Socially responsible investing: incorporating personal values with investment decisions

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3 key takeaways

  • Socially responsible investing provides a mechanism for investors to align personal values with investment objectives.
  • Environmental, social, and governance (ESG) factors can be a key way to assess the sustainability and social impact of an investment in a company or business.
  • In general, ESG investing can be approached in 3 ways: Actively include companies based on ESG factors, exclude companies that violate certain ESG factors, or take a blended approach.

What is socially responsible investing?

At its most basic, socially responsible investing (SRI) provides a mechanism for investors to align personal values with investment objectives by investing in companies with strong environmental, social, and corporate governance conduct. This type of investment strategy may help to provide important societal or environmental benefits through companies with a focus on effectively utilizing environmental resources, fostering safer working conditions, or improving corporate governance.

It's important to note that socially responsible investing doesn't mean you have to settle for lower returns while simultaneously supporting causes you care about. According to research by Morgan Stanley, "There is a positive relationship between corporate investment in sustainability and stock price and operational performance."* After examining performance data for 10,228 open-end mutual funds, researchers found that investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments on a risk-adjusted basis, across asset classes and over time.*

Socially responsible investing has become more prevalent among mainstream investors in recent years, particularly millennial investors (those born after the early 1980s). A survey by Morgan Stanley found that 84% of millennial investors were interested in "sustainable investing" and were twice as likely to make sustainable investment decisions.* But that doesn't mean that socially responsible investing can't be an appropriate choice for investors of all ages.

As you learn more about this topic, keep in mind, the term socially responsible investing is often used interchangeably with "sustainable investing," "responsible investing," and "impact investing."

Understanding environmental, social, and governance (ESG) factors

ESG stands for environmental, social, and governance, which are factors that are generally viewed as assessing how well a company is positioned to address the potential risk and costs associated with these key issues. For example, how is the company managing labor, employee health and safety, or consumer product liability?

The overarching goal of socially responsible investing is to achieve competitive financial returns while also having a positive impact on society, or to avoid investing in companies that conflict with your personal values. For example, if you were concerned about sustainable sourcing, you might choose to buy only a certain brand of coffee. To take it one step further, you might choose to invest in the same coffee company. If you were concerned about a company’s negative impact on the environment, you might avoid investing in companies with extremely high carbon emissions.

Factors to consider when pursuing an SRI strategy

SRI managers and the indexes they track typically incorporate the following ESG criteria into their investment selection process:

  • Environmental factors consider how a company performs as a steward of the natural environment (e.g., a company's carbon emissions, air/water pollution, energy efficiency, raw material sourcing, and other issues related to environmental practices).
  • Social factors consider how a company manages relationships with its employees, suppliers, customers, and the communities in which it operates (e.g., a company's impact on human health, human rights, labor standards, gender diversity, employee engagement, and data protection/privacy).
  • Governance factors can include the quality and reasonableness of a company's leadership, executive pay, audits and internal controls, and shareholder rights (e.g., diversity of the Board of Directors, executive compensation, lobbying and political contributions, and business ethics).

SRI should not be confused with charitable giving or philanthropic efforts to affect social change. For example, if you were concerned about gender equality in the workplace, you could donate to a nonprofit organization that is championing this cause. When it comes to your investment portfolio, you could apply ESG factors to your investment decisions and choose companies that actively promote gender equality.

Generally, there are 3 ways to incorporate socially responsible investing goals into your financial plan or into your investment portfolio:

  1. Actively seek to include ESG factors into your investment decisions. This could include targeting ETFs tied to a certain theme, such as measuring the performance of companies in the MSCI EAFE Index that are "fossil fuel reserves free," which are defined as companies that do not own fossil fuel reserves, such as SPDR MSCI EAFE Fossil Fuel Reserves Free ETF (EFAX). 
  2. Actively exclude companies that violate ESG criteria. For example, if you're concerned about health issues, you might screen out companies that sell alcohol, tobacco, or guns. In 2016 alone, 21 socially responsible ETFs launched with specific objectives such as SPDR SSGA Gender Diversity Index ETF (SHE) which tracks U.S. companies that are leaders in advancing women through gender diversity on their boards of directors and in management. 
  3. Use a blend of inclusive and exclusive ESG criteria to identify companies that may align to your values but may also have the potential to deliver strong results.

Choosing socially responsible investments for your portfolio

Once you've made a decision to invest in a vehicle that relies on SRI factors, the next step is to decide where to allocate your money. ESG factors can be applied to individual stocks or if you're seeking professional portfolio management, SRI-focused mutual funds and ETFs may be a good place to start. Currently, there are more than 150 mutual funds and 45 ETFs with an SRI mandate, according to Morningstar.

As with non-SRI funds, some fund managers may take an active approach and seek to outperform an index, while others may take a passive approach and simply try to match a benchmark index. As you research your choices, keep in mind that no two funds or ETFs are managed the same way, so it's important to read each prospectus carefully.

In summary, determine your motivation, impact goals, and approach to aligning with goals.

Values alignment ESG incorporation

Link investment decisions with personal mission or values

Influence standards of corporate behavior

Impact priorities

Avoid investments in companies that are not compatible with mission and goals

Incorporate ESG factors into investment decisions

Primary technique

Exclusionary screening

Inclusionary screening and best in class selection

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* Sustainable Signals: The Individual Investor Perspective. February 2015. Morgan Stanley Institute for Sustainable Investing.

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