Making a Case for Socially Responsible Investing
Introduction
Definition of Socially Responsible Investing
Socially responsible investing, also known by other terms such as responsible, sustainable, or ESG (environmental, social, and governance) investing, is a practice that uses various socially beneficial criteria to seek out securities to invest in.
Importance of Socially Responsible Investing
Investing has generally been seen as only about making money. Indeed, that is often perceived as the only task of the investment advisor or portfolio manager: “How can I make the most amount of money for my clients given the amount of risk they are willing to accept?”
However, research has indicated that companies who engage meaningfully in environmental, social or corporate governance issues tend to outperform firms with poorer engagement. This argues for investment managers to incorporate socially responsible criteria in their investing decisions. In addition, given the repeated news – and personal experience – that our environment is undergoing tremendous, perhaps irreversible, change, there is increasing demand from investors that they be enabled to invest in products that contribute toward a sustainable future.
Brief History of Socially Responsible Investing (SRI)
This partial historical outline comes largely from the website of the United Nations-supported Principles for Responsible Investment (PRI). References to Canadian events are supplied by me from other sources.
1971: Launch of Pax World Fund, the first socially responsible mutual fund in the US.
1980s: Widespread disinvestment (divestment) from South Africa in protest of apartheid.
1986: Launch of Ethical Funds the first responsible investment fund in Canada.
1989: Publication of the CERES Principles following the Exxon Valdez oil spill.
1990: Launch of the Domini 400 Social Index, one of the first socially responsible indices.
1999: Launch of Dow Jones Sustainability Indices.
2000: Launch of the Jantzi Social Index in Canada.
2001: Meritas Financial Inc. launches socially responsible mutual funds in Canada.
2005: Freshfields Report on ESG integration and fiduciary duty published (including data on Canada)
2008: World Bank issues first labeled green bond.
2020: The CEO of Rio Tinto resigns amid pressure from stakeholders, including investors, following the destruction of sacred indigenous sites.
ESG Factors
ESG investing refers to a set of standards for a company’s behaviour used by investors to screen potential investments. The factors are described below. Many mutual funds and Exchange-Traded Funds (ETFs) will have the letters ESG in their name to indicate that they have used these criteria in their screening process.
Environmental Factors
Environmental criteria consider how a company safeguards the environment, including corporate policies addressing the following:
Social Factors
Social criteria examine how a company manages relationships with employees, suppliers, customers, and the communities where it operates. More specifically, the criteria include:
Governance Factors
Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
Types of Socially Responsible Investing
Negative Screening
This can also be referred to as exclusionary screening. The idea here is to avoid investing in stocks that are deemed morally problematic. For example, BlackRock’s family of iShares ETFs includes a series of sustainable funds. These funds use indices developed by MSCI, a major index provider. The criteria of one particular fund, GEQT, the iShares ESG Equity ETF Portfolio seeks zero business involvement in the following:
For many investors who are inspired by stricter considerations, including religiously founded criteria, additional exclusions might include companies that have involvements in:
Positive Screening
In addition to excluding investment in businesses that engage in irresponsible or unsustainable business practices, investment fund managers will also search for or emphasize investments that are particularly strong in the positive engagement of environmental, social, and corporate governance criteria. Some examples:
Thematic Investing
Thematic investing is not necessarily a socially responsible or sustainable strategy. In the broader sense, it prioritizes long-term trends rather than specific sectors. However, many themes lend themselves to sustainable investment strategies. Some of these themes may not be common in a for-profit context. In that case, the investment may involve bonds, GICs, or other forms of loans to non-profit corporations or credit unions.
Impact Investing
Impact investing is a strategy that aims to generate specific beneficial social or environmental effects in addition to financial gains. The point is to use investment capital for positive social results. In that sense, it may overlap with thematic investing.
Benefits of Socially Responsible Investing
Financial Returns
As with investing in general, the goal is to receive a return on one’s investment. The intention is that by engaging in socially responsible investing, the returns will be sustainable because the investments are in organizations that are beneficial to the environment, find support in the communities in which they operate, and are managed openly and transparently by executives and directors who work hard to eliminate conflicts of interest and unfair labour practices, among other things.
