A new generation of investors is changing the way we think about financial investments. Not only do they want to work hard and invest wisely, but they also want their investments to matter. According to a 2017 survey, more than half of millennials said they always or often invest in sustainable funds.
Spurred by this interest from investors, more wealth managers are factoring ESG criteria into their investment decisions than ever before. Their investment strategy, called socially responsible investing (SRI), considers both financial return and positive social and environmental change.
Institutional investors, including some of the top mutual funds and exchange-traded funds, are making it possible to have your investments align with your values. But how does SRI measure up against conventional funds?
What Are SRIs?
SRIs are investments that are considered to meet a standard of social responsibility. That is, SRI is an investing strategy based around an ethical framework that assumes the investor has an obligation to act for the benefit of society. Virtually all SRI funds abstain from investing in sectors that are deemed detrimental to the natural environment and the planet’s ecosystems (i.e., fossil fuel industries). Other SRIs extend their ethical consideration to sectors they consider to have an adverse effect on society, such as the firearms, alcohol and tobacco industries.
SRIs aren’t solely focused on financial instruments worth avoiding — they’re also interested in seeking out and investing in profitable companies that have a social benefit. For instance, SRI funds often invest in renewable energy projects and green technology.
Socially responsible investments are still, of course, investments. Investing responsibly, therefore, requires investors to consider the potential for returns. To invest in a nonperforming stock is neither financially nor socially responsible.
Types Of Socially Responsible Investing
There’s no one-size-fits-all approach to SRIs. Below are some of the most popular methods of investing with a social conscience.
• SRI funds: These actively eliminate investments that do not adhere to strict ethical guidelines via positive and negative screens. These funds may allocate a portion of their portfolio to charitable causes while abstaining from fossil fuel investments.
• ESG funds: These factor in the material impact of investments, according to environmental, social and governance-based practices. However, the primary evaluation criterion is financial return.
• Impact funds: Every investment in these funds must have a positive social or environmental impact. The fund is established to advance social goals before financial gain.
• Faith funds: This is ethical investing according to religiously prescribed precepts and guidelines.
Negative Vs. Positive Screening
What defines an SRI portfolio has shifted over the years. While there was once a time when SRI investing was marked by a desire to not own the bad (e.g., refusing to purchase tobacco or alcohol stocks), today it is equally defined by a desire to own stocks that promote a social benefit (e.g., sustainable energy and healthcare technologies).
Positive screening refers to the practice of seeking out and investing in — you guessed it — stocks and other financial instruments that have a net positive impact on society. Stocks purchased via positive screening must be profitable while advancing a societal good, such as democratic advancement or ocean cleanup technologies.
Negative screening, on the other hand, is an approach to SRI that filters out securities that are morally unsuitable or antithetical to the fund’s stated goals. Often, negative screening weeds out investments in controversial industries or companies with a high carbon footprint.
Comprehensive SRIs involve negative and positive screening techniques to optimize their portfolio around the acquisition of high-performing ethical securities.
Advantages Of SRI
• A hands-off approach: Investing in SRI-screened stocks and securities allows you to take a step back from your portfolio and let the market take some of the load off your shoulders. Whereas conventional funds often require micromanagement and a hands-on approach to investing, SRIs are generally structured around lower-risk securities and government bonds. These investments have the benefit of letting you focus on other financial objectives without constantly checking in on your portfolio.
• Acting with integrity: Ethical investing takes a stance against companies that are considered to have a net-negative impact on society. By refraining from investing in them, you act in alignment with your core values and can build a reputation as a principled and disciplined money manager.
• Rewarding the good: SRIs aren’t motivated by the desire to punish companies that inflict social or environmental harm. They’re about choosing to reward companies that perform a socially beneficial function.
Disadvantages Of SRI
• Principles over profit: Investing is principally motivated by the potential for financial return. If you limit your options for investing via negative screening, you can remove some of the highest-performing stocks from your portfolio. One recent analysis found that passive SRI funds habitually underperform the S&P 500 and other unrestricted base indexes over a 10-year period.
• Greenwashers: Not all companies that market themselves as “socially conscious” actually are. The practice of “greenwashing” is a rising phenomenon in which companies use marketing tactics and corporate branding via sponsorships and ad campaigns to assert themselves as ecofriendly or socially responsible. However, in practice, many self-appointed ethical companies find themselves rapt with ethics scandals and investigations into controversial environment or social practices.
Is SRI The Right Choice For Your Portfolio?
Social investing is no self-righteous gimmick or passing fad. In fact, U.S.-based SRI assets under management grew 38% from 2016 to 2018. SRI funds are here to stay, and young investors are at the fore of this growing movement.
However, we should be clear that SRI strategies are not for everyone. An SRI portfolio should be pursued only by those who value social equity and progress more than the potential for higher earnings. Socially conscious investors should be cognizant of these trade-offs before getting started.