What Is Socially Responsible Investing? How to Get Started
Whether you’re new to investing or have been doing it for years, you may want to consider socially responsible investing or SRI. This is particularly true if you’re looking for a way to give back and make a positive difference in the world.
Take a closer look at what SRI is and how it works so you can decide if it’s right for you.
What Is Socially Responsible Investing?
SRI is an investment strategy that considers both social change and financial returns. Also known as sustainable investing, value-based investing, and ethical investing, SRI can give you the opportunity to support companies that align with your values.
Investors who pursue SRI look to own shares of profitable, transparent companies that prioritize the environment, human rights, community involvement, and other activities that support people and our planet. They may also purposely avoid companies in industries that they consider questionable or unethical.
Why Socially Responsible Investing?
Every socially responsible investor has their own unique goals. One might prefer green companies that work towards a cleaner environment and reduce the carbon footprint of their products and services. Another investor may steer away from businesses in countries that violate human rights.
There are also many health-conscious investors who actively refrain from investing in companies that sell alcohol or tobacco. In addition, some investors strive to promote morality and forgo firms in industries like gambling and pornography. You can customize your SRI strategy to fit exactly what you do and don’t believe in.
In addition to its benefits to investors, SRI can help companies gain access to capital so they can grow and fund their corporate social responsibility programs. It may also encourage firms to prioritize ethics and improve the way they operate with their employees, customers, and shareholders.
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How Does SRI Work?
Socially responsible investors can choose from a wide variety of investments. The most common types include:
Mutual Funds and ETFs
There is no shortage of mutual funds that are considered socially responsible. If you go to The Forum for Sustainable and Responsible Investment, you’ll find a handy list of hundreds of socially responsible mutual funds and ETFs.
Community Investments
As a socially responsible investor, you can also lend your money to community organizations. To do so, you may put funds into community development financial institutions (CDFIs), such as banks, credit unions, and loan funds, which offer financial services in low-income areas. To find CDFI banks, visit the National Community Investment Fund (NCIF).
Microloans
Microloans are small loans you may make directly to startups. They offer another way to invest your money in a socially responsible way. The most popular microloan organizations you may want to consider include Kiva and Zidisha. Both of them specialize in microloans to entrepreneurs in underdeveloped countries.
It’s important to note that socially responsible investors are not charitable investors. Most of them still want to make a profit and maximize returns. However, their goal is to do so without going against their ethics and values.
What Is ESG?
ESG is an acronym for environmental, social, and governance. These are the three factors that socially responsible investors measure when they assess the sustainability and ethical impact of investing in a certain company. Oftentimes, these investors use ESG criteria to evaluate investments. Here’s a brief overview of what each word in ESG entails.
Environmental
Environmental criteria may cover a company’s waste management program, the way they use renewable energy sources, and how they handle potential air and water pollution. It may also relate to their stance on raw material sourcing, climate change, deforestation, and animal welfare.
Social
Social criteria can include a variety of social issues, many of which deal with relationships. It’s often tied to customer satisfaction, data security, employee gender and diversity, turnover, fair labor practices, and human rights at home and abroad.
Governance
Governance refers to how a company and its employees, shareholders, and customers are treated and managed by its executives and board of directors. It also pertains to executive compensation, internal corruption, political contributions, and lobbying.
ESG and SRI: What’s the Difference?
While the terms ESG and SRI often get used interchangeably, there are differences between them. ESG is similar to SRI in that it considers the social and environmental impact of a specific investment. However, it also looks at how a company’s compliance (or lack thereof) to these standards may play a role in its financial performance.
In addition, SRI investing excludes certain investments or selects them based on ethical guidelines. It uses ESG factors to screen investments negatively and positively. For example, an investor may avoid mutual funds that come from companies that sell drugs and alcohol.
ESG investing is most concerned with environmental, social, and governance factors, while SRI refers to when investors avoid certain investment opportunities.
Why Do Investors Like ESG?
