As investors, the ideal outcome is for our investments to make money for us and to have a positive social impact on our community. Is that possible? That is the goal of socially responsible investing.
Socially responsibility investing (SRI) is not new. In the 1700’s, various religious organizations encouraged their followers to consider how they use their resources. Prohibiting slave trade and avoiding businesses with poor working conditions or those that manufactured guns, liquor, or tobacco were among the early investing parameters.
Today, investors who use the socially responsible lens for investing may also include environmental impact, diversity, ethical corporate management, and social or human rights, among other factors. Because investor opinions may differ on what has a positive or negative impact on society, socially responsible investing is not particularly well-defined or standardized across the industry.
Defining Socially Responsible
As an investor, your first task is to determine what parameters to use to “screen out” companies from your investment portfolio that fail to meet your standards for what qualifies as a socially responsible firm. If you tend to use mutual funds instead of purchasing individual securities, your task is more challenging because you will need to review the fund’s prospectus to determine if your desires match the fund’s definition of socially responsible. Furthermore, the inability to control what specific companies the fund invests in may create difficulty finding the most appropriate option for your own goals.
Some investing strategies used by mutual funds may be focused on a singular approach like environmental or religious mandates; others may take a more comprehensive approach. In building your own portfolio, you may need to consider both types.
Is Performance An Issue?
Surprisingly, the performance of the oldest socially responsible investing index available (the MSCI KLD 400 Social Index) compares well to the returns of the S&P 500 since its inception in 1994. However, this SRI index mainly covers large, blue chip U.S. companies, many of which may not be the type of company SRI investors have in mind when they think about impact investing.
Good investors recognize the importance of diversification among company sizes and sectors. Unfortunately, it is more difficult to find SRI strategies in the categories of U.S. small and mid size stocks, international stocks, or bonds that have strong, long-term track records compared to non-SRI mutual funds. Since SRI funds often avoid certain sectors of the economy (such as energy, for example), proper diversification along those lines can also be an issue.
In the past, underperformance of SRI-focused investment strategies was a valid concern, due in large part to the lack of appropriate low cost, index funds that focused on the SRI market. Internal expenses for actively managed funds in this area were generally 1.5% or higher to compensate for the additional cost of finding small and mid-size companies that reflect the funds’ social mandates.
However, as the popularity of SRI investing has grown, investor options have grown and fees have decreased. It is now possible to find passive SRI index ETFs with fees of 25 bps, or even actively managed funds with total costs less than 100 bps. Over the years, socially responsible investing has also continued to receive growing attention from large foundations and endowments that are looking to align their investment portfolios with the institutions’ fundamental missions and the good of their communities. This additional demand will encourage more competition in this area of investing, likely leading to stronger and more robust product options for individuals who also want to direct their portfolios towards impactful investments.
If you are interested in SRI strategies, remember to look before you leap and make sure the mutual fund’s meaning of socially responsible investing aligns with your priorities. Next consider the expense ratio the fund charges to make sure it is competitive with other options that are now available. While you should be able to easily find success looking for U.S. large-cap SRI strategies that compliment your overall portfolio, niche strategies that focus on small- or mid-cap companies may still be more challenging to find.
Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.