Social and Environmental Impact
While our individual actions have influence, corporations and their government regulators will have a larger impact. Companies that work hard to reduce waste and find more efficient ways to generate the energy they need for production will tend to do better than those that don’t and will be welcomed by the communities in which they operate.
Long-Term Value Creation
Socially Responsible Investing may also go by the term “sustainable” investing. While the term sustainable generally refers to investing that will sustain our world, it can also lead to more sustainable businesses. Companies that build a reputation as socially responsible will likely enhance their brand. If businesses evaluate their practices on ESG criteria, they will reduce their exposure to regulatory violations, lawsuits, and strikes, thereby reducing their overall risk and increasing their attractiveness to investors. Because the companies that are breaking new ground in terms of social responsibility tend to be newer, they are leading the way in innovation, which benefits economic development. One of those innovations is in the area of efficiency. Cost reduction due to efficiencies in energy and natural resources consumption as well as reductions in waste production is effective. Finally, the attractiveness of companies that engage in these practices tends to lead to increased interest among potential employees and better retention of staff.
Challenges of Socially Responsible Investing
Lack of Standardization
The metrics for assessing socially responsible investing are not yet standardized. This makes it difficult to compare performance on socially responsible criteria. This is not just an issue for companies that may wish to promote themselves as socially responsible businesses. It also makes it difficult for retail investors to know which investment fund to choose.
Limited Investment Options
Confusion is not the only issue that presents a challenge to investors. Some are truly clear on what they wish to invest in but find that there are few to no investment funds that invest in the kinds of securities that meet their criteria. This leads to some investors choosing to invest in individual stocks and bonds, which leads to problems like under-diversification and increased risk. This can even be an issue for the investment fund managers themselves, resulting in the elimination of certain sectors or industries from consideration and excess concentration in others. Companies that are software and intellectual property-based may have a small environmental footprint, which means they are highly likely to be considered for inclusion in a fund focused on the environment, but one could well ask whether they meet the criteria of being well-governed. I suspect not all will qualify on those grounds.
Potential for Greenwashing
“The act of providing the public or investors with misleading or outright false information about the environmental impact of a company’s products and operations.” (Investopedia) This is effectively marketing in bad faith. No doubt you have seen some products labeled “organic” or “natural” that have left you wondering about their environmental friendliness. Other methods of greenwashing include vague or ill-defined labels such as “eco-friendly” or simply “green” without providing information to explain what makes those labels legitimate, or providing a token environmentally sustainable product that gives the company a veneer of compliance with socially responsible criteria while allowing the firm to carry on largely unchanged.
I should re-emphasize here that not every investment fund is going to meet every responsible investor’s varied criteria. The funds will have their own specific mandates; perhaps the fund manager wants a broadly diversified portfolio but is focused on “best-in-class” criteria rather than 100% exclusion of fossil fuels, for example. Or a fund that focuses on women in leadership may not set up a screen for environmental concerns but instead has the mandate to emphasize social and governance criteria. These are not examples of greenwashing; rather they point out the necessity of due diligence.
How to Invest Responsibly
Research and Education
There are several good websites where Canadians can go to look for socially responsible investment opportunities.
Good Investing has a list of free resources for sustainable investing.
The Responsible Investment Association of Canada has a set of filters to help investors select investments of various types.
Morningstar, the fund analysis firm, has a helpful screener that includes a sustainability index.
Finally, the Canadian Investment Funds Standards Committee has a list of funds that qualify as responsible investments and allows you to filter the list by several criteria. You can download the list into an Excel spreadsheet if you wish and take advantage of some of the extra filtering power available that way.
The paradox of choice can make it difficult for investors in socially responsible products, but with a little bit of personal education and thoughtful analysis, you can more closely approach the goals and ethical considerations that are important to you.
This is the 193rd blog post for Russ Writes, first published on 2023-04-17
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.