Socially responsible investing (SRI) is an approach to investing that attempts to overweight investment in companies that an individual investor feels reflects their values for “social responsibility.” Obviously, this should be done in a way that doesn’t sacrifice returns in the process.
The notion of socially responsible investing has long been attractive to many investors, but the feasibility of doing it without sacrificing performance, can often seem out of reach or unreasonably costly. Socially responsible investing is a practice that emerges out of moral, social, religious and political perspective, leading to the inclusion or exclusion of certain types of holdings based upon their SRI focus.
While SRI is increasingly popular, it’s not always easy to identify an effective SRI solution. As an investor looking for an advisor who can help achieve your goals, it’s frustrating when an advisor promises to deliver on an SRI approach, but the implementation turns out to be less than ideal. That’s why we decided to provide this guide for evaluating how to assess SRI solutions.
What to Look for in a Socially Responsible Investing Solution
Those who invest in socially responsible investments do so to gain more personal value from their investments. If your personal code of ethics says not to invest in certain kinds of companies, then holding an investment in socially irresponsible companies reduces your personal sense of value from the investments’ returns.
The problem most investors face is that there’s no one, universal way of evaluating the social responsibility of an investment. Investors interested in SRI are not monolithic; they care about a wide variety of issues, and they don’t always agree on which criteria qualify as good or bad. For instance, the United Methodist Church’s investment ethics denote that investors should pursue opportunities to encourage companies to address major health challenges. A different example, Green America, encourages investors to divest from fossil fuels. Different people value different priorities for what it means to be socially responsible.
So, how do you begin to evaluate SRI solutions? Start by carefully defining your views on socially responsible investing, and use that understanding to walk through the following series of steps.
1. Find an advisor that aligns with your investing beliefs.
Because SRI investors’ priorities vary so widely, the first attribute to look for in an SRI solution is how well an advisor fits your beliefs about investing. While most advisors don’t exclusively focus on one set of SRI principles, a great many advisors have guiding philosophies that define their businesses. You should make sure these philosophies fit your beliefs.
Take Betterment, for instance. As a registered investment advisor, Betterment aims to act in its customers best interest, helping to return as much take-home value to its customers as possible, whether that value comes in the form of social responsibility, market performance, cash income, or tax savings. Betterment’s investment philosophy focuses on using scientific research to make investment decisions that earn investors that value. One result of that philosophy is Betterment’s core portfolio strategy, which uses a global diversified basket of exchange-traded funds (ETFs) because of their low cost.
You might find other advisors are even more aligned to your social viewpoints. For instance, some Muslim investors practice halal investing. Today, there are numerous halal-focused brokers and advisors that provide investing that meets halal investing principles.
Regardless of how you conceptualize your SRI values, the key is to seek out an advisor that will be a good fit for you.
2. Decide how you’ll assess “social responsibility.”
Any responsible advisor offering an SRI portfolio strategy should detail why they consider it to be socially responsible. Some advisors might try to show you their reasoning qualitatively by giving you a list of stocks and bonds included in their portfolios. However, you should know that industry-wide criteria are well-established, which enable investors to more systematically assess what kind of investments they’re buying.
Most industry scoring systems for SRI fall under the umbrella of ESG ratings, which stands for Environment, Social, and Governance—the three broad categories for which companies are evaluated. While no ESG rating will ever completely match your personal values, they do tend to satisfy many investors’ corel criteria for socially responsible investing.
More importantly, public ESG ratings give companies a way of measuring their own success. Companies who effectively manage ESG factors as a core process in running their firm have a leg up on companies that don’t.
In offering you mutual funds, ETFs or other strategies that pursue a socially responsible mandate, an advisor should—and very likely will—provide you with ESG ratings when offering you an SRI portfolio strategy based upon a set of funds. As you define what’s important to you, it may be helpful to review these ESG ratings, so that you can better understand what an advisor is providing.
For instance, an advised SRI portfolio may be comprised of SRI-focused mutual funds or ETFs with ratings for each fund provided by an ESG rating service like MSCI or Morningstar. Even with high scores, the composition of these funds may or may not exactly match your concerns and values.
At Betterment, ESG ratings are used to build a portfolio that captures what the largest feasible group of people might agree on in terms of the rules that bound socially responsible companies. ESG isn’t the optimal solution for every SRI investor, but it addresses this need for many investor’s views on SRI.
It can be useful to understand how ESG ratings may or may not screen for these concerns.
However, for its part the ESG movement has helped provide quantifiable ratings of social responsibility. Beyond social or religious concerns, ESG investing looks at a company’s management of environmental, social and governance factors.
In 2016, data provider Morningstar rolled out their sustainability rating for mutual funds and ETFs. They partnered with an outside consulting firm to analyze the portfolios of mutual funds and ETFs to assign a sustainability score. Their methodology looks at the fund’s underlying holdings for controversies, which they define as ESG-related incidents in addition to the portfolio’s scores on the three ESG components. Morningstar notes that the sustainability rating is done based on the fund’s portfolio and is not performance based.
