Yahoo Finance Does Socially Responsible Investing Actually Work?
Socially responsible investing, or SRI, is one of the hottest trends in investing right now. But does it work?
To answer that, it might help to know what SRI actually is. SRI is an investing strategy that often applies screens to exclude companies that don't align with your environmental, moral, ethical, religious, or social values. It can also apply positive screens to seek out investments in companies that "do good."
Environmental, social, and governance (ESG) criteria frequently go hand-in-hand with SRI; socially conscious investors look for companies that are respecting the environment, treat their employees well and respect diversity, and are structured in a shareholder-friendly way.
[See: 10 Long-Term Investing Strategies That Work.]
At the end of the day, socially responsible investing is different from traditional techniques because it aims to produce two types of returns: social and financial. But does it actually achieve those goals?
Defining SRI. Perhaps the most glaring issue facing SRI today is its own nebulous definition. "What is socially responsible is very unique to individuals and there are few absolutes with respect to what is socially responsible or what isn't," says Bob Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania.
ESG practices, Johnson says, are like "restaurant or movie critics, the grading of those practices depends upon who is doing the grading. That is, beauty is in the eye of the beholder."
Take the iShares MSCI KLD 400 Social ETF (ticker: DSI), one of the many socially responsible funds giving investors access to SRI investments. The ETF tracks an index of companies with "positive environmental, social and governance characteristics." Yet one could make the case that Coca-Cola Co. ( KO), one of the fund's top 10 holdings, has been one of the companies most responsible for the global spread of obesity and diabetes.
Portfolio 21 Global Equity Fund Class R ( PORTX) is another fund seeking to prioritize companies with strong ESG thresholds, and specifically claims to exclude, among other traits, companies that engage in "egregious labor practices." Yet the second-largest holding of PORTX is Apple ( AAPL), a company that's been widely criticized for working conditions at Chinese iPhone manufacturer Foxconn, where a number of employees have committed suicide on the job during and leading up to high-pressure production runs.
Excessive screening. Kevin Mahn, chief investment officer of Hennion & Walsh, says that the screening aspect of SRI can also be controversial.
For example, an SRI fund may ban companies that earn a certain percentage of their revenue from tobacco, alcohol, weapons, or gambling. These screens fail to consider that "excluded companies that were perhaps 'sinful' in certain areas were providing positive, sustainable characteristics in other areas."
"Limiting the sectors or industries that are included in a given investment portfolio can also hinder potential diversification and/or growth of capital opportunities," Mahn says. Socially conscious investors are still investors after all, and if returns are materially limited by investing with a conscience, that's a problem for the industry.
Debatable results. Another serious question swirling around socially responsible investing is simply how well it works. From the social side, a 2016 research paper titled "A Pitfall in Ethical Investing: ESG Disclosures Reflect Vulnerabilities, not Virtues," found that "ethics controversies are more likely for firms that adopt popular ESG policies."
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Financially speaking, another paper, "The Price of Sin: The Effects of Social Norms on Markets" (Hong and Kacpercyk, 2009), finds that " sin stocks also have higher expected returns than otherwise comparable stocks, consistent with them being neglected by norm-constrained investors and facing greater litigation risk heightened by social norms."
In other words, screening out sin may cost you. The paper says nothing, however, about how screening in a positive manner, for companies that comply with SRI standards, impacts return.
Shifting to the positives. There's no reason to write off being socially responsible, or prizing ESG-aware companies.
Who doesn't want to live in a clean, safe, sustainable world? Why shouldn't there be diversity on boards and management teams? And there's all too much evidence that when corporate governance goes awry, bad things happen. Just look at Enron and Worldcom, or more recently, Wells Fargo & Co. ( WFC). If appropriate checks and balances were in place, customers, shareholders, and employees would've been spared a lot of heartache and pain.
Furthermore, there's the feeling that socially responsible investing is just the right thing to do.
Thom Duffy, vice president of investment strategy for Knights of Columbus Asset Advisors, puts it this way: "Knights of Columbus, going back to 1882 and our founding, has always been a Catholic organization. For us, to have integrity of principles you can't just say that you believe in something, except when you invest."
"So we like to pursue strong investment returns while maintaining our integrity," Duffy says. "And we've got a more than 100-year history of doing exactly that." Duffy also rejects the idea that screening out undesirable stocks impacts returns.
There's also legitimate reason to believe that SRI can do more than just help you sleep well at night.
The U.S., China and nearly 200 other nations have now ratified the Paris climate change agreement, aimed at reducing global greenhouse gasses. That means that "countries are really serious about this, and so these companies have a leg up on making that happen and profiting from it," says Joe Quinlan, head of thematic strategy at Bank of America, referring to environmentally conscious companies.
Finally, to say that socially responsible investing hasn't had some sort of real impact on the way companies do business simply isn't true. Trillium Asset Management, for example, has successfully lobbied companies like Amgen ( AMGN) and Tailored Brands ( TLRD) to increase transparency and disclosure policies surrounding sustainability. It was also instrumental in lobbying for the Pebble Mine in the ecologically fragile Bristol Bay, Alaska, to be abandoned, which eventually happened when Rio Tinto ( RIO) withdrew from the project in 2014.
So is SRI perfect? No. But it's making a difference. Going forward, expect longer-term studies to be done on SRI, and for its definition to become more and more clear. Just don't think of it as a passing phase.
"We had the BRICS -- Brazil, Russia, India, China, South Africa -- that to me was just good marketing and good spin from Goldman Sachs," Quinlan says.
[See: 7 of the Best Socially Responsible Funds.]
"But when you talk about social impact investing or ESG, this isn't a fad," he says. "This is going to be with us for generations. No doubt about that."
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