Most investors are firm believers in ESG because it allows them to feel good about the companies they invest in. They don’t have to allocate their funds towards a company whose values contradict their own.
Many ESG investors believe that they are taking steps toward a more sustainable future for themselves and the people around them. With ESG, they can align their finances with their values.
While ESG is often referred to as a “feel-good investment strategy,” it can also lead to high returns, making it appealing to many investors. Some financial experts believe that ESG investments may outperform traditional investments over a long period of time. Keep in mind, however, that ESG hasn’t been around for a long time, so there’s not a lot of evidence on how it affects performance.
Pros and Cons of SRI and ESG Investing
Just like all financial strategies, SRI and ESG investing come with benefits and drawbacks, including the following.
Pros
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Shape the world: SRI and ESG may become catalysts for change, especially as they become more popular. By participating in them, you can encourage companies to engage in socially responsible practices.
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Rewarding: It can be exciting to watch your investments succeed. It’s even better when you know your portfolio is made up of ethical companies you support.
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Better returns: There are many studies from various financial experts that show SRI and ESG may actually lead to stronger returns. This means you don’t necessarily have to compromise your financial goals when you build a portfolio that reflects your values.
Cons
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No guarantee: SRI and ESG are not risk-free investment strategies. This means you may or may not end up with positive financial returns. There is a chance you’ll sacrifice financial gains for ethics.
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Can be difficult: Compared to traditional investing, SRI and ESG investing are more involved. Since they’re not passive strategies, you’ll have to do your research and figure out which investments you do and do not want to pursue.
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Subjectivity: What constitutes as socially responsible may be different for you than for someone else. Investing with SRI and ESG in mind is highly subjective and ambiguous. It all depends on your unique views and perspective.
Getting Started With ESG Investing
If you want to become a socially responsible investor, follow these tips to start and build an ESG and SRI portfolio.
Clarify Your Values
First and foremost, think about what values are important to you. Maybe you care about environmental sustainability or human rights. Or perhaps you hope to support companies that prioritize gender equality or diversity.
By taking the time to clearly define your values, you’ll find it much easier to choose the right investments.
Determine a Portfolio Allocation
Ask yourself how much of your portfolio you’d like to allocate toward ESG and SRI. You might be set on only investing in ESG companies. In this case, they’ll be 100% of your portfolio. Or, you may prefer to use ESG and SRI as a way to diversify your existing portfolio and make them 10% or 15% of it.
Choose Your Investments
You’ll need to pick specific ESG investments. These may be mutual funds, ETFs, or individual stocks, for example. You may want to stick to a certain time of investment or mix things off and incorporate a combination of them. We’ve included a list of good options below to get you up and running.
Consider a robo advisor or financial advisor
One of the easiest ways to ensure the funds you invest in meet your criteria is through a robo advisor. A robo advisor can manage and invest money on your behalf, based on your risk tolerance. Since there are plenty of robo advisors on the market, shop around and find one that focuses on or promotes ESG and SRI.
If you prefer to work with a human to support your socially responsible investing efforts, reach out to a local or online brokerage to find a reputable financial advisor.
ESG Funds Worth a Look
Instead of individual stocks, ESG funds are a grouping of stocks. When you buy a fund rather than a single stock, you’ll reduce your risk. This is because a fund will hold the shares of many companies, not just one.
In the event a company in your fund goes out of business, for example, the fund should perform better than if you owned stock in the individual company. Several examples of ESG funds you may want to add to your portfolio include:
Parnassus Endeavor Investor (PARWX): The PARWX focuses on companies that offer positive work environments for their employees. It supports the well-being of employees and looks for “undervalued companies.” PARWX refrains from organizations that are involved in industries like alcohol, tobacco, gambling, and fossil fuels.
Vanguard FTSE Social Index I (VFTNX): This fund avoids any companies that produce or sell alcohol and tobacco. It also refrains from nuclear power firms and those that sell to the military community. VFTNX prioritizes diversity in the workplace and looks for at least one woman on the board of directors as well as zero human rights violations.
