Socially responsible investing

Overview

Socially responsible investing (SRI) is any investment strategy which seeks to consider financial return alongside ethical, social or environmental goals. The areas of concern recognized by SRI practitioners are often linked to environmental, social and governance (ESG) topics. Impact investing can be considered a subset of SRI that is generally more proactive and focused on the conscious creation of social or environmental impact through investment. Eco-investing (or green investing) is SRI with a focus on environmentalism. In general, socially responsible investors encourage corporate practices that they believe promote environmental stewardship, consumer protection, human rights, and racial or gender diversity. Some SRIs avoid investing in businesses perceived to have negative social effects such as alcohol, tobacco, fast food, gambling, pornography, weapons, fossil fuel production or the military. Socially responsible investing is one of several related concepts and approaches that influence and, in some cases, govern how asset managers invest portfolios. The term "socially responsible investing" sometimes narrowly refers to practices that seek to avoid harm by screening companies for ESG risks before deciding whether or not they should be included in an investment portfolio. However, the term is also used more broadly to include more proactive practices such as impact investing, shareholder advocacy and community investing. According to investor Amy Domini, shareholder advocacy and community investing are pillars of socially responsible investing, while doing only negative screening is inadequate. Measuring social, environmental and ethical issues is nuanced and complex and depends on needs and context. Some rating companies have developed ESG risk ratings and screens as a tool for asset managers. These ratings firms evaluate companies and projects on several risk factors and typically assign an aggregate score to each company or project being rated.

History

The origins of socially responsible investing (SRI) may date back to the Religious Society of Friends (Quakers). In 1758, the Quaker Philadelphia Yearly Meeting prohibited members from participating in the slave trade—buying and/or selling humans. One of the most articulate early adopters of SRI was John Wesley (1703–1791), one of the founders of Methodism. Wesley's sermon "The Use of Money" outlined his basic tenets of social investing: not to harm your neighbor through your business practices and to avoid industries like tanning and chemical production, which can harm the health of workers. Some of the best-known applications of socially responsible investing were religiously motivated. Investors would avoid "sinful" companies, such as those associated with products such as firearms, liquor, and tobacco. The modern era of socially responsible investing evolved during the socio-political climate of the 1960s. During this time, socially concerned investors increasingly sought to address equality for women, civil rights, and labor issues. Economic development projects started or managed by Martin Luther King, such as the Montgomery bus boycott and the Operation Breadbasket Project in Chicago, established the early model for socially responsible investing efforts. King combined ongoing dialog with boycotts and direct action targeting specific corporations. Concerns about the Vietnam War were further incorporated by some social investors. An iconic image from the era was a picture in June 1972 of a naked nine-year-old girl, Phan Thị Kim Phúc, screaming and running towards a photographer, her back burning from the napalm dropped on her village. That photograph channeled particular outrage against Dow Chemical, the manufacturer of napalm, and prompted protests across the country against Dow Chemical and other companies seen as profiting from the Vietnam War. During the 1950s and 1960s, trade unions deployed multi-employer pension fund monies for targeted investments. For example, the United Mine Workers fund invested in medical facilities, and the International Ladies' Garment Workers' Union (ILGWU) and International Brotherhood of Electrical Workers (IBEW) financed union-built housing projects. Labor unions also sought to leverage pension stocks for shareholder activism on proxy fights and shareholder resolutions. In 1978, SRI efforts by pension funds was spurred by The North will Rise Again: Pensions, Politics, and Power in the 1980s and the subsequent organizing efforts of authors Jeremy Rifkin and Randy Barber. By 1980, presidential candidates Jimmy Carter, Ronald Reagan and Jerry Brown advocated some type of social orientation for pension investments. SRI had an important role in ending the apartheid government in South Africa. International opposition to apartheid strengthened after the 1960 Sharpeville massacre. In 1971, Reverend Leon Sullivan (at the time a board member for General Motors) drafted a code of conduct for practicing business in South Africa which became known as the Sullivan Principles. However, reports documenting the application of the Sullivan Principles said that US companies were not trying to lessen discrimination in South Africa. Due to these reports and mounting political pressure, cities, states, colleges, faith-based groups and pension funds throughout the US began divesting from companies operating in South Africa. In 1976, the United Nations imposed a mandatory arms embargo against South Africa. From the 1970s to the early 1990s, large institutions avoided investment in South Africa under apartheid. The subsequent negative flow of investment eventually forced a group of businesses, representing 75% of South African employers, to draft a charter calling for an end to apartheid. While the SRI efforts alone did not bring an end to apartheid, it did focus persuasive international pressure on the South African business community. The mid and late 1990s saw the rise of SRI's focus on a diverse range of other issues, including tobacco stocks, mutual fund proxy disclosure, and other issues. Since the late 1990s, SRI has become increasingly defined as a means to promote environmentally sustainable development. Many investors consider effects of global climate change a significant business and investment risk. CERES was founded in 1989 by Joan Bavaria and Dennis Hayes, coordinator of the first Earth Day, as a network for investors, environmental organizations, and other public interest groups interested in working with companies to address environmental concerns. In 1989, representatives from the SRI industry gathered at the first SRI in the Rockies Conference to exchange ideas and gain momentum for new initiatives. The name has since changed to The SRI Conference which meets annually at Green Building certified establishments and has attracted over 550 persons annually since 2006. This conference is produced by First Affirmative Financial Network, an investment advisory firm that works with advisors nationwide providing portfolios specialized in sustainable and responsible investing. The first sell-side brokerage in the world to offer SRI research was the Brazilian bank Unibanco. The service was launched in January 2001 by Unibanco SRI analyst Christopher Wells from the São Paulo headquarters of the bank. It was targeted at SRI funds in Europe and the US, although it was sent to non-SRI funds both in and out of Brazil. The research was about environmental and social issues (but not governance issues) regarding companies listed in Brazil. It was sent for free to Unibanco's clients. The service lasted until mid-2002. Drawing on the industry's experience using divestment as a tool against apartheid, the Sudan Divestment Task Force was established in 2006 in response to the genocide occurring in the Darfur region of the Sudan. Support from the US government followed with the Sudan Accountability and Divestment Act of 2007. More recently, some social investors have sought to address the rights of indigenous peoples around the world who are affected by the business practices of various companies. The 2007, SRI in the Rockies Conference held a special pre-conference specifically to address the concerns of indigenous peoples. Healthy working conditions, fair wages, product safety, and equal opportunity employment also remain headline concerns for many social investors. In the mid-2010s, some funds developed gender lens investing strategies to promote workplace equity and general welfare of women and girls.

