Once considered a niche area of investment practice, socially responsible investment (SRI) now embraces a wide investment audience that includes individuals, high net worth and otherwise, and institutions such as pension plans, endowments and foundations. Religious tenets, political beliefs, specific events and the broad remit of corporate responsibility (i.e. green investing, social welfare) all drive this investment practice.

Indeed, the professional association USSIF: The Forum for Sustainable and Responsible Investment, estimates in its "2010 Report on Socially Responsible Investing Trends" that around $3 trillion in assets under management subscribe to one or more of the aforementioned approaches to socially responsible investing.

Over 250 mutual funds in the United States alone, utilize a social screening process, with assets of approximately $316 billion. There are hedge and exchange-traded funds (ETFs) that adopt a socially conscious approach to investment, as well.

SEE: Socially Responsible Mutual Funds.

Socially responsible investing expresses the investor's value judgment of which several approaches may be used. One example is when an investor avoids companies or industries that offer products or services the investor perceives to be harmful. The tobacco, alcohol and defense industries are commonly avoided by people who try to be socially responsible investors.

In the 1980s, divestment of American companies doing business with South Africa was highly publicized. Another is a performance ranking in terms of how well a company achieves on not only financial metrics, but also on social, environmental, governance and ethical issues.

Yet another involves active engagement between the company's shareholders and its management. Finally, there is the activist tack that involves the investor advocating specific issues. Any one or a combination of these approaches is a critical driver in the process of portfolio management and fiduciary oversight.

Moreover, the practice is global, with different approaches emphasized in various countries as a function of their culture, government, business environment and their interrelationship. What obtains as socially responsible or not has led to differing opinions on whether these approaches yield competitive returns.

For Whose Benefit?
Socially conscious investors may assume a more holistic view of a company when making investment decisions, looking at how it serves its stakeholders, a rubric under which are subsumed not only shareholders, but also creditors, management, employees, the community, customers and suppliers. Within this context, socially responsible investment seeks to maximize welfare while earning a return on one's investment that is consistent with the investor's goals.

On the surface, these two notions may appear contradictory. For example, there may be an implicit cost of such an approach to the extent that it eschews profitable companies and sectors. Tobacco, alcohol, firearms and gambling have been lucrative industries.

However, to a socially conscious investor, their inclusion in a portfolio would fail to serve the investor's objectives of living in a world void of conflict and legal stimulants and depressants. As with any investment approach, the socially conscious investor needs to:

  • Define his, her or its risk and return objectives and constraints.
  • As to the latter, the investor needs to determine what its socially conscious constraints are. These may differ considerably, depending upon the investor. Muslims who wish to be compliant with Shari'a law would exclude any companies connected with the production, sale and distribution of alcohol, any financial institution that lends and any business that profits from gambling. Investors opposed to armed conflict as a means of dispute resolution may avoid any company or industry associated with defense, national security or firearms.
  • Once the investor defines its constraints, it must decide upon an approach to implement them, be it the use of inclusionary or exclusionary screens, best practices criteria or advocacy. The type of investor may determine the most suitable approach. For example, advocacy and dialog with a company or industry would be better suited to a large public pension fund.

    Consider the work of CalPERS or the Swiss billionaire activist Martin Ebner, the latter more an example of individual shareholder activism. By contrast, an individual investor working with an advisor would find the screening process more feasible.

  • Social investing has implicit costs – the returns potentially foregone through the exclusion of companies with unacceptable products or business practices – and explicit costs.

    For those considering an active approach, fees for exchange-traded and mutual funds tend to be a bit higher. For investors seeking a passive management, there are fewer indices to replicate and the funds that do typically bear higher costs.

  • Diversification is always an important consideration. Screens may hamper this process, unintentionally or otherwise. (To learn more, read The Importance Of Diversification.)

Utilizing this type of traditional investment framework would appear to make the process manageable, so long as the investor weighs the costs and benefits of this type of investment approach carefully.

However, there could appear to be a dilemma upon whose horns the investor invariably would be impaled. For example, if investment in such "vice" products as alcohol and tobacco is anathema to a socially conscious investor, what about the transport and energy industries?

After all, the products have to be shipped to the point of sale which requires various means of transport which, in turn, require fuel. These types of considerations make the precise definition of one's socially responsible investment goals all the more crucial. The practice is often a gray area.

Depending upon the perspective of the individual, companies may display characteristics that are both irresponsible and responsible. (For additional reading, check out Extreme Socially Responsible Investing.)

The Bottom Line
Socially responsible investment reflects an investor's values. While the opportunities in this realm of investment management have grown considerably, one may not ignore best practices of investing.

The investor must clearly define their goals when undertaking this sort of approach, recognizing its potential trade-offs and clearly articulating a policy that considers all the variables when looking to maximize the good over the plentiful and abundant.

Risk management and attention to costs are essential. Research seems to indicate that results from socially conscious investing are not statistically significant from a more conventional approach. (For more information, read how to Change The World One Investment At A Time.)

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