Investors increasingly want to align investment portfolios with personal values, citing climate change, clean water, and income inequality among the issues in which societal concerns intersect with financial considerations. The conventional wisdom is that socially responsible investing is a passion primarily for millennials, but many investors beyond the millennial demographic have embraced SRI.
According to the Forum for Sustainable and Responsible Investment, sustainable, responsible and impact investing assets have expanded to $8.72 trillion in the U.S., up 33 percent from $6.57 trillion in 2014.
Major financial services firms are embracing the SRI opportunity. BlackRock established a dedicated group to focus on SRI, Goldman Sachs acquired an SRI firm, and Eaton Vance is acquiring the assets of SRI pioneer Calvert.
[See: 7 of the Best Socially Responsible Funds.]
The agenda for the recent Conference on Sustainable, Responsible, Impact investing illustrates the growth in interest as well as the diversity of issues that are important to socially aware investors. The conference had record-high attendance with more than 700 attendees, and conference sponsor First Affirmative Financial Network was joined by the leadership team from new owner Foliofn.
Aligning personal values with investment portfolios is easier said than done. Investors have a variety of choices, and vast differences in social preferences. Differences in branding also come into play, as SRI product sponsors use terms that may have meaning inside the broad SRI “tent” but may not resonate as much to individuals new to SRI investing.
Socially responsible investing used to be an umbrella term that captured a broad range of strategies, but in recent years has been supplanted by terms such as environmental, social and governance investing, sustainable investing, and impact investing.
The intensely personal nature of a values-oriented approach may be the most challenging aspect of creating a socially responsible investment portfolio. The starting point for most investors is to prioritize among values-based considerations.
Environmental considerations are prominent for many, with climate change frequently cited as the most important consideration. Some investors that prioritize climate-friendly strategies gravitate to a “fossil-fuel-free” approach that excludes oil and gas companies, energy services companies and traditional utilities.
Fossil-fuel-free portfolios avoid energy producers such as Chevron Corp. (ticker: CVX) and Exxon Mobil Corp. ( XOM) that have fossil fuel reserves, as well as energy services companies such as Schlumberger ( SLB) that contribute to the production, storage and transmission of fossil fuels. However, fossil fuel free portfolios may include airlines and other major consumers of fossil fuels.
Other environmentally-focused investors may choose a “low carbon” approach, with an emphasis on reducing the carbon footprint by minimizing fossil fuel reserves and carbon emissions relative to broad-based indexes such as the Standard & Poor’s 500 index.
Low carbon mutual funds and exchange-traded funds may include energy producers excluded from fossil-fuel-free products, though Exxon and other energy producers are typically a smaller proportion of low carbon portfolios than of broad-based indexes. Low carbon products may have substantial investments in energy services companies (which don’t own fossil fuel reserves or create substantial carbon emissions), but avoid airlines and other companies with substantial carbon emissions.
For some investors, eliminating or minimizing exposure to “dirty” energy is only a partial solution. Investors who want to make an “impact” prefer a “divest-invest” approach that combines fossil-fuel-free or low carbon investments with investments that directly support renewable energy.
[See: 10 Energy ETFs That Will Clear Your Conscience.]
Investors should be aware that clean energy mutual funds and ETFs may be considerably more volatile than more broadly diversified products. Although renewable sources of energy accounted for more than half of net incremental energy supply in 2015, regulatory, technological and financial uncertainty has made clean energy a turbulent ride for investors. Some clean energy ETFs and mutual funds declined by more than 40 percent in 2011, rebounding sharply in 2013, then falling again in 2016.
Social and governance considerations are of primary interest to some investors. Gender diversity is a high profile topic for socially responsible investors, and recent academic studies have demonstrated that companies with more female board members deliver superior stock market performance.
Pay equity is an important consideration for socially conscious investors who are seeking better disclosure of pay gaps between men and women doing equivalent jobs, and policies to close those gaps. LGBTQ equality is considered by investors who favor companies offering benefits to same-sex couples and commit to anti-discrimination pledges. Working conditions and child labor are among the prominent issues addressed with technology companies and clothing manufacturers.
Some investment firms are active in advocacy efforts, engaging with companies to try to influence corporate behavior through shareholder proposals, dialogue with management, investor education and proxy voting.
Four recommendations for investors interested in socially responsible investing
Define what you want to accomplish: Determine the investment objective and time horizon; then prioritizing which values-based considerations are “must-haves” and which are “nice to have.”
Decide between absolute and directional alignment with personal values. For some investors, it will be impossible to find a mutual fund or ETF that completely aligns with personal values. Investors who require absolute alignment to personal values may find that a separately managed account is the only way to achieve their investment and social objectives. However, absolute alignment comes with a cost, potentially in higher fees, complexity, or personal involvement in the design process.
Understand investment implications associated with different SRI approaches. There may be financial trade-offs associated with a SRI strategy. For example, a fossil-fuel-free or low carbon strategy may lag the broader equity market if oil prices rebound. It’s important to be fully informed about the trade-offs between approaches.
Complete research into the investment merits of the mutual fund or ETF. The factors typically considered in selecting non-SRI investments also apply when selecting an SRI investment. The quality of the manager, historical performance, and expense ratios should be considerations that occupy equal importance alongside SRI considerations in the selection process.
[Read: 8 Investments That Make a Difference.]
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How to Create a Socially Responsible Investment Portfolio originally appeared on usnews.com