The more established provider of ESG rating analytics is MSCI, an industry-leading provider of data and analytical tools. MSCI is the data provider Betterment used to analyze the holdings within its SRI portfolios. An online ETF ranking tool using MSCI data can be found here.
As an overview, here is a brief description of the components of ESG:
- Environmental factors such as efforts to mitigate a company’s pollution of the environment.
- Social factors might include how well a company manages diversity in the workplace. For example, companies that don’t encourage diversity might find themselves having trouble hiring enough qualified employees.
- Governance factors might include a company’s policies regarding executive compensation or whether the company selects truly independent board members.
3. Evaluate offerings within the scope of SRI today.
When evaluating advisors’ offerings, it’s difficult for individual investors to critically examine SRI offerings, even with ESG ratings. This is because, within the broader market, socially responsible investing is still in its relative infancy. For many, many years, even as ESG ratings emerged, the demand for SRI funds and portfolios has been relatively low.
That’s why it’s important to evaluate any offering within the scope of SRI as an emerging section of the advice market. Today, the largest group of SRI products available are ESG-rated mutual funds. Today, US SIF, the Forum for Sustainable and Responsible Investment, reports 203 available ESG mutual funds. Most of these funds are actively managed with high expense ratios. The average expense ratio of all 202 mutual funds reported by US SIF is above 1%.
With such a high average expense ratio, some advisors might rationalize that SRI comes with a premium. However, that doesn’t need to be the case. There are signs that SRI fund fees could decrease in the future as the market for SRI matures. In recent years, lower cost, passively invested ETFs have emerged, and as the assets in these funds increase, the costs associated with investing in them will likely fall.
If you consider Betterment’s SRI portfolios, part of the offer is to continually improve the portfolio strategy to make it ever more socially responsible while ensuring it remains globally diversified, cost-controlled, and tax optimized. The understanding with this type of portfolio strategy is that the universe of funds is still immature, and that investors should help build a better future for SRI, rather than simply settling for the industry’s approach to charging higher fees for SRI.
4. Don’t fall for misconceptions about lower quality.
In an article earlier this year, Morningstar made case that funds with strong ESG scores via their sustainability rating system are often high-quality funds as well. This provides evidence that, while a high ESG score does not, in and of itself, lead to higher performance, it may not hurt performance either. They had five major points.
- Funds with the highest sustainability rating were twice as likely to hold 5-star rankings (their highest score for risk-adjusted return within a fund’s peer group) as 1-star (their lowest ranking) rankings.
- Morningstar’s analysts have given a higher rate of top rankings to funds with the highest sustainability ranking than with the lowest ranking.
- Funds with the highest sustainability ratings exhibited a lower level of volatility of return than those with the lowest sustainability rating.
- Funds with the highest sustainability rating tended to score higher on Morningstar’s financial health rating, an indication that their portfolios held higher quality companies than those with the lowest sustainability ranking.
- Funds with the top sustainability ratings tended to have stronger economic moats (a structural competitive advantage) on a composite basis than did funds with the lowest sustainability rating.
While this data is not definitive, it does provide a strong indicator that a high ESG score often translates into a company that is well-managed. When you consider these facts alongside long-term performance comparisons that show that SRI funds often match performance of other comparable funds, then a clear takeaway is that as an investor, you may not have to settle for lower performance just because you want to take an SRI approach to your money.
The misconception that socially responsible investing always leads to lower returns is rampant throughout financial services, even though there are significant counterpoints to that view.
Responsible investing starts with responsible advice.
The first tip we offered in this article is to find an advisor that understands your personal viewpoints on investing. We say to start there because an appropriate SRI solution for you is bound to come from an advisor looking out for your best interest.
Good financial advice is that which looks at more than just the choice of a portfolio strategy; it should monitor the overall costs you’re taking on, the tax impact of your investing approach, and risk control tactics like diversification. As mentioned above, Betterment’s SRI solution is one where iteration is part of the inherent promise precisely because Betterment tries to offer its portfolio strategies as part of its overall advice.
In releasing an SRI solution, Betterment realized that no SRI solution today is near perfect when you consider that SRI investors deserve proper diversification and controlled costs just as non-SRI investors do. The Betterment SRI portfolio strategy has a higher ESG rating than Betterment’s core portfolio strategy, but in the future, Betterment aims for that rating to improve even more.
Whether you choose Betterment’s SRI portfolios or any others, the key is to invest with your entire financial picture in mind. Are you using an SRI approach for all of your investments? Is SRI only a priority for certain kinds of savings? How willing are you to balance your desire to express SRI values with changes in volatility and risk? These are the kinds of a questions that an advisor, like Betterment’s advising team or our broader advisor network, can help you answer and operationalize.
Learn more about the Betterment SRI portfolio strategy here.
Betterment is the largest independent online financial advisor with more than $10 billion in assets under management. The service is designed to help increase customers’ long-term returns and lower taxes for retirement planning, building wealth, and other financial goals. Betterment takes advanced investment strategies and uses technology to deliver them to more than 270,000 customers across its three business lines: direct-to-consumer, Betterment for Advisors, and Betterment for Business. Learn more.