The financial services industry is suddenly flush with asset managers offering Socially Responsible Investments. Investors are faced with a confusing bit of alphabet soup with terms like SRI, ESG, impact investing, and so forth. A good way to understand the difference is to consider the history of socially responsible investing as a whole.
Squares and Rectangles
There are many approaches to socially responsible investing but not all are the same. Each style and approach serves a purpose, though what that purpose is may not be easily discernible by its name. Knowing what works best for you and your clients comes down to understanding your needs and how the investment style works.
The first American Socially Responsible Investing (SRI) programs were established by religious groups in the late 1800s aiming to exclude weapons, alcohol, tobacco, slavery, gambling, and pornography as investment options. A century later, in the 1980s, several funds sought to exclude South African companies in protest of the country’s apartheid regime. Famously, the United States Conference of Catholic Bishops (the "Bishops’ List") seeks to exclude a variety of businesses (also referred to as "sin stocks") considered contrary to Catholic beliefs. This exclusionary approach is what we often call Socially Responsible Investing. While no more or less socially responsible than other approaches, exclusion lists are commonly referred to as SRI out of historical precedence.
Icons of Activism
Impact Investing has been around for many generations. In the 1980s, Carl Icahn and T. Boone Pickens became the standard bearers of activism, though not for social or environmental reasons. Activists take controlling equity positions in firms they feel that they can improve. Today, activist investing endeavors take the form of issue-minded clearinghouses – like the one managed by the United Nations – that allow shareholders to aggregate resources and voting power to drive environment, social, or corporate governance change at publicly held businesses. Impact investing can also be done through lending, like with green bonds – bonds that allow issuers to direct money into environmental and social projects.
Best in Class
In the late 1990s, the first strategies to include environmental, social, and corporate governance factors ("ESG") did so as a risk management tool. These Best-in-Class strategies score each company in a given industry. A portfolio is then built by including only the highest scoring companies from each industry group. The aim is to give investors broad market exposure but to only the best businesses of each industry.
Environmental and social trends can be used to discover investment ideas. Social trends including aging global population, a growing middle class in emerging economies, and urbanization can create investment opportunities. Likewise, air pollution and the depletion of resources inspire technological advancements subsequently creating potential investment opportunities or marking the end of some industries. The interested investor can use insights from such trends to invest in upcoming business or possibly steer clear of failing companies.
ESG factors can also be used to gauge the sustainability of specific businesses. For example, a solar panel manufacturer that produces great panels but has poor labor practices and pollutes surrounding bodies of water could be an unsustainable company in a sustainable industry.
Matching Values and Earning Value
No investor considers themselves an irresponsible investor, not even those who consciously invest in sin stocks. Investors may want to educate themselves on these various practices before determining what fits their values.
SRI may or may not provide outsized performance, but many feel that these strategies best represents their beliefs. There are those that feel tracking the global equities market is best, so a best-in-class model might suit them. Others, still, might want to concentrate their efforts and invest with engagement in mind; this takes a lot of work but can also be rewarding. Investors can work with their financial advisor to help determine how to implement environmental, social, and corporate governance awareness into their portfolio.
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This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted. Diversification does not guarantee a profit or protect against a loss.
All investing involves risk, including the risk of loss.
ESG Investing focuses on investments in companies that demonstrate adherence to environmental, social and governance (ESG) practices, therefore the universe of investments may be reduced. An ESG strategy may sell a security when it could be disadvantageous to do so or forgo opportunities in certain companies, industries, sectors or countries. This could have a negative impact on performance depending on whether such investments are in or out of favor.
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