Current strategies

Socially responsible investing is a growing market in both the US and Europe. In particular, it has become an important principle guiding the investment strategies of various funds and accounts. As of late 2024, ESG ETFs reached over 640 billion U.S. dollars in assets.

Government-controlled funds

Government-controlled funds such as pension funds are often very large players in the investment field, and are being pressured by the citizenry and by activist groups to adopt investment policies which encourage ethical corporate behavior, respect the rights of workers, consider environmental concerns, and avoid violations of human rights. One outstanding endorsement of such policies is The Government Pension Fund of Norway, which is mandated to avoid "investments which constitute an unacceptable risk that the Fund may contribute to unethical acts or omissions, such as violations of fundamental humanitarian principles, serious violations of human rights, gross corruption or severe environmental damages". In the 2000s and 2010s, pension funds were under pressure to disinvest from the arms company BAE Systems, partially due to a campaign run by the Campaign Against Arms Trade (CAAT). Liverpool City Council passed a successful resolution to disinvest from the company, but a similar attempt by the Scottish Green Party in Edinburgh City Council was blocked by the Liberal Democrats.

Mutual funds and ETFs

Socially responsible mutual funds counted by the 2014 Trends Report increased in number to 415 in 2014, up from 333 in 2012, 250 in 2010, 173 in 2005 and 2007, 189 in 2003, and 167 in 2001. The overall number of mutual funds incorporating environmental, social and corporate governance (ESG) has increased four-fold since 2012. Additionally, 20 exchange-traded funds (ETFs) that incorporate ESG criteria were identified with $3.5 billion in assets at the end of 2011, an increase from the eight ETFs with $2.25 billion in net assets identified in its 2007 report—the first Trends report to track ETFs [11]. Unlike the Employee Retirement Income Security Act of 1974 (ERISA), which severely limits the extent to which socially responsible goals can be considered in managing corporate and Taft-Hartley pension assets (due to ERISA's overriding goal of protecting employees' pensions), registered investment companies can take these factors into account so long as the disclosure and other requirements of the Investment Company Act of 1940 are met. US SIF maintains charts describing the socially responsible mutual funds offered by its member firms.

