The Independent Market Observer

SRI and ESG: Investing with the Good Guys

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Aug 12, 2014 1:17:24 PM

and tagged Investing

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SRI and ESGFollowing up on yesterday’s post, I want to look at two areas of the investment world that have a lot to say about how we invest our money—and how we make our profits.

Ways to invest with your conscience

Socially responsible investing (SRI) is just what it sounds like—investing only in companies that are “socially responsible.” I put that in quotes because this can mean different things to different people. Oil is out for some; guns are out for many; tobacco is a pretty universal no-no. Beyond that, criteria might include women on the board, a clean environmental track record, no investments in countries deemed inappropriate, and so on. Because of this diversity, SRI is difficult to evaluate on a systemic level.

Another challenge is that SRI takes the focus off financial results, making it hard to tie these factors directly to performance. Advisors may have a fiduciary duty based on investor results—arguably, one that isn’t fulfilled by avoiding attractive investments that don’t meet SRI standards. Whether an investor accepts this or not, the inclusion of nonfinancial standards at least muddies the waters when evaluating results.

Environmental, social, and governance investing (ESG) is the next step, where managers attempt to translate the good intentions of SRI into actionable investment theses. In theory, selecting companies based on these factors is good business. Better environmental policies could lead to lower costs, or avoid penalties, as BP learned. Better social policies could enhance consumer acceptance and market share—see Nike and its sweatshop problems. And better corporate governance might also yield better results.

Because ESG strategies are based on more specific criteria that are directly applicable to corporate actions, they tend to be more investable (and more trackable) than SRI strategies.

But what about performance?

This is an evolving area, and the results so far are mixed.

Commonwealth started offering SRI/ESG portfolios in our Preferred Portfolio Services® Select program nearly four years ago, in September 2010. Over that time frame, performance has been generally in line with (but slightly below) the unconstrained versions of the active portfolios, probably due to cost variations in the underlying assets. In most cases, the difference isn’t substantial—around half a percent per year or so—but it’s there, and it’s consistent.

Although four years is far too short a time frame to judge performance, it is indicative. Another piece of the puzzle is that even fund managers who don’t specifically follow the SRI/ESG mandate have become more sensitive to these issues, so funds that use these tools but don’t build their identity around it may offer some of the same benefits.

Bottom line: worth looking into

SRI/ESG strategies haven’t yet demonstrated their potential to generate excess returns. On the other hand, the cost of using them doesn’t seem significant either. Other things being equal, SRI/ESG investing is proving to be a valid strategy for doing well by doing good.

Investing in the stock market involves gains and losses and may not be suitable for all investors. The investment’s socially responsible focus may limit the investment options available and may result in returns lower than those from investments not subject to such considerations.

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