Investing for Good

Four years ago, I wrote about Socially Responsible Investing (SRI) in this blog. SRI is investing in companies based on an assessment of their Environmental, Social, and Governance policies, or ESG. In 2014, SRI funds had just passed $100 Billion in assets and have since grown twenty-fold to over $2 Trillion globally.

At that time, I had reservations that SRI funds carried a number of pitfalls, including weak diversification, high expense ratios, and poor performance. I discussed one of the original SRI exchange traded funds, KLD, which in 2014 had an expense ratio of 0.50%.

Things have changed for the better. Today we have new SRI funds which are better diversified and have reduced tracking error versus a core Index-based ETF like we normally suggest. Expense ratios have fallen dramatically, with some SRI funds as low as 0.15% to 0.20%, which is much more competitive with traditional ETFs.

With these newer funds, I think we can now say that investing using SRI principles should have similar performance to our traditional portfolios. I don’t know that the performance will be any better, but I no longer am concerned that SRI will automatically condemn you to under-performing a non-SRI approach today.

For the first time, we have the tools to create a globally diversified portfolio of SRI funds which are low cost, transparent, and rules-based. What is lacking, however, is a long track record: of the 38 or so SRI ETFs available to US investors today, about half are less than two years old. This requires extra research and due diligence to understand what you are actually buying and how the fund might perform in different market environments.

For a lot of investors, we want to invest in companies which do good, and not the ones who pollute the environment, support dictators, sell tobacco, or treat their employees, customers, or shareholders with callous disregard. That’s the appeal of SRI; it aligns our money with our values.

When you invest in an index fund, you own all the stocks in a benchmark, including some which maybe you’d rather not own. With the proliferation of index investing, the largest shareholders of many companies are often Vanguard and Blackrock, the two largest index fund providers.

Although index funds vote on behalf of shareholders, they have largely voted in favor of management proposals. Indexers cannot sell their shares if a company is doing bad things. If it’s in the index, the fund has to own it. This weakens the role of shareholders as owners and beneficiaries of corporate decisions and the accountability of executives to shareholders.

I see a beneficial role for SRI investors within capitalism because they tell company executives and boards that they have to do better on ESG criteria or we will not invest in their company. To that extent, I believe we are already seeing improved corporate behavior thanks to SRI investors including ETFs, activist funds, and large pension plans such as CalPERS.

Are you interested in Socially Responsible Investing? Would you like to see what your portfolio might look like if we used SRI funds instead of traditional Index ETFs? We do not want to sacrifice performance, which is why we have been cautious about adopting SRI funds. But with better diversification and lower expense ratios, today’s SRI funds are significantly improved. Let’s talk about how we might implement SRI for you.

Socially Responsible Investing

Canadice 2014

Socially Responsible Investing (SRI) has taken off in recent years as many investors want to align their portfolio to reflect their personal beliefs.  Fortunately, it is becoming easier to access high quality SRI investments and we are happy to incorporate our clients’ wishes whenever possible. This year, the amount invested in SRI funds surpassed $100 Billion and I think it’s safe to say that SRI has moved from being a small niche to a mainstream approach.

I want to emphasize two very important considerations for anyone contemplating adopting SRI principles for their portfolio.  First, you may want to support an idea or sector, such as Solar Energy.  You might think that by buying stock in a solar company, you are supporting that company, but you’re not actually providing new capital.  Other than in an Initial Public Offering (IPO), trading shares is just buying and selling between investors in the open market.  Although solar power is a great idea, many investors suffered losses in recent years when the stock market eventually recognized that solar panels had become a commoditized product with low profit margins. If you want to buy individual stocks, be sure that you buy the company based on its investment fundamentals and not just because you believe in the idea or think it will be “the next big thing”.  Otherwise, you’d be better off investing in regular funds and using your profits to make donations to the causes you want to support.

For most investors, I suggest you avoid individual stocks altogether and instead choose from the many Socially Responsible funds and ETFs that are available today.  This brings me to my second recommendation: when selecting an SRI Fund, always look at its holdings, weightings, and diversification. SRI guidelines limit which stocks a fund manager can select. For example, they may be prohibited from owning alcohol, tobacco, nuclear power, or defense companies. As a result, SRI funds are often heavily weighted in just two or three sectors of the economy. Today, many (if not most) SRI funds have their largest holdings in the technology industry. Concentrated funds can look attractive when those sectors are performing well, but often perform very poorly when their top sectors tumble.  Make sure your funds are well diversified and that you are not buying a sector fund in disguise.

For a core US equity holding, consider the iShares KLD 400 Social Equity (ticker: DSI).  This is an index Exchange Traded Fund (ETF) that holds the 400 largest US companies that have been screened for positive environmental, social, and governance qualities.  If you currently have a large cap mutual fund in your portfolio, you could use DSI as a replacement to add an overlay of socially responsibility, while maintaining a liquid and diversified portfolio.  With an expense ratio of 0.50%, it is a relatively cheap way to build a core SRI equity position compared to most actively managed mutual funds.

I would, of course, use several other SRI funds to build out a more complete portfolio.  While equity investing tends to get most of the attention in SRI, investors should also consider their fixed income holdings.  When you own the bond of a company or government, you are in fact a lender who has provided capital and receives interest from that entity.  So if you decide to embrace the Socially Responsible Investing approach, don’t forget to also include your bond funds.  Alternatively, you could work with an advisor such as myself to help select individual bonds and build a bond ladder for your portfolio.

Unfortunately, I do not expect an SRI portfolio to outperform a traditional asset allocation, and anticipate it may even lag over time. SRI reduces sector diversification, but also SRI funds tend to have a higher expense ratio than the ETFs we use for our core equity positions. Still, I admire what SRI aims to accomplish, which is to tell corporate management that as owners, shareholders demand companies do the right thing for the environment, human rights, and society. It’s clear that corporate lapses can contribute to increased risks for our economy, not to mention for the company itself. Too many mutual funds and ETFs are not proactively using their capacity as the largest shareholders to advocate for improved corporate governance. That’s a bigger issue than I can tackle as an advisor and investor, but my hope is that SRI will help apply pressure to corporate boards to do better.