A Guide to Socially Responsible Investing

My Dad is a no-nonsense guy who always challenges me to “put your money where your mouth is” when it comes to my values. Sometimes it’s a figurative challenge and other times it’s a suggestion to literally make a mindful choice about where I spend money. Socially responsible investing is a trendy name for an investing approach that follows my Dad’s time worn advice: invest your money in companies that operate in line with your beliefs. The goal of most socially responsible investing is to grow your money – like any other investment strategy – while also supporting good in the world.

Good in the world comes in many forms and socially responsible investing tends to follow environmental, social, and governance (ESG) standards, the three factors used to measure a company’s impact on society and sustainability. Specifically, common themes over the past few decades have focused on social and political trends like respecting the environment, ethical sourcing of business inputs (e.g., raw materials), and treatment of employees. 

While Millennials and Gen Z’ers are often associated with socially responsible investing, many investing professionals agree that companies considered to be good corporate citizens might also be high quality businesses worthy of investment.

In the U.S., assets invested in the socially responsible investing universe have grown exponentially since 1995, according to the US SIF Foundation, a leading authority in this space.¹ It’s estimated that over 25% of all the money invested with U.S. professional investment managers reflects socially responsible principles, causing publicly traded companies, fund managers, and investors of all generations to take notice. And maybe that is exactly the point.

Most socially responsible investments have similar financial success as the broader markets, despite a common belief that earnings must be sacrificed to “do good.” In fact, multiple studies show that many “best in class” companies in major indexes like the Dow Jones or S&P 500 also happen to meet ESG standards or are aligned with the United Nations Sustainable Development Goals.² In other words, these organizations are successful and meet socially responsible investing standards.

There are a few ways to go about socially responsible investing. Many different approaches can be done by individual investors and professional managers alike, including:

• ESG funds.
• Negative screening.
• Positive investing.
• Impact investing.
• Community development investing. 

I’ll provide an overview of these approaches so you can determine which, if any, make sense for you.

ESG funds are portfolios of stocks and/or bonds from companies that have met certain ESG criteria. Often, these exchange-traded-funds (ETFs) are built in a way that mirrors the makeup of popular indices like the S&P 500, making them diversified and easy to buy. Sometimes, these funds will exclude stocks of certain industries considered to score low in terms of ESG criteria, such as tobacco companies, firearms manufacturers, and non-sustainable food producers.

When picking companies in an ESG fund, ESG factors do not take the place of analyzing typical financial metrics. Instead, they’re considered as an additional filter. In response to investor demand for information about whether a company meets ESG standards, 95% of S&P 500 companies now disclose ESG information.³ Research firms often use this information to create ESG scores and ratings that help investment managers decide which companies to include in an ESG fund. Typical ESG factors include:

• Environmental: Impact on climate change, natural resource management, pollution, waste and recycling policies, and relationships with “green” agencies, such as the federal Environmental Protection Agency (EPA) or the New York State Department of Environmental Conservation (NYSDEC). Companies that have been fined, sanctioned, or otherwise investigated by such agencies are likely to have lower ESG scores than companies that haven’t.
• Social: Product liability, employee health and training, labor relations, employee turnover, customer service and satisfaction, employee inclusion/diversity, ethical sourcing of materials.
• Governance: Board and management diversity, tax transparency, management stability, corporate communications, classes of stock, executive compensation metrics.

The positive investing approach to socially responsible investing is when you purposely select investments that align with ideals you want to support, kind of the mirror image to negative screening. The idea is that by specifically supporting certain companies, you will be directly helping them contribute to the wellbeing of society through their operations. 

Past beneficiaries of positive investing included companies that were dedicated to civil rights, women’s rights, or anti-war efforts. Today, the focus includes principles like fair trade, green transport, organic food, and tackling poverty. Portfolio managers of ESG ETFs tend to utilize both negative screening and positive investing.

The goal of impact investing is to help address some of the world’s most pressing challenges, even if earnings take a back seat. The Global Impact Investing Network (GIIN), a nonprofit organization, defines impact investing as “investments made with the intention to generative positive, measurable social and environmental impact alongside a financial return.”⁶ 

Impact investments are made in both emerging and developed markets and in various ways, like stock investments, venture capital, debt financing, and private equity. Four characteristics of impact investing are:⁷

• It’s intentional: You invest with the conscious intent to make a positive impact.
• Returns are expected: Different from charitable giving, you expect that money invested will earn a return or at least be preserved.
• Wide range of returns: Different from traditional investing, you accept a wide range of earnings, from concessionary (below market) to market rates. Most impact investors look for competitive returns.
• Impact measurement: You measure success on more than just financial returns. Key aspects for impact investors are accountability and progress toward social goals.