Primer on Socially Responsible Investing
July 14, 2020
SRI, ESG, and green investing are all variations on the broad theme of aligning investments with one’s values. The concept is not new, but it has evolved significantly over the years. My own involvement with socially responsible investing started fifteen years ago. At the time, if a client expressed a desire to address a social issue such as green energy through their portfolio, we would incorporate a single mutual fund that excluded oil. There simply weren’t a lot of other options. That has all changed and now the universe of good investments has expanded so much that it’s possible to create a dedicated diversified portfolio that contains most of the broad asset classes we believe are important to own with the same characteristics as a traditional portfolio.
The earliest socially responsible investments (SRI) had negative screens, meaning they simply excluded companies with negative social effects that investors wanted to avoid from tobacco, a poor environmental record, alcohol, fast food, pornography, and weapons, to name a few. With these negative screens, the early mutual funds excluded entire industries which could result in large variations from their benchmarks. These early funds were also prohibitively expensive.
The industry has since evolved in a number of ways since those early days. Fund research is more readily available, especially now that an increasing number of companies are voluntarily disclosing some sustainability metrics. Fund costs have come down, and there are simply more funds to choose from. Importantly, instead of just excluding companies that don’t meet a strict set of social criteria rules, many funds now reward companies that are making a positive impact.
The term ESG, now widely used, refers to Environmental, Social, Governance. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how a company manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
Do socially responsible funds outperform the market?
Anyone can choose a time period to support their underlying thesis on performance, i.e. there are periods where socially responsible funds outperformed relative to more mainstream funds but other periods where they underperformed. The main driver for the use of SRI funds should be philosophical and values-based, not because of performance expectations; however, today’s funds strive to provide returns in the ballpark of their respective benchmarks at a reasonable cost.
How granular can I get with the issues most important to me?
There are several good broadly defined mutual funds to choose from that allow a typical investor to meet most of their ESG goals. At Sand Hill, one vehicle for ESG investing that we offer is the ability for clients to create the equivalent of a personal equity mutual fund through a subadvisor relationship we have. This account is managed in the context of your larger Sand Hill portfolio and allows you to customize your own fund from a menu of ESG choices. The minimum per account at present is $1M.
Portfolio size, however, isn’t a limiting factor for those clients interested in ESG investing. Sand Hill also utilizes several ESG mutual funds for exposure to the same broad asset classes that we include in a typical diversified portfolio with modest size minimums. Some categories, such as alternative investments, are more challenging to fill, but our goals remain the same for all clients: create a diversified, low cost, tax-efficient portfolio that supports long-term goals.
Is Socially Responsible Investing right for me?
We want to accommodate our clients’ requests for socially responsible portfolios within the parameters listed above (diversified funds and portfolio, low costs, fund goals aligned with client goals). However, ESG is not something we will recommend for all clients. While it can be a great way to put your money where your mouth is, there are just as many instances where allowing the portfolio to perform optimally with no constraints and then writing a check to charity will achieve the same goal in a much simpler manner. If this area is of interest to you, we encourage you to reach out to your Wealth Manager to have a more personalized discussion about your investment portfolio.
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