Socially Responsible Investing Comes of Age

Global equity markets mostly consolidated sideways last week, although the Dow Jones Industrial average managed to reach a new all-time high of 22,000 after a few of its key constituents reported better-than-expected earnings. Meanwhile, Friday’s closely-watched U.S. employment report came in on the strong side with non-farm payrolls posting an increase of 209,000 jobs. The unemployment rate stayed flat at 4.3% and year year-over-year wage growth remained on track at a solid 2.5% growth rate. With risk markets finding some balance over the seasonally quieter summer months, it is a good time to take a look at the growing popularity of ‘socially responsible’ investing.

“Can investors do well by doing good through socially responsible investing?” This was the question posed to a team of experts at the Inside Smart Beta ETF conference in New York City last month. While the lively panel discussion was quite provocative, many of us left with a few more questions than answers.

Regardless of one’s opinion about combining personal investment strategies with the ideals of socially responsible investing (SRI), the trend is now too big to ignore. A report from the Global Sustainable Investment Alliance showed a 25.2% increase in SRI assets from 2014 to 2016 with these strategies now comprising over $22 trillion in market value. SRI investments have grown faster than the overall market for managed funds across almost all developed regions including Europe, the U.S. and Japan according to the GSIA study.

Responsible investing has clearly gained traction among younger investors. One of the panelists commented that over 90% of millennials are interested in SRI. However, even older folks are warm to the concept with approximately 53% of Baby Boomers showing interest.

The notion of ‘values-based’ investing has been around for a long time but more recently has become mainstream. The relatively loose classification known as SRI has lately morphed into a more defined acronym: “ESG” which stands for environmental, social and governance factors. Various independent agencies are now grading publicly-traded companies according their compliance with defined standards within each of these categories; but the agencies are not all in agreement with their results. Investopedia defines ‘ESG’ as a set of standards for a company’s operations that socially conscious investors use to screen investments. Environmental criteria measure how a company performs as a steward of the natural environment with respect to climate change, carbon emissions, water pollution and energy efficiency. Social criteria gauge standards for corporate labor, health and safety, and whether or not a company gives back to its community. And finally, governance relates to executive compensation, business ethics, financial compliance and transparency.

With such an abundance of often divergent SRI agendas, the overriding question may not be whether to invest in socially responsible funds but how exactly does one define socially responsible? For example, some see nuclear energy as an environmentally sustainable resource while others believe the exact opposite.

And then there is the question of what weight should be given to each of the various factors? Hain Celestial Group, Inc., one of the largest independent organic foods companies, presumably has a very high ‘social’ score given the quality of its ‘healthy-for- you’ food products. Hain, however, last summer announced problems in its public accounting which led to a 30% drop in the stock price. Since then, financial statements have been delayed several times. Not such a great score on governance.

Investors who wish to purchase a portfolio of securities which have been screened for ESG criteria can do so individually or through SRI mutual funds and exchange-traded funds (ETF’s). The largest ESG ETF is the iShares MSCI KLD 400 Social ETF (ticker DSI) with approximately $864 million in assets. The Exchange-Traded Fund (ETF) segment altogether comprises over $23 billion in assets.

In terms of performance, the KLD fund has modestly underperformed the broader market. Over the past five years, the ETF provided an annualised return of 12.20% compared to 13.02% for the S&P though the end of the latest quarter.

Of course, investment returns are important, but may not be everything to everyone. Investors should feel good about their strategies. Being confident in one’s investment philosophy typically leads to more consistent contributions to the financial plan and this helps tremendously in achieving future goals.

In some sense, the premise of having a special SRI portfolio seems to suggest that corporate profitability is at odds with doing the right thing – whatever that might be in the eyes of the observer. But is this really the case? The idea of ‘winner takes all’ evokes images of the factory sweat shops employing child labor at the turn of the last century while dumping chemical by-products into the nearest river. But I would argue that the corporate agenda in today’s world is not very different from what ESG strategies purport to achieve.

For example, most successful managers work very hard at attracting and retaining talent (high ‘social’ score required) and that means treating employees well. Similarly, CEO’s who wish to keep their positions are charged with maintaining good corporate governance practices such as having clean audits and staying out of the new headlines in a negative way. Any worthwhile CEO has a busy job balancing all these factors and of course earning a profit to keep the company relevant.

The rising adoption of social media has only intensified the impact of outside scrutiny and the need for companies to maintain a positive image in the eyes of the public. Signet Jewelers Limited saw its stock tank and profits shrink last year immediately after news of them possibly selling fake diamonds went viral on the internet. Other examples include BP’s tragic oil spill in the Gulf of Mexico and the improper account opening scandal at Wells Fargo. Interestingly, probably none of these headline events could have been predicted before they occurred. In fact, just prior to their scandal, Wells was widely considered a financial institution beyond reproach.

At LOM we use ESG factors as a component in evaluating investments. Sustainability is a broad concept which underscores the concept of consistent, long term performance. Our ideal investments possess business models which are ‘sustainable’ in every sense of the word.

At the end of the day, companies which do “good” likely will do well over time and eventually be rewarded in the market. Active investment managers should definitely consider ESG factors as part of their philosophy. However, given the reality of running a business in today’s environment, so-called “ESG” funds appear a bit gimmicky to me. But if a relatively pleasant song and dance helps investors sock more away to meet later goals, those additional fees and potentially lagging performance could be worth it for some.

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The information contained in this article is for information purposes only, and represent the views of the author. It is not intended as specific investment or financial advice, or a recommendation or solicitation to buy or sell any security. Any investments or strategies listed in this article may not be suitable for all investors. Past performance is not indicative of future performance, and as with any investment, prices may fluctuate. It is recommended that advice is sought from a qualified investment professional prior to implementing any financial plan. LOM has made every effort to ensure that the contents herein have been compiled from sources believed reliable, however LOM does not warrant the accuracy, adequacy, timeliness, or completeness of this information expressly disclaims liability for errors or omissions in this information.