By Justin Pritchard, CFP®
Want to do some good with your money? Socially responsible investing (SRI) allows you to make an impact with your savings—and avoid putting money into some of the world’s worst offenders.
You don’t necessarily have to choose between good returns and good values. While SRI limits the universe of options to invest in, there are still plenty of quality investments to pick from. Some argue that socially conscious companies should actually do better over the long-term due to a happier and more diverse workforce, healthy community relations, and less “headline risk.”
What is SRI?
SRI is the practice of investing according to your morals. Using positive and negative screens, you invest only in organizations that meet specific criteria. In practice, SRI (also known as sustainable, responsible, and impact investing) means different things to different people—because one individual might value certain things more than others. But the concepts are the same, whether you value sustainability-themed investments or companies that promote social justice.
- Positive screens: To make an impact, you invest in companies that behave in ways that align with your ethics. The goal is to support those organizations and be involved with positive change.
- Negative screens: You can also steer clear of companies and activities that conflict with your values. On a large scale, doing so makes it harder for those companies to raise capital and encourages them to change their ways. In the nearer-term, at least you can avoid participating in harmful practices.
- Shareholder activism: When you invest in a company, you’re a partial owner, so you have the right to vote for boards of directors and other corporate decisions. Large shareholders can steer the direction of things even before they come to a vote by applying pressure to companies. You and I might not have the billions to pull that off, but pooled funds run by activist managers (including pension plans and SRI mutual funds) have more power—and you can add to those pools of money.
How SRI Works
SRI is not new—individuals and institutions have been doing it for decades. Early versions of SRI focused on “sin stocks” like gambling, tobacco, pornography, and alcohol. But again, the term means different things to different people. Some sustainability-focused investors have no problem with alcohol, while some faith-based investors eschew it.
The category of environmental, social, and governance (ESG) investing has gained traction in recent years. We’ll use a summary of ESG to illustrate the basic concepts of SRI.
- Favors companies and projects are good for the natural environment. Those might include services related to renewable energy and clean water.
- Avoids companies that produce harmful products or pollute the environment. Examples include companies involved with major spills or other, less-publicized disasters.
- Favors companies that are beneficial to the communities they operate in. They may be active with local charities, hire and promote a diverse workforce, and pay employees a fair wage.
- Avoids companies that lack engagement and diversity, and which put profit over community. Examples include those with PR problems, and those associated with sexual harassment and data breaches.
- Favors companies that embrace shareholder activism, have diverse leadership teams, and operate transparently. Those companies may come from any industry, as long as they don’t fail any negative screens.
- Avoids companies that use “creative” and unfair practices to enhance profits (or executive compensation). Examples include those involved with accounting scandals or questionable political contributions.
How to Invest With Your Values
If that all sounds good to you, there are several ways to implement a socially-conscious investing strategy.
Mutual funds: The easiest approach might be to use mutual funds or ETFs with an SRI focus. You have numerous options to choose from, and new competitors enter the space regularly.
- Advantages: If you find a fund that aligns with your ethics and risk tolerance, you can invest and be done with it. By pooling funds with like-minded investors, you can limit where your money goes and feel some satisfaction about investing with your ethics. Both active and passive fund options exist.
- Disadvantages: It may be hard to find a fund that matches your morals exactly, and it’s important to understand the fees involved. Passively managed funds are typically less costly than active funds.
Institutional money managers: Another option is to use SRI investment advisors that are not packaged into retail mutual funds (in other words, not available directly to the general public). Those managers may share some of the same features as mutual funds, but they are slightly different.
- Advantages: Higher investment minimums and dedicated investors may help to reduce expenses and turnover. These managers may have a more niche focus than broadly available mutual funds.
- Disadvantages: You may need to commit to fewer managers if you have limited funds. Depending on the manager, fees may still be higher than you like.
Do-it-yourself: If you want to select individual stocks, bonds, and other investments on your own, you can do so. Several databases and rating services may help you identify investments that align with your goals.
- Advantages: You can customize the positive and negative screens to fit your needs. You can vote proxies yourself instead of relying on anybody else to do so.
- Disadvantages: Transaction costs may be high, especially if you make ongoing (monthly) investments. It’s hard for most individuals to diversify, leaving you vulnerable to concentrated positions. It takes time, energy, and know-how to select securities, execute trades, and maintain the portfolio. SRI ratings might be too simple, giving high scores when an organization does not meet your standards.
But Can You Make Any Money?
The traditional investment world has long held that you make a sacrifice when you use SRI strategies: They say you can feel good about how you invest, but your investments won’t perform as well.
That’s not necessarily true.
To be sure, screening changes the landscape. You may have more or less exposure to certain industries, and that can help you or hurt you. Depending on economic conditions and market cycles, there will undoubtedly be times when you underperform, although you could potentially outperform “standard” investment mixes.
For example, ESG screens tend to favor technology companies over mining companies. Why? Technology companies tend to have more women and people of color in leadership, and they don’t generate waste that needs to go somewhere. That’s not to say that mining companies are evil—we wouldn’t have mobile devices, safe transportation, or other necessary products without them. The question (again, depending on what’s important to you) may be how the companies operate: Do they minimize waste and clean up after themselves, or do they just look for low-income areas to dump by-products in?
Researchers have tried to solve the debate about whether or not performance suffers with ESG. In recent years, several studies have been promising for socially-conscious investors, and (for optimists, at least) that probably makes sense intuitively: “Good business” is good business, and chickens often come home to roost.
However, no good will come of predicting or expecting outperformance, so let’s not even go there. The world will always surprise us, at least in the short-term—and sometimes the short-term is not long enough to prevent tragedy. Knowing that, it may be best to use SRI strategies primarily because it makes you feel better. If you’re getting market-like returns, given your level of risk, that might be good enough. Outperformance would obviously be nice, but even slight underperformance might be tolerable as long as it does not prevent you from reaching your goals.
If your SRI investments underperform, you have several options. You can live with it, and feel satisfied with your moral choices. Or, you can go back to traditional investing and give to charities to offset any discomfort you have about changing strategies.
Ready to Move Forward?
If you’d like help investing in a socially-conscious way, please let me know. We can discuss strategies and develop a strategy where you do everything yourself—or have me handle the logistics.
Disclosures: Justin Pritchard is a Certified Financial Planner practitioner.
Investing in mutual funds is subject to risk and loss of principal. There is no assurance or certainty that any investment strategy will be successful in meeting its objectives.
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