Today is Earth Day, and with increasing attention around this holiday, there’s definitely a sense that change is in the air. Whether it’s the increasing awareness of the environment, disparities in the workplace, and other socially conscious issues, there seems to be a growing sense of urgency to do better by the environment and by our fellow human beings. So why not do the same with investing?
As it turns out, many of these feelings are in fact being expressed by a growing number of investors. In a poll updated last year by Morgan Stanley, 52% of respondents said they were “somewhat interested” in sustainable investing, with approximately 23% stating they were “very interested.” The figures moved even higher when specifically focusing on millennials, and similar results have been found across numerous third-party polls.
There is also growing pressure within the corporate world. For multiple years, Blackrock’s Larry Fink has called on global CEOs to demonstrate stronger management on socially responsible issues. As the largest asset manager in the world, the company plans to use its significant voting rights to steer companies in more socially responsible directions. Even state governments are placing stricter mandates on utility firms, forcing them to increase the amount of energy produced from renewable sources.
The trend is clearly gaining momentum, so how does one participate as an investor?
“Socially Responsible” Defined
When it comes to investing, “socially responsible” is still a very broad and subjective concept. What one investor deems socially responsible is often completely different from another. Up until recently it has mostly fallen on each investor to decide what companies, industries, or sectors they should exclude from their portfolio-with the goal of aligning their investments with their personal beliefs. For example, if you didn’t want exposure to tobacco or gun producers, you would simply exclude them from being purchased in your portfolio. This form of “exclusionary” investing is referred to in the industry as “SRI,” and is the most common form of socially responsible investing being used today.
SRI vs. ESG
But while excluding specific categories can certainly be effective, a newer and much more robust form of socially responsible investing is gaining momentum. This methodology is referred to as “ESG,” which stands for Environmental, Social, and Governance. It is through these high-level categories that a company’s “social responsibility” is assessed. The “E” in ESG covers areas such as carbon emissions and renewable energy projects; the “S” includes policies around employee diversity and safe work conditions; while the “G” encompasses issues like board independence and executive compensation.
There is no global standard on how to evaluate these metrics, but a handful of third-party firms have established thorough research and ranking methodologies. By using these ratings, investors can go much further in their application of socially responsible investing. Instead of simply excluding companies they don’t want to own, they can actively seek out companies doing a better job managing environmental, social and governance issues.
Will My Portfolio Performance Suffer?
Performance is the most common concern for someone considering a socially responsible investment portfolio. And there have actually been numerous studies going back in time attempting to quantify the impact. At this point, it is still inconclusive whether socially responsible investing can generate any outperformance, but most studies indicate it can at least match performance of the broader market.
A recent study by MSCI produced some interesting results around companies with higher ESG rankings:
- Higher ranked ESG companies tended to be more profitable and paid higher dividends than lower ranked firms.
- Higher ESG rated firms showed lower incidents of idiosyncratic risk as measured by large stock drawdowns (i.e. lower tail risks).
- Higher ESG rated companies exhibited less earnings volatility and less systemic volatility.
For socially conscious investors, the hope is that by voting with their investment dollars, they’re able to bring about the change they want to see in the world, while still saving for retirement and achieving their long-term investment goals.
Demand for SRI is clearly growing, as is pressure in the corporate world to better manage ESG issues. These forces will likely only intensify over time. In addition, the advent of ESG research and rankings allows investors to more actively incorporate socially responsible filters into their investments. So if you’ve ever been interested in a more socially responsible portfolio, now is as good as time as any to make the switch.
If you still don’t know where to start, take a look at our Socially Responsible Personal Strategy. This is Personal Capital’s turnkey solution built with best-in-class ESG-ranked U.S. stocks, and our proprietary Smart Weighting methodology.