Socially responsible investment (SRI) “may involve financial sacrifice”. That’s according to Olivia S Mitchell, a professor of business economics and public policy at the Wharton School of the University of Pennsylvania, who was interviewed by the Wall Street Journal last week.
In an article entitled The Financial Sacrifice of Socially Responsible Investing, Mitchell said investors would “limit [their] investment menu” by looking at SRI, and could “end up ruling out many of the most profitable and highly stable firms around the world”.
But her analysis is certainly not accepted across the board, and there is evidence out there to suggest the so-called “financial sacrifice” is actually more of a financial advantage.
Blue & Green Tomorrow posed the same four questions to the US Forum for Sustainable and Responsible Investment (US SIF) that the WSJ posed to Mitchell, and this is what they said.
What are some of the limitations of socially responsible investing?
Sustainable and responsible investing spans a wide and growing range of products and asset classes, embracing not only public equity investments, but also cash, fixed income and alternative investments. By including environmental, social and governance (ESG) issues in assessing a potential investment, investors have actually expanded their investment options, rather than limiting them.
What Mitchell told the WSJ: For sure, you’ll limit your investment menu. Depending on how strict your criteria are, you could end up ruling out many of the most profitable and highly stable firms around the world. Returns may also be cut due to compliance costs associated with SRI accreditation.
How hard is it to define these investments?
Sustainable and responsible investing (SRI) is an investment discipline that considers environmental, social and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact. It is an investment approach with multiple strategies that spans asset classes.
What Mitchell told the WSJ: Even trickier is the fact that reasonable people disagree about what socially responsible means: firms that avoid polluting, limit pay for managers, or ‘do good’ in their local communities? Also, such factors are often difficult to measure in practice, and there’s little clear guidance on how much weight to attach to each of the components in an overall rating or index–especially if the scores conflict.
What does this mean in practical terms?
There are two principal approaches to SRI. The first is ESG incorporation, which considers ESG criteria in investment analysis and portfolio construction; this can take several forms. Some may actively seek to include companies that have stronger corporate social responsibility (CSR) policies and practices in their portfolios, or to exclude or avoid companies with poor CSR track records. Others may incorporate ESG factors to benchmark corporations to peers or to identify ‘best-in-class’ investment opportunities based on CSR issues. Still other responsible investors integrate ESG factors into the investment process as part of a wider evaluation of risk and return. Some investors reserve a portion of their portfolios for venture funds, loan funds and other vehicles that help to foster businesses in underserved communities or introduce products that yield social and environmental benefits.
The second approach is shareowner engagement, which involves the actions sustainable investors take as share owners to communicate to the managements of portfolio companies their concerns about the companies’ ESG policies and to ask management to study these issues and make improvements.
What Mitchell told the WSJ: Setting benchmarks and measuring performance for socially-targeted corporations is complex and costly, and even the rating groups have been known to disagree among themselves.
How does performance typically stack up against other investments?
Research studies demonstrate that companies with strong corporate social responsibility policies, programs and practices are sound investments. For example, a 2012 study by Deutsche Bank Group Climate Change Advisers found that incorporating ESG data in investment analysis is “correlated with superior risk-adjusted returns at a securities level.” A report by the United Nations Environment Programme Finance Initiative (Unep-FI) and Mercer examined 36 representative academic studies and 10 related industry research reports about SRI performance and found that “there does not appear to be a performance penalty from taking ESG factors into account in the portfolio management process.” For additional research studies, see here.
What Mitchell told the WSJ: My own research showed that SRI-attentive firms in Japan were more conservative managers than their non-SRI peers. This could portend lower future investment returns, though perhaps also less volatility in share prices. Since it’s become so difficult to earn returns at all these days, be sure you understand the costs of SRI investment rules before agreeing to a restricted investment diet.