Today’s celebration of Earth Day demonstrates support for environmental protection. Whether it’s the increasing awareness of environmental impact, addressing disparities in the workplace, or pursuing social responsibility, we’re witnessing 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, a growing number of investors share this sentiment. In a poll updated last year by Morgan Stanley, over 75% of respondents showed interest in sustainable investing. The figures moved even higher when specifically focusing on Millennials. Similar results have been found across numerous third-party polls.
There is also growing pressure within the corporate world. For several 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 which companies, industries, or sectors they should exclude from their portfolio. Socially responsible investing (SRI) provides investors with the option 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 it’s 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.
- 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 proactively 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. As it turns out, numerous historical research studies have investigated this very topic. The most common conclusion? You do NOT have to sacrifice returns to invest more responsibly. In fact, a growing number of credible third-party research is showing there might even be a performance benefit.
Many of these same studies have also produced some interesting findings at the company level.
Put simply, companies with higher ratings on material ESG issues tend to be more profitable and produce stronger financial results. This is because ESG issues are financially material to a company’s bottom line. Think of an industrial manufacturer. By reducing their water and energy footprint, they can lower their resource use and input costs – that flows directly through to earnings.
The same concept can be applied to the social and governance factors. Companies who do right by their employees can improve their ability to retain top talent, while more diverse workforces, particularly at the executive level, have been linked to greater levels of innovation and financial performance.
Given all these factors, it’s no wonder socially responsible investing is growing at such a rapid pace. What’s more, 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 conscious portfolio, now is as good a 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.