While socially-responsible investing has been around for some time, its recent popularity boom has more companies offering socially and eco-friendly investments. For the average investor, determining the best option for your portfolio can be challenging.
What is socially-responsible investing? This approach can be traced to religious groups trying to avoid so-called sin investments. In today’s world, stocks commonly viewed as “sin stocks” are shares of companies that deal in liquor, tobacco, and gambling. By eliminating sin stocks, individuals could potentially feel morally comfortable with their investment decisions.
Over the past few years, socially-responsible investing has expanded from the traditional sin screen to include screens for defense (including gun manufacturing), the environment, LGBT rights, and other social concerns.
Companies are now moving from the term socially-responsible investing (SRI) to stating that they screen for environmental, social, and governance (ESG) factors when making their investment selection. As a result, you may see companies refer to either SRI or ESG when discussing their investments.
How do you know if your investment uses ESG screening? Everyone has a different approach to screening for ESG. The screening processes are referred to as negative and positive screens. When someone uses a negative screen, they are excluding companies with particular practices. For example, someone may decide that they do not like tobacco. As a result, they create a portfolio without tobacco companies.
Positive screening includes companies that meet certain criteria. With more people looking to environmentally-friendly investments, someone using a positive screen may look to firms that are leaders in reducing their carbon emissions.
ESG screening can become a challenge for investors.
One mix may exclude companies that create a certain amount of carbon each year, while another may include some of those companies due to their activism in reducing their carbon footprint. While some investors may decide that they want to exclude companies because they do not have LGBT protections or benefits for domestic partners, others may decide that they want to invest in those companies provided they have members of the board working to change those policies.
Before you begin your research, determine your parameters. Decide if your investments should exclude companies based on your ideals or if you should include progressive companies that might be rapidly on their way to meeting your standards.
Does ESG investing result in lower performance? Due to its limitations, responsible investing has received the reputation of providing investors with lower returns than traditional investment styles. People who use responsible investments are thought to be putting their morals before their desire for return.
While I agree that many who utilize this strategy are doing so for moral reasons, I do not believe that they are necessarily sacrificing return. Every investment style may potentially yield a few solid options, a few poor options, and many in the middle. It is up to you, the investor, to find the strategy that is right for you. As with other investment strategies, you will want to do your research before making any decisions.
Will all asset classes be included? If you’re concerned about having a well-diversified portfolio and you want to use ESG investing, you may have to balance your morals with effort and diversification. Depending on your screening parameters and size of your portfolio, you may find it difficult to locate ESG investments for each equity and bond asset class.
While some of my clients want an entire portfolio of ESG investments, it is not always practical. For my clients who desire responsible investments, we discuss their portfolio goals and moral objectives. From there, we determine how much of their portfolio can include standard investments and allocate the rest to responsible investing.