Diversification And Socially Responsible Investing

In the old days of socially responsible investing (SRI), following your conscience tended to come at the cost of at least a few percentage points in lost returns. SRI funds were few in number, and they tended to focus on avoiding broad swaths of the investing universe. Staying away from companies that slaughtered animals for food or provided feed for slaughterhouses, for example, would mean not investing in many large multinational firms—and in the large-cap mutual funds that hold those companies. Or objections to Asian labor practices would rule out putting money in many promising international stock funds that invested in that region. If you wanted to have a broadly diversified portfolio, you could pretty much forget about SRI.

Recently, though, several changes in socially responsible investing are making it much easier to diversify. Many SRI funds have shifted their emphasis from passively avoiding objectionable investments to an approach that actively seeks investment in profit-driving fundamentals—and that leads the funds to previously unexplored corners of the corporate world. Rather than simply shunning companies that profit from tobacco, polluting industries, child labor, or other frowned-upon products or behaviors, today’s SRI funds invest in companies that embrace socially positive behaviors that may also boost the bottom line. Many SRI investment managers look for companies that focus on environmental sustainability and responsible governance, which they believe will foster success and reward investors.

This trend has led to a new acronym, “ESG,” for “environmental, social, and governance.” Today’s SRI investors believe companies that focus on these three characteristics will perform better in the long term, partly by reducing their potential liability amid rising tensions in these areas.

Another factor in SRI’s evolution is a rapid growth in the number of SRI funds. Increasing concerns about the environment and moral issues ranging from abortion to gun violence are prompting more fund managers to offer SRI-focused choices that may specialize in a particular area. Having more mutual funds and exchange-traded funds built around SRI principles makes it easier to tailor investments to your concerns and helps you to diversify. And whereas in the past most SRI funds concentrated on large-cap stocks—and usually considered only a narrow range of those big companies—now investors can also choose from among small-cap and mid-cap SRI funds.

One widely cited study, the Social Investment Forum’s 2007 Report on Socially Responsible Investing Trends, showed that between 2005 and 2007, the amount of money committed to SRI funds rose at an 18% annual rate. More than 10% of all investment dollars under professional management in the United States, or $2.7 trillion, was invested in SRI funds in 2007, the report said, and more than 260 socially screened mutual funds were available in the United States, up from just 55 in 1995. A number of recent studies have shown that funds screened for social concerns have performed comparably to non-SRI funds in terms of average annual growth.

If you are interested in SRI, or ESG, what do you need to know? Here are some questions to explore, courtesy of Morningstar:

  • What issues are most important to me?
    Are you interested in a religious or a secular fund? What issues are driving your decision—the environment, workplace diversity, weapons proliferation?
  • How does a fund screen its investments?
    Do the fund managers screen out all involvement in your issue, or do they take the approach of investing only in those firms with “best practices” in the industry involved in your issue?
  • Is this fund involved in shareholder activism and community investment?
    Look at the fund’s website or call the fund company to find out whether managers actively push for change among companies they invest in, and determine whether this matters to you.
  • Is this a good investment?
    You must do your homework as you would with any fund, and also be aware that many SRI funds charge higher fees to pay the cost of added research.
  • How do these funds work within my overall portfolio?
    Any fund you invest in should be seen as part of a rational investing strategy that is properly diversified, including SRI funds.

We can help you consider these and other questions related to social responsible investing and work with you to create a portfolio that addresses your priorities, financial and otherwise.

This article was written by a professional financial journalist for Phase 3 Advisory Services, Ltd and is not intended as legal or investment advice.

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