As a topic up for public discussion, socially conscious investing comes with some political touchiness, mostly thanks to its inherent interconnection with the broader climate science debate. Just as our overall political climate has pulled us further apart and closer to the poles of our partisan spectrum, the divisiveness surrounding socially conscious investing has created the appearance of two camps in total opposition. And just as in our political discourse, fundamentally important nuance falls to the wayside.
In turn, much of the financial industry continues to discount any socially conscious approach as misguided philosophy, therefore dismissing consistent demand from investors. And as some socially conscious investors may themselves misunderstand or overlook meaningful details, advisors remain unwilling to engage. In fact, only 18% of financial advisors in 2017 reported ever having a conversation with clients about responsible investing options, according to Nuveen. Yet about three quarters of investors seek that kind of investment solution, according to Morgan Stanley.
Something so innately complex as socially responsible investing deserves a far deeper look from all sides than politicization allows, which means reasonable proponents must work even more intently on communicating its important distinctions that matter most to every investor. Until then, the financial industry will continue to conflate socially conscious investing approaches, to assume all approaches undercut returns and to misunderstand the ways in which different approaches can make a more meaningful impact.
Conflating The Approaches
Many socially conscious investment critics often unknowingly conflate various socially conscious investing approaches into one, formulaic methodology. Often, these critics erroneously narrow the definition down to what’s known as socially responsible investing (SRI), whereby an asset manager prioritizes specific values ahead of performance by excluding certain sectors, companies or products from a portfolio. This often manifests in the removal of climate-unfriendly companies, thus connecting what’s otherwise a straightforward investment methodology to a particular political leaning.
Since blindly screening out entire industries could in fact create unintended risks and performance downside, critics more partial to fossil fuel protectionism tend to argue that socially conscious investing as a whole fundamentally goes against the fiduciary role of an investment manager. While that may arguably hold true for a hardline SRI methodology, many other socially conscious investment approaches can create a much more meaningful balance between personal values, risk and performance. A top-down ESG strategy, for example, prioritizes returns as well as risk aversion by investing in companies that rate highly in environmental, social and governance (ESG) factors.
Assuming They Undercut Returns
Since many for years believed that the screen-out SRI approach represented the entirety of socially conscious strategies, conventional wisdom suggested doing good unavoidably meant doing damage to portfolio returns. Surprisingly, both sides of the political divide have perpetuated this narrative as many of those most inclined to invest for good have also assumed the necessity of such a trade-off. And yet a closer look shows that socially conscious investors can not only perform in line, but may in fact outperform strategies that don’t make certain socially conscious considerations.
Beyond traditional financial analysis, ESG integration goes deeper into more fundamentally important aspects of a company that influence its long-term viability and therefore the stability and growth of its stock price. In fact, numerous studies have shown that ESG analysis can benefit performance in part by limiting potentially catastrophic company-related ESG risks. One Morningstar study, for example, showed that ESG-related funds as a group outperformed the overall fund universe in 2017. Meanwhile, 54% of those funds ranked in the top half of their respective Morningstar categories.
Misunderstanding Meaningful Impact
Since socially conscious investing serves such an important purpose, steadfast proponents sometimes advocate for a somewhat misguided approach that only seems most effective, whereby investors must not only divest from companies with which they don’t agree (i.e. traditional energy companies), but also invest solely in companies specifically structured to do good in the world beyond the bottom line (i.e. solar companies). This method—a combination of an SRI screen-out and what’s specifically known as impact investing—represents a higher-risk strategy that very few Americans can afford to follow, thus serving up an easy target for skeptics and resulting in more effective ideas wallowing in between the political poles.
By pushing past the politics, investors can uncover more nuanced ESG approaches that balance personal values with financial metrics like an investor’s risk tolerance and time horizon. Doing so allows more of the investor population to take part in broader change, effectively democratizing the influence of our collective dollars. Instead of hand-picking higher-risk impact companies in specific impact sectors (i.e. renewable energy), ESG investors can create entire portfolios that balance risk and invest in highly rated ESG companies in all industries. Rather than just some impact investors empowering a few impact companies, a nation of ESG investors can instead hold all companies in all industries accountable to higher standards.
Ultimately, proponents of socially conscious investing—and advisors in particular—must lead others toward elucidating the details that truly matter rather than asserting righteousness for the sake of disparaging those that (maybe illogically) oppose such strategies. Doing so will pull back the political lens so that we all might finally pay more attention to the nuances of each approach, earn better returns and, most importantly, create a far greater impact for the world—something I hope we can all one day recognize as fundamentally apolitical.