspect to it. But it’s inclusionary, too.
A company might be in an industry known for causing environmental damage. However, it could also be involved in reforestation initiatives and or investing in cleaner, next generation energy alternatives. Rather than automatically excluding it from consideration as an investment, ESG rankings would take that into account.
Companies and organizations from Morningstar to United Nations-supported Principles for Responsible Investment (PRI) to As You Sow (there are many others), rank industries and companies based on how they perform on ESG factors. They also keep databases of socially responsible funds and advise on how shareholders can push for change.
Where Does Impact Investing Fit Into All of This?
Community and impact investing are two other types of values-driven investing approaches.
While the philosophy and intent are the same as other types of socially conscious investing, the strategy is different. It helps to think in terms of a continuum, with excluding certain industries and companies on one end and proactively investing in projects and initiatives designed to impact specific communities or support specific projects on the other.
Like SRI, impact investing views potential investments through the lens of how well they square with deeply held values. But impact investing is much more hands on in terms of tactics.
Hoque describes community investing as a category of sustainable and impact investing. Community investing channels public and private investment to low income and other underserved communities in order to provide capital, credit and training that these communities would otherwise lack.
Venture Capital Wants to Make an Impact, Too
Impact investing isn’t just for nonprofits or state and local governments. Venture capital is on board, too.
Nancy Pfund, Founder and Managing Partner of DBL Partners, pursues a “double-bottom line,” aiming for “top-tier financial returns” while working closely with individual portfolio companies to help them optimize social contribution, climate effects and community engagement.
For her, it’s a matter of putting first things first: “You have to really believe it’s going to be a successful financial investment first and foremost.”
What Socially Responsible Investing Isn’t
What comes to mind when you hear SRI or ethical investing? People often think “it’s just negative screening,” Hoque says.
But in reality, she says, the social investing industry has changed so much in 10 years. There are many new products, ways to invest and people —both professional money managers and regular investors — joining the bandwagon.
Another popular misconception, she says, is that it only involves public equity. In reality, fixed income, private equity and real estate are also options for SRI investing.
One of the biggest misunderstandings Hoque runs into is the belief that socially conscious investing is somehow not consistent with fiduciary duty. Financial practitioners classified as fiduciaries have a legal duty to act prudently and solely in clients’ interests.
Close behind that concern is that it is a formula for lower returns. She points to “positive correlation between ESG and financial performance,” adding that since “ESG factors are long term investment value drivers, why should they be ignored?”
Does Being Responsible Mean I Have to Sacrifice Returns?
So is there a tradeoff between investing with your conscience and getting good returns? Pfund doesn’t think so.
“We believe there is no sacrifice between driving significant social progress and delivering a financial return,” she said. She points to Pandora, Solar City, NextTrakker and Tesla — all companies DBL Partners invested in — in making the case “there was no sacrifice of social return and we were able to accomplish some significant financial goals.”
She’s right. There doesn’t have to be a tradeoff. According to a 2017 report by TIAA Investments, “statistical analysis showed no meaningful difference in returns when comparing responsible investment indexes with relevant broad market indexes.” Other studies have found similar results.
There Are no Guarantees
They can be poorly managed or disappoint just as any other type of investment can. You still have to do your homework before investing. That means researching funds, managers and companies just as you would any other type of investment.
How Can the Average Investor Research Companies and Decide Where to Invest?
The good news: There are lots of guides, references and sources of information. It’s also getting easier to find an investment fund with a strategy and options that meet your needs and goals.
But Hoque says the biggest thing is to figure out your issues that you want first to screen against or have a positive impact on. “Knowing what you’re passionate about and interested in helps you frame the question,” she said.
When it comes to choosing, there are socially responsible stock and bond indexes and more and more mutual funds and ETFs that track them.
Here are a few of the most well-known: MSCI KLD 400 Social Index, iShares MSCI KLD 400 Social ETF and the Vanguard FTSE Social Index Fund. Calvert and Parnassus are two of the oldest fund companies running socially conscious funds. There’s also TIAA-CREF Social Choice Bond.
You might also be able to invest through your 401k or other retirement plans.
But Beware the Hype
Lots of companies claim to be “a new type of financial firm.” And several financial technology companies offer automated investing offer socially conscious investing choices. That’s all to the good.
Just be sure to read the fine print.
You want to make sure companies not only match your goals, but that their actions match their claims. As Hoque says, if they don’t offer details it might be a sign they don’t really know what they’re doing yet, or that their socially conscious claims are just an intention.
Start Where You Are
Hoque suggests checking fund disclosures for a description of the funds and the options, fees and performance as a starting point.
US SIF has a searchable mutual funds database where you can compare mutual funds’ and ETFs’ financial performance as well as their ESG data. Morningstar's Sustainability Rating for Funds assigns ESG Ratings to 20,000 funds.
There’s also the United Nations-supported Principles for Responsible Investment (PRI), As You Sow and many other organizations that rank industries and companies based on how they perform on ESG factors, keep databases of socially responsible funds and advise shareholders on ways to push for change.
Do What You Can
Even though stock mutual funds get a lot of the media focus, SRI doesn’t have to only be about individual stocks. Crowdfunding, public benefit corporations and B Corps are options, too. As Pfund notes, there’s something for everyone.
And you don’t have to wait until you’ve amassed a small fortune to get started. Pfund suggests starting with small amounts of money. She emphasizes there’s no substitute for going on someone’s site and looking at what they have to offer.
Pfund also advises those starting out to support their values with direct action.
“You can do more than [just] allocating only investment dollars,” she said. Individuals can help by working on those causes on the outside and also by being a voice supporting companies in doing the right thing.
Sustainable investing isn’t going to take over the world tomorrow, but it is clearly here to stay. There may even come a day when it’s so second nature that, as Pfund says, you won’t need this category because it will be the default setting when investing.
She had an apt question: “Why wouldn’t you want to invest this way if you could?”
There are no working crystal balls; the future is always murky. But one thing that should always be front and center as you frame your investing decisions is how an investment fits into your overall financial picture.
“People should just read the description of the funds and the options,” Hoque said. “Check [the] fees associated with it. Spend some time researching them online. Follow the media coverage to see if the companies are a good match.”
Hoque added something that really hit home: “People have options now; they don’t just have to invest anywhere.”