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In the modern day, there is an increasing number of investors that are wanting to own companies that share their own values, and this can best be accomplished through a process known as socially responsible investing. Socially responsible investing, or SRI, offers investors the opportunity to make a positive social impact through their allocations while aligning their own values with their investment decisions.
Socially responsible investing is also used interchangeably with ethical investing, sustainable investing, or green investing, and it refers to an investment process that integrates the analysis of a company’s social responsibility with traditional financial measures in pursuit of better returns.
In the past, socially responsible investing was associated with “negative screening”, or avoiding businesses that are associated with alcohol, tobacco, gambling, pornography, abortion, weapons, heavy polluters, or companies that are vocal about human rights concerns. Today, SRI goes beyond avoiding businesses – it has evolved into a process that integrates environmental, social, and governance (ESG) criteria into financial analysis and decision making.
Traditional financial analysis is an important starting point in evaluating potential investments. Environmental, social, and governance (ESG) criteria is an added layer of investment analysis that evaluates different companies on environmental, social, and governmental factors. By screening companies on the basis of ESG criteria, managers can derive additional insight into the quality of management, potential hidden risks, and the ability of the company to thrive.
Environmental screens look at a company’s energy use, resource management, and pollution record in concert with their commitments to sustainability and green business practices. Better environmental performance can lead to lower energy costs, reduced regulatory and lawsuit risks, and positive brand recognition.
Social screens evaluate companies on the strengths of their employee relations, product integrity, and human rights policies. Companies with higher quality social practices enjoy productivity increases, enhanced brand loyalty, and a reduction in lawsuit and reputation risks.
Governance screens look at the culture of a company. Does the company have accurate and transparent accounting practices? How does the company make decisions regarding executive compensation, salaries, and benefits? Has the company faced legal or ethical issues in the past? Companies with excellent governance ratings can reduce brand risks, avoid negative financial surprises, and are more responsive to shareholder interests.
A 2012 study by Deutsche Bank Group Climate Change Advisors found that incorporating environmental, social, and governance (ESG) data in investment analysis is “correlated with superior risk-adjusted returns at a securities level”.
Additionally, a 2005 report from the Social Investment Forum on Socially Responsible Investing Trends in the United States states that empirical research “has repeatedly confirmed that, when properly managed, risk adjusted, and controlled for investment style, socially screened portfolios perform comparably to their unscreened peers.”
As the studies above illustrate, applying social and environmental standards does not have to mean sacrificing performance. SRI has an increasing presence within the financial community, which is largely due to the competitive returns that ESG-screened portfolios have generated. The connection is clear – companies that do not follow responsible business and governance practices will tend to have a greater earnings risk due to regulations violations, lawsuits, boycotts, and strikes. Good ESG performance can help to protect companies from reputational and regulatory risks, enhance employee productivity, create favorable brand recognition, and significantly reduce energy costs. Each of these factors can potentially enhance earnings and lead to competitive, sustainable returns. In other words, ESG screening can bolster performance by both exposing hidden risks and identifying companies with stronger workplace practices and higher quality management.
As shareholders, investors can have significant influence over the management of the companies they choose to invest in. Through mutual funds, individual investors can pool their respective voices into a singular strong voice that has the opportunity to engage companies through direct dialogue, proxy voting, and the filing of shareholder resolutions. Shareholder advocacy can be a powerful tool to promote meaningful economic, social, and environmental change. Investors have the ability to quite literally change the world through their investments – so why don’t you get started?