The Pros and Cons of Socially Responsible Investing (SRI)
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Some investors just don’t want pornography in their portfolios. Others want to stay away from tobacco, alcohol, left issues, right issues, religious factors, or a variety of other factors.
To accommodate these concerns, socially-responsible investing (SRI) has evolved as a thematic approach to investing. SRI may involve avoiding companies that sell potentially harmful or addictive goods such as alcohol, tobacco, guns, or pornography, or emphasizing businesses that focus on environmental concerns, clean energy, employee lifestyle, social justice, and more.
There is much debate in the advisory community about whether socially-responsible investing strategies have a material impact on the risk & return outcomes of client portfolios. Let’s take a look at some of the pros and cons of socially responsible investing:
The Pros of Socially Responsible Investing:
- SRI may help you sleep better at night, knowing that you’re doing something to avoid investing in unethical causes. In the past, it would have been necessary to manage your own portfolio of carefully selected, individual securities to accomplish this.
- However, advances in technology and easy access to information has led to a proliferation in the availability of socially-conscious strategies. According to The Forum for Sustainable and Responsible Investment, there are over 456 mutual funds in the environmental, social, and governance (ESG) investing space. [1]
- There seems to be an SRI vehicle out there for everyone, with some even observing specific religious affiliations. For example, the Amana Income fund (AMANX) adheres to Islamic principles, while funds like New Covenant Growth (NCGFX) are consistent with Presbyterian beliefs.
The Cons of Socially Responsible Investing:
- What defines a socially-responsible company is ambiguous and subjective. Avoiding tobacco companies is simple enough, but adhering to other SRI guidelines can get murky, fast. For example, if a CEO of a company makes a sizable donation to the other side of the pro-life/pro-choice debate, some investors may consider that unforgivable. As another example, the FTSE KLD 400 Social Index has Coca-Cola as a top holding. Depending on your views toward obesity, you may or may not consider that an ethical investment.
- Another con is that, although mutual fund fees have fallen in recent years, the fees for socially-conscious strategies are typically higher than passively-managed funds. Portfolio managers tend to charge higher fees to compensate for their need to constantly monitor companies’ activities to ensure the standards of the fund are being upheld. Those higher fees can have a material drag on performance.
- What about diversification? Building a well-diversified, global portfolio can be a challenge when a client wants to invest in companies with a proven record of following stringent guidelines. This is not because great, sustainable companies don’t exist globally, but because the information needed to screen companies on a global level may not be readily available. This could affect the ability to diversify and reduce portfolio risk.
- Plus, while SRI strategies may help a client sleep better at night, it’s difficult to quantify the impact that such investing actually has. If the client wants to see the material impact they’re having on the world, they may have better results by focusing on maximizing investment performance and using the proceeds to fund charitable endeavors.
So what approach is best? It depends on your personal situation. If socially-responsible investing will help you sleep better at night, it may be worth exploring, at least for a portion of your portfolio.
For others, it’s possible to have a more material impact through charitable donations and philanthropy, while avoiding the higher fees, challenges to diversification, and subjective nature of socially-responsible investing.
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November 26, 2024
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