Thornburg Better World International Fund (TBWIX): The Thornburg Better World International Fund focuses on companies with sustainable business models that could or have already made a positive difference in the world. Its top holdings include Kanzhun Ltd. and Tencent Holdings Ltd.
iShares ESG MSCI USA ETF: The iShares ESG MSCI USA ETF revolves around companies that have a high intangible value assessment (IVA), which analyzes a firm’s risk to major ESG issues within its industry. It steers away from companies affiliated with tobacco or weapons.
From the Experts
We spoke with experts about SRIs to learn more and get advice on how to approach SRI investing.
Featured Experts
Ronald Hill, professor at American University and author of “Corporate Social Responsibility and Socially Responsible Investing: A Global Perspective“
Robert T. Ryan, senior instructor at DePaul University
How can people interested in SRI balance between making a profit and investing in an ethical way?
Ronald Hill: People should recognize that ethical firms get into fewer problems and often perform better as a consequence. Regardless, following one’s values is its own reward.
What advice would you give to people interested in SRI on how to choose a community development financial institution to invest with?
Ronald Hill: Do a deep dive into who they are across as many data points as possible. Look at rating agencies and understand the criteria they use. Do your own exploration and look under the carpet for what they do and do not say, as well as what they do say.
What are the benefits and drawbacks of SRI?
Ronald Hill: The benefit is feeling like you are investing according to your core values. The drawback is even the best firms make mistakes and you have to live with certain imperfections regardless of intentions.
How can a socially responsible investor choose the best companies to invest in?
Robert T. Ryan: A successful SRI strategy is one that provides returns that are greater than, or equal to, alternative opportunities for investment of similar risk where the investments reflect the investor’s values and expectations regarding the role of business in society.
Each investor must decide for themselves what it means to be socially responsible and each company must define its purpose and role within society.
A company that does not know its purpose does not know its customers and does not know which opportunities to pursue for future growth.
How can a socially responsible investor create an SRI strategy?
Robert T. Ryan: An investor interested in SRI must define for themselves what the SR in SRI stands for, then seek out the companies or assets available for investment that meet that definition in daily practice.
There are good companies that sell products that some say shouldn’t be allowed—the energy sector is one example of an industry experiencing controversy.
However, there are companies doing good things in every product market.
The investor selects those opportunities they are most confident in for meeting the expectations for corporate behavior and returns in those market segments they want to support.
What types of investments are best for someone interested in SRI? How can investors make the right choices?
Robert T. Ryan: There are numerous organizations providing ESG/SR ratings. Investors should look to those and then personally research the companies they intend to invest in for ESG-related issues or potential issues in the same way that due diligence on management teams is done because ESG/SR issues represent real business risks that will impede the company’s performance and harm investors in the long run when they arise.
Serious investors are finding that companies with high ESG ratings tend to be the best-managed companies, and, therefore, worthy of investment.
SRI Frequently Asked Questions
The concept of SRI dates back to the 1700s when the Quakers refused to participate in the slave trade, which was the business of buying and selling humans. For quite some time, socially responsible investors simply avoided “sin industries” like tobacco and gambling. In the 1960s, however, this trend evolved and people began to make investment choices to benefit the greater good.
Negative screening is a technique that involves screening a company’s products and services as well as their practices to decide whether to invest in it. If you find out a company engages in drugs, for example, you may avoid it.
While SRI can make you feel good, there’s also increasing evidence that states it can actually help your portfolio. This is because companies with a strong ESG track record often perform well or even better than their peers. In fact, they are usually more resilient when the market is down.
If you like the idea of an investment strategy that aligns with your personal morals, values, and beliefs, SRI may make sense. It can help you meet your financial goals while you support causes that can change the world for the better.
Sponsored by a division of Goldman Sachs, the SRI Conference is an annual event that has been around since 1990. It’s known as the “largest, longest-running, and preeminent ESG-focused conference” and strives to take steps towards a more environmentally sustainable and socially equitable economy.
