"Investors want their conscience and their wallets to both feel good about the companies they are investing in through their stock portfolios." --"The Changing Face of Socially Responsible Investing," Forbes magazine, April 26, 2016.
With the dramatic growth in access to the internet, investors have benefited from increasingly rapid access to information about the companies in which they invest. With just a click or tap, they can find out whether their investment managers hold companies in the oil and gas sector; with some additional research, they can also learn about whether those companies are investing in technology to reduce their carbon footprint, and whether company management holds the same views on climate change as they do.
The modern responsible investment industry is very diverse: Investors can choose investment vehicles that exclude companies whose actions run counter to their values. Or, they can invest in products that seek to make a difference by targeting change in corporate behavior. Such strategies may be referred to using various terms such as Socially Responsible Investing; Impact Investing; and Environmental, Social, and Corporate Governance (ESG) Investing. We refer to the entire spectrum of approaches as Social Impact Investing (SII).
Interest in SII has grown rapidly over the last two decades and is now a global phenomenon. The UN-backed Principles for Responsible Investment, a global initiative launched in 2005 to promote responsible investment, has nearly 1,500 signatories, from over 50 countries, representing US $60 trillion. 220 of those signatories signed on in 2015 alone.1 Additionally, the Forum for Sustainable and Responsible Investment estimates that assets under management are now $7 trillion, up from $3.7 trillion in 2012 and $639 billion in 1995—a tenfold increase in ten years.2
Increasing Signatories Promote Responsible Investment
Source: Principles for Responsible Investment; annual figures as of April 2016.
As more investors get involved, the field has evolved to meet their diverse needs. We work with individuals, foundations and endowments, family offices, and religious institutions to ensure that their portfolios are aligned with their values. In this paper, we'll answer investor questions about the possible effects on portfolio returns, availability of investment choices, and concerns that substantial assets are needed in order to align one's portfolio with one's values.
Will my portfolio returns suffer?
Let's put a longstanding misconception to rest: for a well-managed portfolio, performance shouldn't suffer because of the inclusion of social and sustainable factors. Most long-term studies show responsible investment strategies perform competitively on a risk-adjusted basis.3 A study featured in the Journal of Investing has shown that the social or sustainability parameters are not major performance drivers, positive or negative.4 The real drivers of portfolio performance are the same as for any investment portfolio: diversification and risk management practices.
What are my choices?
Religious convictions were the impetus for the first social investors, and continue to motivate many investors. To serve a faith-based investor, money managers can exclude companies involved in controversial businesses such as alcohol production, weapons manufacturing, or adult entertainment. But the field has widened dramatically, and investor choices are much broader than even just a decade ago. Today, money managers use a variety of approaches for SII. We have grouped them into four categories: Exclusions, Solutions, Engagement, and Impact.
Exclusions. Money managers who rely on this approach will exclude companies that investors seek to avoid. Managers can also implement much broader exclusions. For example, if you are concerned about the use of hydraulic fracturing for resource extraction (‘fracking'), you may ask your money manager to avoid companies that use this technique. If you are concerned with animal welfare, your money manager can identify companies involved in animal testing and avoid incorporating them in your investment portfolio.
Solutions. This is when money managers look for companies whose products and services contribute to addressing global environmental and social problems—hence the term ‘Solutions.' Renewable energy companies are a straightforward example of the kind of company that would fit this definition. This approach can also include pharmaceutical companies working on under researched diseases, or financial companies offering services to traditionally underserved communities.
Engagement. With this approach, money managers seek to establish a candid and trusting dialogue with companies in order to advocate for changes that are beneficial to shareholders and other stakeholders. Examples include voting in favor of resolutions, asking for better disclosure of a company's environmental risk management program, or communicating with boards of directors to understand how new directors are recruited and nominated. With this approach, money managers may work collaboratively with other investors to streamline the conversation with company management. The UN-backed Principles for Responsible Investment initiative, as well as several other investor groups, like the Interfaith Center on Corporate Responsibility, help investors work together to engage with companies on areas of common interest.
Impact. This phrase is often used to refer to investments in private companies, sometimes with an impact-first requirement. But the Global Impact Investing Network, a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing, defines impact investing as "investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return." By this definition, an SII approach may be used across your portfolio, although the availability of appropriate strategies and investment options may differ across asset classes.
Integration. Some money managers will combine Exclusion, Solution, Engagement, and Impact approaches in an integrated fashion. For example, managers using a best-in-class approach may score companies on environmental, social, and governance (ESG) factors. These scores are used to select the best companies on ESG factors in each sector to build a sector-diversified, what is believed to be a best-in-class ESG portfolio. This approach is usually combined with the manager's financial research on the company. Another money manager could elect not to exclude any industries, but prioritize companies with a strong ‘Solutions' profile based on observed global trends.
The range and breath of investment choices within these groupings has multiplied rapidly over the past few years. An increasing number of financial companies offer an approach that allows for a customized and personalized approach to portfolio construction.
Do I have enough to invest?
Some investors think responsible investment choices are only available to high-net-worth investors, or worry that their only choice will be a socially responsible packaged product that may not be a great fit for them. Investors now have access to a wide variety of separately managed accounts that offer a more customized approach and the minimum investments for these types of accounts have fallen as the demand and variety of these types of accounts have increased.
There are good reasons for investors to consider, or reconsider an SII strategy. Many of us have views on the types of companies in which we would like to invest, and modern technology has made it easier for us to identify those companies as well as the ones that we would rather avoid. In the past, there were fewer options to invest with our values, but the SII industry has evolved rapidly in recent years. As SII has moved into the mainstream, growing demand is driving an ever greater range of investment choices. These choices reduce the concern that the money manager investing your assets won't be making decisions based on your priorities.
Another good reason to revisit SII is competitive performance. While there may be some impact on returns due to diversification effects over a given time period, many studies show little effect—positive or negative—over the longer term. Of course, an investment's social policy could cause it to forgo opportunities to gain exposure to certain industries, companies, sectors or regions of the economy. This could cause the investment to underperform similar portfolios that do not have a social policy. Also, a socially responsible investing style may shift in and out of favor. If investing means more than performance considerations, and you consider where your money goes as important, we suggest you discuss the potential risks and opportunities of specific SII strategies with your financial advisor. Your advisor can help you determine which strategies are suitable for your specific circumstance.
1 UN-backed Principles for Responsible Investment, April 2016.
2 "Socially Responsible Investing is Coming of Age", Investment News , March 6, 2016.
3 Bauer, Rob, Kees Koedijk, and Roger Otten. "International evidence on ethical mutual fund performance and investment style." Journal of Banking and Finance , 2005. Derwall, Jeroen, Kees Koedijk and Jenke Ter Horst. "A Tale of Values-Driven and Profit-Seeking Social Investors." Journal of Banking and Finance , 2011.
4 Kurtz, Lloyd, and Dan diBartolomeo. "The Long-Term Performance of a Social Investment Universe." Journal of Investing , 2011.
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