Understanding Sustainable and Responsible Investing

At one time, considered a niche area of investment practice, Sustainable and Responsible Investing (SRI) now embrace a broad investment audience that includes individuals, including high net worth and otherwise, and institutions such as pension plans and endowments foundations. Religious tenets, political beliefs, specific events, and the broad remit of corporate responsibility—such as green investing and social welfare, drive this investment practice.

Examples of Socially Responsible Investing

Socially responsible investing expresses the investor’s value judgment, of which there are several approaches:

  • One example is when an investor avoids companies or industries that offer the investor’s products or services harmful. The tobacco, alcohol, and defense industries are considered taboo by people who try to be socially responsible investors.
  • Another is considering a performance ranking in terms of how well a company performs, not only in terms of financial metrics but also regarding social, environmental, governance, and ethical issues.
  • Yet another involves active engagement between the company’s shareholders and its management.
  • Finally, there is the activist tack that involves the investor advocating for specific issues.

One or a combination of these approaches can be a critical driver in the process of portfolio management and fiduciary oversight. Moreover, the practice is global, with different approaches emphasized in various countries as a function of their culture, government, business environment, and inter-relationship of these factors.

What counts as socially responsible, or not, has led to differing opinions about whether these approaches yield competitive returns.

For Whose Benefit?
Socially conscious investors may assume a more holistic view of a company when making investment decisions—looking at how it serves its stakeholders and creditors, management, employees, the community, customers, and suppliers. Within this context, socially responsible investment seeks to maximize people’s welfare and environment while seeking a return on one’s investment consistent with the investor’s goals.

On the surface, these two notions may appear contradictory. For example, there may be an implicit cost of such an approach to the extent that it eschews profitable companies and sectors. Tobacco, alcohol, firearms, and gambling have been lucrative industries.

However, to a socially conscious investor, their inclusion in a portfolio would fail to serve the investor’s living objectives in a world void of conflict and legal stimulants and depressants. As with any investment approach, the socially conscious investor needs to:

  • Define his, her, or its risk and return objectives and constraints.
  • As to the latter, the investor needs to determine what their socially conscious restrictions are.
  • Investors opposed to armed conflict as a means of dispute resolution may avoid any company or industry associated with defense, national security, or firearms.
  • Once an investor defines their limitations, they must decide which approach to implement, including screens, best practices criteria, or advocacy. The type of investor may determine the most suitable method. For example, advocacy and dialog with a company or industry would be better suited to a large foundation than individual investors. By contrast, an individual investor working with an advisor would find the screening process more feasible.
  • Social investing has implicit costs—the returns potentially foregone by excluding companies with unacceptable products or business practices—and explicit costs. For those considering an active approach, fees for exchange-traded and mutual funds tend to be a bit higher. For investors seeking passive management, there are fewer indices to track.
  • Diversification is always an important consideration. Screens may hamper this process, unintentionally or otherwise.

Utilizing this type of traditional investment framework would appear to make the process manageable, so long as the investor weighs the costs and benefits of this type of investment approach carefully.

However, there could appear to be a dilemma upon whose horns the investor invariably would be impaled. For example, if investment in such “vice” products as alcohol and tobacco is an anathema to a socially conscious investor, what about the transportation and energy sectors?

After all, the products get shipped to the point of sale, which requires various means of transport, which need fuel. These types of considerations make the precise definition of one’s socially responsible investment goals all the more crucial.

Depending upon the perspective of the individual, companies may display characteristics that are both irresponsible and responsible.

The Bottom Line
Socially responsible investing reflects an investor’s values. While this investment management realm’s opportunities have grown considerably, one may not ignore investing in the best practices.

Investors must clearly define their goals when undertaking this approach, recognizing its potential trade-offs and clearly articulating a policy that considers all the variables when maximizing the good over the plentiful and abundant.

Risk management and attention to costs are essential. Research indicates that results from socially conscious investing are not more statistically significant than a more conventional approach.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Investing involves risk, including loss of principal.

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