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Is socially responsible investing right for your clients?
Will Myers, 08/23/2019
These days, when you're talking with one of your clients about expanding their portfolio, some form of this question is bound to come up: Can I earn a healthy return and do good at the same time?
Fueled by a raft of financial media coverage over the past two decades, the idea of socially responsible investing (SRI) has taken hold in the mind of the average investor. For socially conscious investors, the promise of making money and making the world a better place is important.
As an advisor, your primary job, of course, is to earn a return on your clients' investments. So a critical question is whether environmental, social, and governance criteria can help or hurt your clients' portfolios. Spoiler alert: Performance results are mixed.
Against that backdrop, how should you advise your curious clients? Here, we'll take a look at the SRI landscape and consider the pros and cons of investing with a conscience.
The SRI boom
Given the popularity of SRI, it can be helpful to step back and consider the many reasons your clients might have for adding a socially responsible component to their portfolio. In other words, what exactly are we talking about when we talk about social investing?
The origins of SRI go way back, with some tracing it to the financial practices of religiously minded investors more than 200 years ago. But the current SRI boom dates to the 1980s and '90s, when several mutual funds were established that catered to investors interested in affecting social and environmental issues.1
The two terms that have really stuck around are SRI and ESG, or “environmental, social, and corporate governance" investing. Beyond that, the movement goes by many names, depending on their specific emphasis: “community investing," “ethical investing," “green investing," “impact investing," “mission-related investing," “responsible investing," “sustainable investing" and “values-based investing."2
In 2018, an astonishing 26% of all money under professional management in the U.S. was invested using SRI strategies, according to The Forum for Sustainable and Responsible Investment. That's roughly $12 trillion in assets. And this is no passing trend: Since 2016, sustainable investing has grown 38%.3
The potential benefits of SRI
From the standpoint of your clients, the biggest benefit of SRI investing is the ability it gives average investors to put their values into action—to make investment decisions that are in line with the issues that are important to them.
Before you talk to your clients about the pros and cons of SRI/ESG investing—call it what you will—it can help to get a sense of the values underlying their desire to invest socially. That way, you can build a closer relationship with your client and get a sense of what type of investment vehicle might be right for them.
Just asking the question about what doing good means to them can be empowering for investors. Michael Kealy, AAMS, Coach at TD Ameritrade Education, says, “For some investors, it may be gender equality within the corporate workplace. For others, perhaps an orientation toward climate awareness or renewable energy. There are so many branches to explore nowadays that it isn't a one-stop shop."4 For nearly every socially conscious investor, there's an SRI fund that may meet their needs.
Conflicting performance data
But what about the financial results: do SRI funds perform as well as those that aren't restricted by social criteria? As an advisor, you might be skeptical.
In reality, the jury is still out. One study published in the Journal of Sustainable Finance and Investment concludes, “We clearly find evidence for the business case for SRI investing. Based on this exhaustive review effort, our main conclusion is: the orientation toward long-term responsible investing should be important for all kinds of rational investors in order to fulfill their fiduciary duties and may better align investors' interests with the broader objectives of society."4
Other evidence isn't as glowing. Several studies have shown that SRI investing can significantly impact returns. According to a working paper by Wharton School professors who study the issue, “The costs associated with socially responsible investing can be economically significant."
That's true even for those with a partially socially responsible portfolio. The authors note that “the cost of the SRI constraint is especially high for investors who insist upon allocating their entire mutual fund investments to socially responsible funds, but it is also quite substantial for the average SRI investor who allocates only a third to that subset of funds."5
One of the big challenges of SRI is the lack of reliable data around performance, though there's some sense in the industry that performance may be on the upswing.
Kealy notes that beginning in 2018, ESGs began to make performance gains—something he attributes to a paradigm shift among younger investors.
Bottom-line returns aren't the only gray area. Another problem is that the term can be vague—and so can the funds. Martin Whittaker, CEO of JUST Capital, says, “In the SRI space, there is a tendency for funds to be niche, or non-transparent about the social or environmental elements of their strategies."
Looking under the hood
Given this uncertainty about the financial benefits of SRI investing, where does this leave you as an advisor?
When it comes to talking with your clients, it's best to listen, respond directly to their questions, and proceed with caution. First, get a sense of how important socially conscious investing is to them, and enter the conversation with an open mind. Investing with a conscience can be a source of significant importance for your clients. But it's critical for you, as the advisor, to help them navigate—and evaluate—the many SRI funds out there.
Whittaker says, “Investors should proceed with the same level of caution and diligence as with non-SRI investments. It is important to 'look under the hood' when selecting an SRI fund." As with any type of investing, diversification can be key, especially given that many ESG funds are concentrated in a certain sector or industry. “Being aware of sector allocations should be front and center," says Kealy.
Be sure to let your clients know that there is the possibility that SRI investing can negatively impact their returns. If you feel that a client seems to be prioritizing the “social" over the “investment," it might be wise for you to remind them that the ultimate goal of investing is to earn a healthy return in order to meet their objectives—and it's your job to make sure they're not at risk of compromising that goal.
But also be clear that investing with a conscience isn't necessarily a recipe for fiscal foolishness, especially in a fast-changing world. “Sub-par performance isn't necessarily to be taken for granted from here on out given the popularity of ESG investing," Kealy notes. “Popularity can drive alpha."
1 “The Origins of Socially Responsible Investing." The Balance, March 26, 2019. (Found here.)
2 “SRI Basics," The Forum for Sustainable and Responsible Investment. (Found here.)
3 “Sustainable and Impact Investing—Overview," The Forum for Sustainable and Responsible Investment. 2018. (Found here.)
4 “ESG and Financial Performance: Aggregated Evidence from More than 2,000 Empirical Studies." Journal of Sustainable Finance and Investment, December 15, 2015. (Found here.)
5 “Investing in Socially Responsible Mutual Funds." Scholarly Commons eLibrary, May 2005. (Found here.)
6 “Can Socially Responsible Investing Add Meaning to Your Money?" The Simple Dollar, July 28, 2016. (Found here.)
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