What is Socially Responsible Investing?

The business world is constantly evolving. And as business practices continue to change, so does the public’s opinion of what practices are considered ethical. For obvious reasons (profitability), companies stand to benefit from being viewed in a positive light, but the importance of ethical business practices doesn’t end there.

In recent years, investors have been placing greater weight on a company’s values and business practices as key metrics in determining whether it’s the right investment for them. While socially responsible investing (SRI) isn’t exactly a new concept, it has been gaining more traction among investors in recent years. In fact, in 1995 there were only 55 mutual funds that engaged in SRI, with $12 billion in assets. Today, there are approximately 500, with assets of $569 billion!

At first glance, SRI may seem like a simple concept. Study the company and determine if they engage in activities you don’t believe are morally, socially, or environmentally responsible. For example, if a company associated with firearms, tobacco, alcohol, or non-sustainable environmental practices, you can easily voice your disapproval by not investing in that company.

Now, with vertical market ventures becoming increasingly prevalent, it’s more challenging to distinguish the “good” companies from the “bad.” These days, many companies are so intertwined with other companies that readily identifying companies that are socially responsible across the board is almost impossible .

A Break Down of Socially Responsible Investing

There are three primary questions that investors typically ask when evaluating whether a company meets their social responsibility standards for investing:

  1. What are the company’s core values?
  2. How does the company conduct business? (i.e., what do their business practices look like and who do they associate with?)
  3. How does the company impact the environment? (And even if they’re core practices have a neutral affect, are they doing anything positive for the environment?)

With the way the world currently functions, it’s very difficult to find a company that perfectly aligns with all of your core values and beliefs. There are tons of activities that are considered “negative,” and it’s important to choose which ones represent a hard line for you.

Some factors to consider include:

  • The company’s political views
  • What religious views, if any, the company upholds
  • Any history of discrimination
  • Whether they send jobs offshore to foreign countries
  • Partnerships with other companies with values or behaviors you don’t support
  • The production or marketing of a product you might consider harmful in some way
  • Use of child labor
  • A record of unfair, unethical, or unlawful treatment of employees

There are countless moral and ethical issues you can add to this list. It’s ultimately up to you, the investor, to decide which activities you’ll condone or support with your investments.

The Basic Components of SRI Portfolios

SRI portfolios consist of a mixture of companies that focus on a variety of socially responsible business behaviors. Some of the more common SRI portfolios feature the following components:

  • Environmentally friendly technology
  • Affordable housing options and construction projects
  • Low carbon footprint
  • Gender diversity and equality
  • Community-specific objectives promoting local socially responsible causes
  • Clean transportation
  • Green power (solar, hydroelectricity, wind farms, etc.)

There are plenty of other ventures that investors may prioritize, which is one reason why SRIs are highly subjective. Your personal beliefs and core values are the compass that will guide your portfolio allocations.

What Does a Socially Responsible Company Look Like to You?

This is where things can start to get a little sticky. A company that appears to be socially responsible as a singular entity might associate with other companies that don’t hold such high moral or ethical standards.

Picture a company with farming operations that produce an array of environmentally friendly wheat and barley products. On its own, that company might appear to be ethical and in perfect alignment with your personal beliefs. That same company, might however, be the primary barley supplier for another company that produces beer or other alcohol.

While alcohol is legal and a commonly accepted part of society, different investors are bound to view the morality of that type of product quite differently.

Let’s take this potential dilemma one step further. You might also consider the fact that the wheat and barley supplier relies upon farming equipment that was manufactured and shipped from factories overseas rather than domestically. For some, that’s just the way the world works. For others, there’s little tolerance for supporting other economies outside of the US.

The point is, the lines between morally responsible and unethical are easily blurred. And where you draw the line is up to you.

It’s important to recognize that there are certain compromises you may need to make in order to achieve any degree of success with your SRIs.

SRI Funds

If investing in socially responsible companies sounds appealing, but the thought of evaluating individual companies, their specific business practices, and affiliations seems overwhelming, there is an alternative: you can invest in SRI mutual funds and exchange-traded funds (ETFs).

One advantage of investing in funds is that you can focus on specific aspects of social responsibility that you value most highly. Many funds feature companies that engage in specific socially responsible practices.

Here’s a list of the ten largest SRI ETFs in terms of assets (as of September 2018):

  • iShares MSCI KLD 400 Social ETF (DSI)
  • SPDR SSGA Gender Diversity Index ETF (SHE)
  • iShares MSCI USA ESG Select ETF (SUSA)
  • iShares MSCI ACWI Low Carbon Target ETF (CRBN)
  • SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX)
  • iShares MSCI EM ESG Optimized ETF (ESGE)
  • iShares MSCI EAFE ESG Optimized ETF (ESGD)
  • Global X S&P 500 Catholic Values ETF (CATH)
  • FlexShares STOXX Global ESG Impact Index Fund (ESGG)
  • SPDR MSCI EAFE Fossil Fuel Reserves Free ETF (EFAX)

Robo Advisors with SRI Portfolios

A number of robo-advisors have jumped on the SRI bandwagon and are offering special SRI-focused portfolios. For example, Betterment has recently introduced a new fully-diversified SRI portfolio (they’ve also unveiled a Charitable Giving feature that allows users to donate shares to their favorite charity). And M1 Finance created a pre-designed investing “Pie” that is devoted to companies that focus on environmental, social, and ethical causes. And if you’re looking for an investing platform that was specifically designed to help users invest in SRI, you may want to check out Swell Investing or Wealthsimple.

The Ethical Upside and Financial Downside of SRIs

Now, before you run off to invest your hard-earned dollars into socially responsible stocks, you should be aware of the potential downside that comes with this type of investing strategy.

First of all, socially responsible investing is a fairly recent trend. As a relatively new sector, you might find it difficult to locate funds with more than a few years of investment experience and results. On top of that, SRIs tend to come with higher expense ratios.

Moreover, there’s no guarantee that the funds will perform as well as a standard S&P 500 index fund. In fact, if you choose to invest exclusively in socially responsible companies, you may end up excluding yourself from investing in some of the most profitable companies in the marketplace.

Is SRI Right for You?

Socially responsible investing speaks to our better natures. For some investors, it makes sense to align their investments with their values and social ideals. After all, haven’t your values influenced you career choice and the way you live your everyday life? Why not let your investments do the same?

Unfortunately, SRI does come with a distinct downside: investing exclusively in socially responsible companies can significantly limit your investing upside and in some cases actually lose you money.

Moreover, it’s debatable whether SRI actually moves the needle when it comes to encouraging companies to be on their best behavior. Since you’re purchasing stock from another shareholder rather than directly from the company, the social impact of your investment is rather limited. In fact, many would contend that SRI is mostly a symbolic gesture.

Ultimately, the extent to which you invest in socially responsible companies is up to you. And while it’s a noble effort, just make sure you’re aware of its limitations.

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