How to Be a Smarter Responsible Investor

Good news, responsible investors: You can have your values and still eat, too. Responsible investing is a martyr strategy no more, but that doesn’t mean it’s risk-free.

The argument against responsible investing used to be that it was a concessionary strategy, says Doug Heske, CEO of San Francisco-based Newday Funds. If you wanted to invest your values, you’d have to accept lower returns. But research has proven this isn’t the case.

“Every piece of evidence we’ve seen over the past decade refutes this,” Heske says. In fact, studies show responsible investing “is actually additive.”

Oxford University and Arabesque Partners examined 200 studies. In 80 percent of those studies, good sustainability practices resulted in higher stock price performance. In 88 percent of them, robust ESG practices improved operational performance.

“You don’t have to sacrifice returns anymore to accomplish good in this world,” Heske says. But if you aren’t careful, trying to accomplish good could result in your taking on undo risk in your portfolio.

[See: 7 Robo Advisors for Socially Responsible Investors.]

Don’t forget your head when investing your heart. Being a smarter responsible investor means keeping a close eye on diversification, cost and if your responsible fund truly does align with your values.

Responsible investors face concentration risk. “Diversification is a really important element of smart investing, and one of the biggest mistakes investors can make when they’re considering values-based investing is to not be diversified,” writes Mark Sette, a certified financial planner and portfolio manager at Wealthsimple, in an email.

Investors with too narrow of a values-based investing approach may expose themselves to concentration risk, says Brendan Erne, director of portfolio implementation at Personal Capital in San Francisco. The more narrow your values, the greater your potential concentration risk.

If you only want to invest in solar and wind producers, you’ll dramatically limit your investable universe. “Such a narrow focus would reduce your portfolio’s diversification and put your financial goals at risk,” Erne says.

“The best way to get around this is to apply your values in the context of a fully-diversified portfolio,” he says. “Instead of just investing in wind and solar producers, build a portfolio of stocks from all economic sectors and only apply your value in the areas where it’s most relevant.” For instance, apply your renewable energy value to your energy or utilities stocks or funds.

Responsible investors don’t get a free pass on diversification. You still want a globally diversified portfolio of stocks and bonds. This means owning companies from across regions of the world and of varying sizes, or market capitalizations, says Mike Kerins, founder and CEO of RobustWealth, a B2B digital wealth management platform headquartered in Lambertville, New Jersey.

[See: 7 of the Best Socially Responsible Funds.]

Be smart about socially responsible ETFs and mutual funds. The easiest way to build a diversified responsible portfolio is through mutual funds or ETFs that invest your values. But even funds can face concentration risk.

Pay attention to how many stocks your funds own and if they are heavily weighted in just a few names. You don’t want to put all your money into a low carbon ETF with only 30 stocks, Kerins says.

“Like any investment, keep an eye on fees,” Sette says. “SRI investing can be a little more expensive — someone needs to screen the investments to ensure they meet certain criteria, and that can add cost. But there are a lot of low-fee options now, so make sure to do your research and make sure you’re keeping costs low.”

Then read the fund fact sheet to ensure it really is aligned with your values. Similar to how you’d look at a politician, you want the fund to generally reflect your values and to be OK with any areas it doesn’t reflect your values, Kerins says.

No company is perfect, and your portfolio needn’t be either. Just as no politician is perfect (what a lark), no company is, either.

“It’s OK to invest in companies that aren’t perfect,” Erne says. “The key to value-based investing is to invest in companies that share your values and are trying to change for the better.”

Instead of focusing on the limited number of companies producing wind or solar power, “look for companies attempting to transition away from fossil fuels, even if they still have fossil fuel exposure,” he says.

[See: 8 Global ESG Funds to Diversify Your Sustainable Portfolio]

Try ESG for a one-stop shop. ESG, or environmental, social and governance, investing can be a core part of a responsible investor’s strategy, Erne says. ESG investing considers the impact of a company’s environmental, social and governance practices on its financial performance. ESG rankings give companies with more sustainable environmental, social and governance policies higher scores.

Many investors’ values are already rolled up into these ESG categories, Erne says. For instance, companies with more robust renewable energy programs will have higher ESG scores.

ESG funds can be a good starting place for your responsible portfolio. If you want to layer more values on top of that, go ahead, but beware of concentration risk from inadequate diversification.

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How to Be a Smarter Responsible Investor originally appeared on usnews.com

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