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While responsible investing itself dates back thousands of years (think of religious texts that deal with matters of money and interest) the roots for what we term “Socially Responsible Investing” in the US formed in the 1960s. It took forty years for those roots to blossom into what could be termed an industry, but the growth was undeniable. By 2017, according to the Forum for Sustainable and Responsible Investment, more than one out of every four dollars under professional management in the U.S. (more than $12 trillion) was invested with sustainable investing strategies. By 2020 the options available to investors ensure that almost all can find a solution that caters to their particular needs.
A caution: none of the terms above are strictly governed. It is always a good idea to dig a little deeper when faced with a possible investment solution to ensure that the investment aligns with your values and will function as you expect. We are going to focus on defining the two terms most prevalent in the investment world, Socially Responsible Investing (SRI) and Environmental, Social, and Governance (ESG) investing, but know that there are other strategies out there and that even ESG and SRI are sometimes used interchangeably.
At its core, SRI takes a binary approach to investing: Stocks are either allowed or not allowed in a portfolio based on the values of the investor. Investment performance is a secondary consideration. Called negative-screening, this approach eliminates an investor’s exposure to certain types of stocks. For example, a common screen is to avoid “vice” companies such as those who sell tobacco, guns, or alcohol. Negative screens can also be applied to issues. You can find screens for avoiding large polluters, certain industries such as oil or private prisons, or companies doing business in a boycotted country. Relative to ESG investing, SRI is a strict approach that allows no excuses.
Unlike SRI, ESG investors are focused on investment performance and that is the primary goal. However, ESG investors argue that future performance is closely related to a given company’s environmental, social, and governance practices. Therefore, instead of screening out all companies in a certain sector, ESG investors can review the sector to find what they deem to be the best investment opportunity. This is often called positive-screening. For example, an ESG fund could include an oil company that spends a significant amount of time and money on clean energy projects and research, or a company with a more diverse board of directors than its competitors. ESG investors argue that encouraging companies to clean up their activities (as shareholders) is good for the company long-term, good for external stakeholders, and ultimately best for the investor. ESG investors essentially argue that the world is more gray than the black and white of an SRI viewpoint.
For years, professional investors joked that so-called “responsible investing” was simply a good way to guarantee poor returns. Sure, the reasoning went, you might feel good about how your money was invested, but you were not going to feel good about how that money grew. SRI supporters, however, would retort that even if true this “cost” was worth sticking to their values. That joke is not aging well. In a 2019 study, Morgan Stanley found no trade-off in financial performance between the two investment approaches between 2004 and 2018. Not content with equal performance, and buoyed by slight outperformance starting around 2017 (see the chart: Median Total Returns of Sustainable and Traditional Funds) some investors are now claiming that selecting investments based on their ESG practices might actually lead to outperformance, or at the least less downside potential.
For example, following the first quarter, virus-related, sell-off of 2020, Jon Hale, Ph.D., CFA of Morningstar found that ”24 of 26 environmental, social, and governance-tilted index funds outperformed their closest conventional counterparts.” Skeptics pointed out that ESG focused index funds were less impacted by the energy industry’s implosion, but a research report by investment manager BlackRock indicated that it was actually a range of characteristics such as employee job satisfaction, the strength of customer relations, and the effectiveness of a company’s board that drove the outperformance for ESG minded companies. BlackRock also noted the emergence of a strong consumer preference towards sustainability-focused investments. In BlackRock’s summation, sustainable strategies no longer require a return tradeoff and can offer better risk-adjusted returns.
Sure to be an ongoing debate similar to active versus passive investing (hiring a mutual fund manager to pick stocks for you vs. investing in a low-cost index fund), it is our opinion that it is too soon to tell definitively if ESG investing has pushed the debate in favor of responsible investing vs. traditional investing. However, the investing world has certainly made note of the gains made by ESG focused firms and changes are underway as companies begin offering more information on their ESG related corporate practices to investors.
More than ever, investors are able to find an investment solution that caters exactly to their needs. Those who want to actively screen out certain industries are able to do so, those who want to set a baseline of corporate responsibility but not eliminate entire sectors can do so as well.
We believe that your money should align with your values. Whether or not that means you use SRI, ESG, or conventional investments will ultimately depend on how you want to make that happen. While some might want to eliminate all investments in a specific industry, others will prefer focusing their investments on the best actors in each industry, while still others will invest their money conventionally and make donations to groups that they want to support. And for those wondering, no, the options do not end there (e.g. Impact investing, a topic for another day).
Most importantly, how you invest (or donate) needs to fit your financial plan. Investments are a tool for you to achieve your goals and just one part of a comprehensive plan. We work with our clients to make sure that how they are invested is aligned with their life goals as well as their life values. If you are uncertain whether this is currently the case for you, we are happy to jump on a call and help you find the answer.