More and more people are looking for ways to do good in the world. So it's no wonder that people are starting to question what goes on behind the scenes with their investments. Making sure that our money aligns with our values was always a bit difficult until socially responsible investing (SRI) entered the investment scene.
I sat down with Brendan Erne, the Director of Portfolio Implementation from Personal Capital, to explore exactly what SRI is and why it is taking the investment world by storm.
Let's dive in to socially responsible investing and find out if it does, in fact, pay well to do good.
What is Socially Responsible Investing (SRI)?
Socially responsible investing (SRI) is a particular type of investment. It goes by many names, including “green” investing, ethical investing, or sustainable socially conscious investing.
Regardless of what it is called, socially responsible investing aims to allow people to make investments that align with their values and beliefs. Think of it as putting your money where your mouth is. Or maybe your heart!
But how exactly do you know who and what to invest in? There are actually third party research firms that provide socially responsible index scoring data. That means they rate the behaviors of different companies. This rating is like giving investors a peak behind the curtain.
Two of the biggest research firms are Sustainalytics and MSCI. Both Sustainalytics and MSCI use risk ratings that measure categories specific to SRI. The purpose of these metrics is to show how the company being analyzed performs against those risks compared to its peer companies.
Then, individuals, as well as investing companies and platforms, can use that scoring data to create a more socially responsible portfolio.
What Categories Does SRI Cover?
Socially responsible investing can be thought of in two ways: one part of SRI is exclusionary and the other is inclusionary.
Exclusionary investing is a negative screening that basically allows investors to avoid investments that don’t align with their values. For instance, some people choose to actively exclude tobacco or big oil from their holdings portfolio. Think of it as who or what you cross off the guest list of your own personal investing party. This type of exclusionary investing is the more traditional form of SRI.
Recently, however, a new type of SRI is gaining popularity. Inclusionary SRI is a positive screening that helps investors choose companies based on different factors. Companies are scored on their ESG, or their environmental, social, and governance efforts. This provides an additional layer of analysis.
This way, investors can actively choose which companies to put in their portfolios. The ESG score helps them look at different categories.
Some categories include:
- Carbon footprint,
- Renewable energy,
- Diversity of workforce, and
- Executive compensation
This ESG analysis then allows investors to proactively seek out companies that operate in line with values that the investors hold.
Does Socially Responsible Investing Perform Well?
Many people are looking to make socially responsible choices as individuals. Sometimes, though, they have reservations about extending these choices to their investments. One of the most common questions that new and seasoned investors have about SRI is “Does socially responsible investing perform well?”
You can evaluate SRI performance by looking at two components: the financial performance of the company that prioritizes ESG issues and how SRI investing plays out in the stock market.
While SRI is still relatively new to the US investment scene, the initial data looks very promising in both regards.
SRI Boosts Financial Performance of Companies
More and more companies are making moves to prioritize the environmental, social, and governance (ESG) factors of how their companies run. An increasing amount of evidence shows that ESG impacts profitability.
For instance, companies that make an effort to reduce their water use and energy footprints do good for the planet and also lower their cost. Conversely, a big carbon tax hits some companies that rely on big oil. That tax slap hurts their bottom line.
More so, from a social aspect, companies that are making an effort to prioritize ESG benefit there as well. It’s no secret that companies who consistently do right by their employees are able to solicit and retain top talent.
Another compelling reason to look for companies that value SRI is because those companies often prioritize diversity. Diversity in the workforce, especially at higher levels, is linked to better performance and innovation.
Overall, it seems clear that socially responsible investing produces more profitable and stronger financial results for the companies.
But what about the benefits for people who want to back these companies? Well, there’s good news for investors, too.
Exploring Evidence That SRI Benefits Investors
One of the most exciting studies surrounding SRI comes from the Deustche Bank meta analysis released several years ago. Deustche Asset Management teamed up with the University of Hamburg to explore how ESG might impact corporate performance. The full analysis aggregates over 2,000 studies on ESG, making it one of the most comprehensive ESG studies done.
The primary conclusion from the study is that there is a nonnegative relation between ESG and a company’s corporate financial performance. Put another way, there's no obvious negative effect. On top of that, there are a growing number of studies showing that there is actually a performance benefit.
SRI Shows Up in Top Stock Performers
In addition to the meta analysis at Deustche Bank, a Harvard Business School finding also underscores the profitability of SRI. When looking at a select set of US stocks, the top performers outperform the benchmark on an annual basis by about 6%. That means that there is a growing body of evidence to suggest that SRI doesn’t just benefit the company; it also boosts the performance of the stock for investors.
SRI Adoption Rate
People are flocking to socially responsible investing. While SRI initially gained traction in Europe, it is spreading like wildfire in US markets now. Initially, large pension funds and similar entities in the United States started looking at SRI. Now, the popularity of SRI has filtered down to the everyday retail investor.
That means that many investment platforms and brokerages, such as Personal Capital, are trying to make SRI options more readily available to investors like you and me.
Over the last two years, more than $17 trillion is now part of socially responsible investing funds. That means that approximately 1/3 of professionally managed US dollars now falls within the umbrella of SRI. That is a 42% increase within those two years since the previous analysis was done.
Personal Capital has also seen an uptick in demand for SRI. At the start of 2020, approximately one in every five clients were exploring SRI options. By the end of the year, the demand increased to 1 in 3.
How Personal Capital Can Help
Personal Capital can help investors looking to explore socially responsible investing. They consistently want to help you increase your return and reduce your risk. Now, their investment approach can include an SRI perspective.
Personal Capital built their SRI a bit differently. Both exclusive and inclusive filters help investors make informed choices. For instance, you can avoid investing in individual US energy stocks that support big oil, while also choosing to support the most ESG-focused companies.
Personal Capital employs a best-in-class approach to choosing their SRI options. In fact, their picks rank around the 90th percentile on ESG metrics.
Additionally, investors have the option of using individual stocks to allow for greater customization. When selecting these stocks, investors can utilize a values based approach. By ruling out the different areas of the market they do and do not want to be invested in, these investors can make sure their investments align with their values.
Plus, they are usually more tax efficient, too. That's winning across the board!
Closing Thoughts on Socially Responsible Investing
You recycle and compost. Or maybe you do different kinds of advocacy and outreach in your community. Perhaps you try to prioritize charitable giving as a family and teach your children to value diversity.
Individuals try to make a lot of positive choices in day-to-day life. So what about those positive choices and money?
That's where SRI comes in. Before SRI, it was hard to know what mattered to different companies. Now, though, you can make sure that your money matches what matters to you.
If SRI interests you, take some time to explore more with Personal Capital or your current brokerage. Thanks to SRI, you're one step closer to doing even more good in the world.
Have you heard of socially responsible investing? Do you think SRI has a place in your money plan?
Please let us know in the comments below.
Personal Capital Disclosure
SRI scoring data powered by Sustainalytics. Advisory services are offered for a fee by Personal Capital Advisors Corporation (“PCAC”), a registered investment adviser with the Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Investing involves risk. Past performance is not indicative of future returns. You may lose money. PCAC is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC is a wholly owned subsidiary of Empower Holdings, LLC. 2020 Personal Capital Corporation. All rights reserved.