For investors who seek to align their finances and personal beliefs, socially responsible investing– or as the concept more recently is being called, “sustainable and responsible investing” (SRI) – is one of the fastest growing areas of investment management and one that continues to gain ground despite challenging market conditions of the past several years.
In fact, the latest financial crisis may be one of the drivers of this trend, perhaps causing investors to look at their investment strategies in a more comprehensive way. “It made nearly everyone revisit their investing,” says Michal Ann Strahilevitz, a professor of business administration and marketing at Golden Gate University who studies how emotions affect a range of behaviors. “Sometimes when the wealthy gain or lose a lot of wealth, they start to think about other areas of their life that also matter.”
While no investment strategy was immune to the most recent financial crisis, more investors sought a socially responsible style when they committed their funds. Assets involved in sustainable and responsible investing increased more than 13% from 2007 to 2010, compared with the broader universe of professionally managed assets that rose less than 1%, according to the Forum for Sustainable and Responsible Investment (US SIF). By the beginning of 2010, 12% of all professionally managed investments were in socially responsible investments.
Can You Do
Well While Doing Good?
The traditional view of SRI had been to solely focus on screening out companies that disagree with the investor’s views on environmental, social or corporate governance practices.
Today, however, socially responsible investors attempt to reward the companies doing the most good by assembling a portfolio with a “best of sector” approach, says John McCareins, senior investment program manager at Northern Trust. In other words, rather than avoiding investments that are not compatible with their values, investors seek out companies with the highest environmental, social or governance records relative to their peers.
This positive rewards-based approach helps investors cast a wider net with their investments and likely may make SRI portfolios more competitive. Portfolios based on the negative screening approach, on the other hand, risk underperforming the wider market since they avoid investments in certain sectors.
In his research covering 1995–2008, Oklahoma City University Associate Professor of Finance James Ma found a slight theoretical disadvantage for SRI funds because of opportunity cost – a reduction of as much as two percentage points per year. But how much returns theoretically might be affected depends on how much of the investment universe is screened out. That’s less of an issue with the newer rewards-based approach. Plus, in practice, researchers have found conflicting evidence as to whether SRI funds underperform conventional funds.
In addition, concerns that investors who follow their beliefs sacrifice performance seem to diminish over time, McCareins says. In fact, returns for one of the oldest SRI indexes, the MSCI KLD 400 Social Index, slightly trail its benchmark, the S&P 500 Index. Over a 10-year period, the MSCI KLD 400 Index saw a 1.09% gain as of the beginning of December, while the S&P 500 gained 2.88% during the same period. Similarly the MSCI World ESG Index has performed in-line to slightly ahead of its benchmark, the MSCI World Index. Since its inception a little over four years ago through October, the MSCI World ESG Index has returned -4.06% versus the MSCI World Index return of -4.37% with a very similar risk profile. The takeaway is that investing responsibly and achieving investment objectives are not mutually exclusive, particularly for investors biased toward a passive approach to portfolio implementation, McCareins says.
Investors with long-term rather than short-term return perspectives may be better suited for SRI, says US SIF CEO Lisa Woll, because of its focus on long-term competitive financial returns and positive societal impact. A big-picture outlook can help ride through uncertain times in the short run.
McCareins adds that people who use their beliefs to guide their investing typically look for returns beyond necessarily what can be measured by numbers. “How do you measure value contribution? How do you measure performance and achievement of your objectives?” he says. For example, many investors today use SRI to achieve their immeasurable goals of better corporate governance. “Investors want more transparency,” says Thomas Wackerlin, senior product manager at Northern Trust. “They can use the investment process to demand good governance.”
Right for You?
There is no “typical” socially responsible investor, Woll says. “You can say [socially responsible investors] are highly engaged in the world and very interested in their community,” she says. Investors can access a range of investments across asset classes using one or more socially responsible strategies.
Ultimately, investors must decide if they want to measure the success of their portfolios strictly by the return on investments, or if they also seek to achieve other objectives with their investments. Those objectives, in turn, will dictate which SRI approach– screening out investments that do not align with values or rewarding companies with the highest environmental, social or governance records – is the best fit.
Regardless of the type of socially responsible investment chosen, any individual who has decided to invest based on personal beliefs should work with a trusted investment advisor rather than try to screen companies on his or her own, Ma says. Advisors have access to proprietary research information that can narrow and rank different companies based on their social and financial performance.
But Wackerlin points out that requests for these strategies largely are client-driven. “Clients come to us with a definite view,” he says. “They’re just coming to us to make it happen.”