Everyone has his or her own values and vision of how the world could be a better place. For some, the most important concern may be the environment. For others, it may be social justice issues. Whatever our biggest concern is, our values can affect how we view corporations and the impact they have on society. This can also influence our investing decisions.
Socially Responsible Investing (SRI) — sometimes referred to “sustainable investing” — is an investment strategy that considers the social and environmental impact of a company, not just the financial return. Financial gain is still important but so is social good.
Socially responsible investors may choose to avoid specific companies or industries based on their products, business practices, or their impact on the environment. For example, one may avoid companies that manufacture firearms, alcohol, and tobacco, fossil fuels, or any product they think harms society. They may also avoid companies that add pollutants to the environment. On the flip side, socially responsible investors may choose to invest in specific companies because they value their products, their business practices, or how they care for the environment.
How can you identify socially responsible companies?
To find socially responsible investments, companies can be analyzed and rated on their environmental, social, and governance (ESG) performance. This is in addition to analyzing the financials of the company.
The environmental standard in ESG examines a company’s climate change policies, carbon footprint, goals to reduce greenhouse gas emissions, recycling policies, products, use of renewable energy, and other factors that impact the environment.
The social standard examines employee treatment, pay, benefits, diversity in hiring, health and safety policies, how a company treats its business partners and suppliers, their public position on social justice issues, donations to the community, and other social issues.
The governance standard examines executive compensation, conflicts of interest, composition of the board of directors, shareholder voting rights, transparency in accounting methods, history of lawsuits, relationship with regulators, lobbying, and other corporate governance issues.
There is no official standard or central authority for ESG ratings, but there are several providers of ESG research, reports, data, and ratings. They all have their own methodology and standards to evaluate ESG criteria. Some of the most popular providers include Dow Jones Sustainability Index (DJSI), Thomson Reuters ESG Research Data, MSCI ESG Research, Bloomberg ESG Data Service, and Corporate Knights Global 100. Money managers, institutional investors, and the like use providers like these to assist in their investment decisions.
How do you select your own socially responsible investments?
You can always make your own stock selection. But picking stocks is hard. It’s not easy to find companies that have solid financials, strong management, marketable products, and all the factors that contribute to a profitable return. When you consider ESG criteria as well, it makes your analysis that much more difficult. But don’t worry. You can leave the investment management to the experts.
For example, you can invest in mutual funds or exchange-traded funds (ETFs) that focus on socially responsible principles. They are offered by the biggest and best known mutual-fund companies. The money managers at these funds consider a company’s ESG rating and performance when making their investment selections. These funds’ objectives may not differ much from any other fund investing in the same asset class — except that they exclude companies that do not meet certain social and environmental criteria. Some SRI or ESG-conscious funds may focus on a specific industry such as renewable energy.
You can also invest using a managed account. Like a mutual fund, a managed account has an investment manager that makes all the investment decisions based on the account’s investment objectives. Also like mutual funds, the portfolio objectives can include socially responsible investing principles and ESG criteria.
Don’t ignore basic investment principles in favor of being socially responsible!
Socially responsible investing does not mean that you disregard important investing principles. Investing involves risks and socially responsible investing is no different. You still face the volatility of the financial markets and the possibility of losing your money.
When investing, you need to determine your financial goals, time horizon, and risk tolerance. Make sure you have the right asset allocation. Short-term financial goals should not be put into stocks. It does not matter how socially responsible a company is, the stock market is volatile and no single company is immune to it. Investing in stocks is appropriate for your long-term financial goals only.
Make sure your investments are diversified. A company may manufacture a great product that has a positive impact on the environment or have high ESG ratings, but that does not guarantee the company will be successful. Companies fail all the time. That is why you shouldn’t put all your eggs in one basket. If you put all your faith and money in one or two companies, you will have a lot of risk exposure. You can decrease your risk by investing in a variety of companies and industries. One of the best ways is through mutual funds and ETFs. And as discussed above, there are many funds that adhere to socially responsible principles.