The value in socially responsible investing

Once considered a niche area of investment practice, socially responsible investment (SRI) now embraces a wide investment audience that includes individuals, high net worth and otherwise, and institutions such as pension plans, endowments and foundations. Religious tenets, political beliefs, specific events and the broad remit of corporate responsibility (i.e. green investing, social welfare) all drive this investment practice.

Indeed, the professional association USSIF: The Forum for Sustainable and Responsible Investment, estimates in its “2016 Report on Socially Responsible Investing Trends” that around $8.72 trillion in assets under management subscribe to one or more of the aforementioned approaches to socially responsible investing; that’s a rise of 33% since 2014.

In the United States alone, around 519 registered investment companies – including mutual funds, variable annuity funds, exchange-traded funds and closed-end funds – utilize a social screening process, with assets of approximately $1.74 trillion, according to the USSIF’s most-recent report.

Socially responsible investing essentially expresses the investor’s value judgment and several different approaches may be used. One is when an investor avoids companies or industries that offer products or services the investor perceives to be harmful. The tobacco, alcohol and defense industries are commonly avoided by people who try to be socially responsible investors.

In the 1980s, public pressure against apartheid led American companies to cease doing business with South Africa. Today, companies are routinely evaluated not only on financial metrics, but also on social, environmental, governance and ethical issues.

Socially responsible investing can also involve active engagement between the company’s shareholders and its management. Finally, there is the activist tack that involves a large investor putting public pressure on a company over specific issues. Any one or a combination of these approaches is a critical driver in the process of portfolio management and fiduciary oversight.

Moreover, socially responsible investing is global, with different approaches emphasized in various countries as a function of their culture, government, business environment and their interrelationship. What obtains as socially responsible or not has led to differing opinions on 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, a rubric under which are subsumed not only shareholders but also creditors, management, employees, the community, customers and suppliers. Within this context, socially responsible investment seeks to maximize welfare while earning a return on one’s investment that is consistent with the investor’s goals.

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 its socially conscious constraints are. These may differ considerably, depending upon the investor. Muslims who wish to be compliant with Sharia law would exclude any companies connected with the production, sale and distribution of alcohol, any financial institution that lends and any business that profits from gambling. 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 the investor defines its constraints, it must decide upon an approach to implement them, be it the use of inclusionary or exclusionary screens, best practices criteria or advocacy. The type of investor may determine the most suitable approach. For example, advocacy and dialogue with a company or industry would be better suited to a large public pension fund.
    • Consider the work of CalPERS or the Swiss billionaire activist Martin Ebner, the latter more an example of individual shareholder activism. 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 through the exclusion of companies with unacceptable products or business practices – and explicit costs.
    • For those considering an active approach, fees for socially responsible exchange-traded and mutual funds tend to be a bit higher. For investors seeking a passive management, there are fewer indices to replicate and the funds that do typically bear higher costs.
  • 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.

That doesn’t mean there aren’t some dilemmas. For example, if “vice” products such as alcohol and tobacco are anathema to a socially conscious investor, what about the transportation and energy industries that service those products? Moreover, depending upon the perspective of the individual, companies may display characteristics that are both irresponsible and responsible.

The investor must clearly define his or her goals, recognize the potential trade-offs and clearly articulating a policy that considers all the variables when looking to maximize the good over the plentiful and abundant.