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Socially Responsible Investing: Invest in a World You Can Be Proud Of

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 sustainable investing reduces 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.”

On this page:

  • What is SRI?
  • Environmental, social, and governance (ESG) issues
  • How to invest with your values
  • Financial impact of irresponsible businesses
  • Is this a smart investing strategy? Spoiler alert: Yes, it can be.

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, ESG, responsible, or impact investing) means different things to different people—because one individual might value certain things more than others. But the concepts are similar, 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.
  • Material risks: Investment managers often want to quantify what they’re doing and measure the risk (including the risks they’re avoiding). Sustainable investing attempts to reduce exposure to events and issues that will have a financial impact on the companies you invest in. In many cases, those types of controversies can also align with your values.

How Sustainable Investing Works

Values screening, impact efforts, and material risks: Three elements (that may interact with each other) of sustainable investing
Three elements (that may interact with each other) of sustainable investing.

SRI is not new—individuals and institutions have been doing it for decades. Early versions of SRI focused on so-called “sin stocks” like gambling, tobacco, pornography, and alcohol.

But values differ among different groups, making the topic confusing. Some sustainability-focused investors have no problem with alcohol, and they value organizations that make an impact. Another challenge is that it’s hard to measure some values-based approaches (although that doesn’t make them bad approaches).

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.

Environmental:

  • 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.

Environmental issues may be among the easiest to get a handle on because they’re often based on physical science. You can measure things like how many gallons were lost in a toxic spill, and you can quantify carbon emissions relatively easily.

Social:

  • 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.

Social topics are harder to define and measure. The most interesting data may exist only in anecdotes and news stories, and it’s a challenge to organize, categorize, and report on the topics you care most about. Plus, a company may be “less good” than it appears, depending on who you ask, making the definition somewhat subjective.

Governance:

  • 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 create incentives that skew executive compensation and promote reckless behavior). Examples include those associated with accounting scandals or questionable political contributions.

Governance measures are somewhat straightforward. You can use logical tests and some basic math to determine if companies pass your screens. For example, does the company have women and people of color in executive leadership, and how many?

Good business is good business. And being mean can often come back to haunt you.

How to Invest With Your Values

If that all sounds good to you, there are several ways to implement a socially-conscious investing strategy.

Tip: To learn more about your risk preference, try this risk questionnaire developed with input from psychologists.

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.

Impact vs. Risk

As you evaluate your sustainable investing strategy, it might be helpful to distinguish between investment risk and investment impact.

Investment risk refers to losing money as a result of some type of event. When we’re talking about SRI or ESG, those events might things that result in bad press and financial consequences. For example, a company might lose customer information in a data breach. In addition to making people unhappy and losing trust (which can reduce revenue going forward), the company might have to pay fines, penalties, or other costs to clean up the mess. There’s a real financial risk that can impact the stock’s performance—and even traditional financial models would see that as a problem.

Impact is often about things you value personally. For example, you might prefer companies that have diversity in their boards of directors and executives, even if there’s not an (easily identifiable) instant and direct impact on revenue. However, the company is doing good things, and we’d expect it to perform well with diverse viewpoints. Or, you might want to invest in companies that focus on renewable energy—simply because you think that’s what’s best for the earth.

As you look at scoring models for SRI and ESG, you might find that they focus on one of these factors while ignoring the other. The investment risk is the most easily quantifiable, so large financial firms are eager to measure and publish information on those factors. However, if impact is more important to you, you may need to do some extra homework.

“The perfect is the enemy of the good.”

When it comes to socially conscious investing, you might not be able to focus on the issues with the perfect level of detail.

If you move your IRA into ESG-focused funds, the ice caps won’t stop melting, poor people won’t immediately see fewer hurdles, and executive boardrooms won’t suddenly reflect the racial and gender makeup of the U.S. population.

Still, you can invest in a portfolio that dramatically reduces exposure to things you don’t want—and that promotes the things you do want. This is a step in the right direction, and the options should continue to improve for you over time.

As just one example, socially-focused fixed income investing is challenging. If you apply screens that are too strict, you might not have much to choose from. Unless you’re willing to put most of your money into stocks (typically considered a high-risk approach), you may need to be satisfied with partial improvements until this world matures.

It’s All Connected?

Fortunately, there may be some overlap among socially-conscious companies. Imagine an organization that treats workers well and avoids controversial lawsuits. That company might also be likely to employ environmentally sustainable practices and be a positive force in the community.

Perhaps it’s easier to understand this from the opposite direction: Imagine a movie with a company that is environmentally destructive, mean to employees, and lacking diversity in leadership. It would not be surprising if that company was also polluting the environment—especially in poor neighborhoods around the company plant.

When you invest in companies that make an effort to be “good,” you might make an impact in several ways.

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 when companies misbehave.

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 a financial 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.

What About Greenwashing?

In a world where investors are increasingly focused on responsible corporate action, some organizations make a good show of being environmentally and socially responsible. They might even include buzzwords in advertisements that lead you to believe they’re doing the right things. However, there’s a difference between talking the talk (and even writing policies and procedures related to ESG) and walking the walk. So-called “greenwashing” happens when companies try to present themselves as enlightened—but they’re only doing enough to make themselves look good.

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:

Investing in mutual funds and other financial vehicles 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.

Investors should consider the investment objectives, risks and charges, and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. Contact Justin Pritchard at 970-765-0595 to obtain a prospectus, which should be read carefully before investing or sending money.

The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.

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