Once considered a niche area of investment practice, socially responsible investing (SRI) now embraces a wide investment audience that includes individuals, including those of 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—such as green investing, social welfare—all drive this investment practice.

Examples of Socially Responsible Investing

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.
  • Another is considering a performance ranking in terms of how well a company performs, not only in terms of financial metrics but also regarding 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 for specific issues.

One or a combination of these approaches can be 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 interrelationship of these factors.

What counts as socially responsible, or not, has led to differing opinions about 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, as well as creditors, management, employees, the community, customers, and suppliers. Within this context, socially responsible investment seeks to maximize the welfare of people and their environment 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 Sharia law would exclude any companies connected with the production, sale, and distribution of alcohol, and 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 an investor defines his constraints, they 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 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 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.

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 an anathema to a socially conscious investor, what about the transportation and energy sectors?

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.

Depending upon the perspective of the individual, companies may display characteristics that are both irresponsible and responsible.

The Bottom Line

Socially responsible investing reflects an investor's values. While the opportunities in this realm of investment management have grown considerably, one may not ignore the 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 more statistically significant than a more conventional approach.