Key: X = No investment; P = Positive investment; R = Restricted investment; NS = No screens.

Separately managed accounts

According to the 2014 Report on US Sustainable, Responsible and Impact Investing Trends, among separate account managers, 214 distinctive separate account vehicles or strategies, with $433 billion in assets, incorporated ESG factors into investment analysis. Where a separate account is subject to ERISA, there are legal limitations on the extent to which investment decisions can be based on factors other than maximizing plan participants' economic returns.

Shareholder advocacy

Shareholder resolutions are filed by a wide variety of institutional investors, including public pension funds, faith-based investors, socially responsible mutual funds, and labor unions. In 2004, faith-based organizations filed 129 resolutions, while socially responsible funds filed 56 resolutions. Regulations governing shareholder resolutions vary from country to country. In the United States, they are determined primarily by the Securities and Exchange Commission, which regulates mutual funds and applies the 1940 Act and by the Department of Labor, which regulates certain plans and applies ERISA. These regulatory regimes require pension plans and mutual funds to disclose how they voted on behalf of their investors. U.S. shareholders have organized various groups to facilitate jointly filing resolutions. These include the Council of Institutional Investors, the Interfaith Center on Corporate Responsibility, and the US SIF. From 2012 to 2014, more than 200 US institutions and investment management firms filed or co-filed proposals. These institutions and money managers collectively controlled $1.72 trillion in assets at the end of 2013. The top categories of environmental and social issues from 2012 to 2014 were political contributions and climate change and environmental issues.

Community investing

Community investing, a subset of socially responsible investing, allows for investment directly into community-based organizations. Community investing institutions use investor capital to finance or guarantee loans to individuals and organizations that have historically been denied access to capital by traditional financial institutions. These loans are used for housing, small business creation, and education or personal development in the US and UK, or are made available to local financial institutions abroad to finance international community development. The community investing institution typically provides training and other types of support and expertise to ensure the success of the loan and its returns for investors. Community investing grew almost 5% from 2012 to 2014. Assets held and invested locally by community development financial institutions (CDFIs) based in the US totaled $64.3 billion at the start of 2014, up from $61.4 billion in 2012.

Investing in capital markets

Social investors use several strategies to maximize financial return and attempt to maximize social good. These strategies seek to create change by shifting the cost of capital down for sustainable firms and up for the non-sustainable ones. The proponents argue that access to capital is what drives the future direction of development. A growing number of rating agencies collects both raw data the ESG behaviour of firms as well as aggregates this data in indices. After several years of growth, the rating agency industry has recently been subject to a consolidation phase that has reduced the number of genesis through mergers and acquisitions.

ESG integration

ESG integration is one of the most common responsible investment strategies and entails the incorporation of environmental, social and governance ("ESG") criteria into the fundamental analysis of equity investments. According to the non-profit Investor Responsibility Research Center institute (IRRCi), approaches to ESG integration vary greatly among asset managers depending on:

Management: Who is responsible for ESG integration within the organization? Research: What ESG criteria and factors are being considered in the analysis? Application: How are the ESG criteria being applied in practice?

Negative screening

Negative screening excludes certain securities from investment consideration based on social or environmental criteria. For example, many socially responsible investors screen out tobacco company investments. The longest-running SRI index, the Domini 400—now the MSCI KLD 400—was started in May 1990. It has continued to perform competitively —with average annualized total returns of 9.51% through December 2009 compared with 8.66% for the S&P 500. Various academic studies have found positive, negative, and neutral associations between SRI fund orientation and financial performance.

Divestment

Divestment is the act of removing stocks from a portfolio based on mainly ethical, non-financial objections to certain business activities of a corporation. Recently, CalSTRS (California State Teachers' Retirement System) announced the removal of more than $237 million in tobacco holdings from its investment portfolio after six months of financial analysis and deliberations.