Traditionally, investing means generating a profit, with savvy investors building their portfolios around the companies with the best financial performance to maximise their return on investment. However, a new trend has emerged in recent years, with investors taking into account corporate social responsibility when investing rather than focusing on profits alone.
Enter Socially Responsible Investing (SRI). SRI is an approach to investment decisions that looks beyond purely financial elements to examine the social impact of companies and their products practices.
SRI portfolios are becoming increasingly popular, especially among younger investors. But how exactly do they work, and how effective are they in terms of ROI and social impact? This guide will cover everything you need to know about socially responsible investments.
What is socially responsible investing?
In socially responsible investing, investors tailor their investment portfolio to invest only in companies and funds which match their personal beliefs and values. They aim to encourage companies to adopt more socially responsible practices, such as sustainability, fair labour practices, and equal opportunities.
SRI can often mean different things since everyone’s definition of what counts as “socially responsible” will differ somehow. As such, SRI can be somewhat subjective and open to interpretation. As a result, socially responsible investment strategies also go by various other names, such as:
- Sustainable, responsible, and impact investing.
- Environmental, social, and governance (ESG) investment.
- Values-based investing.
- Impact investment.
- Sustainable investment.
- Ethically conscious investing or socially conscious investing.
At its core, however, all of these SRI variations operate on the principle of encouraging positive social and environmental impacts through investment.
How does socially responsible investing work?
There are a few different methods that a socially responsible investor may use to carry out socially responsible and ethical investing. First, they may use negative screening. This process involves ruling out investments in any company that deals in products and services that don’t match your values. For instance, a negatively screened portfolio might avoid investment in companies producing fossil fuels or weapons.
The opposite approach is a positive investment — investing specifically in companies whose work creates a positive impact or promotes practices you believe are ethical. For example, positive investing could mean investing in a company that designs clean energy solutions or is committed to positive labour practices.
Another option is community investing. Community investing involves investing directly in projects that will benefit your local community by creating new opportunities, resources, or infrastructure. Examples include investing in local businesses and startups or buying financial products designed around community investments.
Why is socially responsible investing important?
SRI is becoming more popular as an investment strategy because it looks beyond the financial impact of your investments to examine what effect they have on society. In doing so, socially responsible investors can ensure that their investments create real change in the world and benefit other people while also turning a profit.
Therefore, SRI is an excellent way of committing to a cause you care about and making an impact. For instance, if you’re passionate about climate action, investing in sustainable funds and companies with low carbon operations or net-zero commitments can help to promote these practices further. At the same time, divesting from companies whose practices you disagree with can help to discourage those practices in the future.
Is socially responsible investing effective?
It’s hard to gauge precisely how effective SRI is in driving change since the aims and values of SRI investors and responsible investing funds can vary so much. In addition, there may not be an immediately apparent cause-and-effect relationship between investments and social impacts.
However, history can show the power of socially responsible investment practices. One prominent example lies in civil rights. In the 1980s, campaigns to disinvest from South African companies played a significant role in pressuring the South African government to dismantle discriminatory policies of apartheid.
This example shows that investing ethically can positively impact society in remarkable ways. Many believe that similar campaigns to divest from fossil fuel companies will be instrumental in addressing growing concerns over climate change.
Does socially responsible investing make financial sense?
While socially responsible investors aim to make positive environmental and social impacts, it’s important to remember the other purpose of these investments: making a profit.
Some critics of SRI claim that limiting investing options through socially responsible investing risks limiting choices for investors’ portfolios, leading to missed investment opportunities that could generate better financial returns.
While there are certainly pros and cons to weigh up when looking at ethical investing strategies, there’s much evidence to suggest SRI is just as profitable as traditional investing.
The ROI of SRI funds and portfolios has frequently been shown to be no worse than traditional investments. One analysis even found that 80% of reviewed studies demonstrated that strong sustainability practices positively affected an investment’s performance.
Another study found that negative screening would have had little to no effect on the returns of a portfolio of the top 20 Australian companies from 1926 to 2015. Filtering out industries such as tobacco or gambling would not have caused any noticeable decrease in profits.
In recent years, even the mining industry, which has typically outperformed many Australian indices, was outperformed by certain Australian sustainable and ethical funds. All of this is to say that SRI does make financial sense — it can help you make a profit while also making a social impact.
How to invest in socially responsible companies?
If you’re interested in social investment there are several different investment approaches to take. The first and most crucial step is to decide which values matter most to you.
Will you base your investments around sustainability and reducing emissions? Equal opportunities? Fair labour practices? Decide which social causes are your priority to help you get a clear idea of your responsible investing goals.
Your next choice is how you will invest in socially responsible companies. One method is to pick out individual companies to invest in based on your values and social priorities. This approach means carefully researching a wide range of companies to find the ones you want to invest in.
While this approach ensures that all your investments closely match your values, it can be highly time-consuming and leave you with a portfolio that can be hard to manage. A much easier way to approach ethical investments is to buy into a socially responsible ETF.
What is a socially responsible ETF?
An ETF (exchange-traded fund) is a parcel of securities such as bonds and shares traded as a single unit. Like a managed fund or mutual fund, they’re managed by an investment manager or fund manager to reflect specific investment goals.
Socially responsible ETFs are made up of stocks in companies that match the desired social impacts of the ETF. These ETFs are carefully assembled by a fund manager or asset manager who assesses how well a company matches the values and goals of the ETF and how well they are likely to perform.
Socially responsible, sustainable, and ethical ETFs are a great way to diversify your portfolio without researching several individual companies. All you need to do is check the principles for responsible investment that the ethical fund or ETF uses to select companies to ensure these values match your own, buy into the ETF, and let the fund managers handle the rest.
Different ethical ETFs may have different priorities. A sustainability fund or green bonds ETF, for instance, would aim to invest in sustainability leaders and green investment funds. On the other hand, a social index fund may generally invest in companies with high ESG ratings.
Many resources and information sources help you find a responsible investment fund or individual companies that meet your SRI or ESG criteria. For instance, financial institutions such as the Responsible Investment Association Australasia (RIAA) are dedicated to helping people invest responsibly in Australia and New Zealand.
You could also seek advice from a financial advisor or portfolio manager. As well as providing valuable financial advice, financial advisers can help you research SRI and ESG factors more effectively through their more profound knowledge of companies, funds, and other types of financial products.
As with any investment, whether or not you should partake in SRI depends on your objectives, financial situation, and other personal factors. Overall, though, SRI is an option with a lot of appeals.
They provide investors with a way to create real change through their investments, encouraging the adoption of global sustainable practices, better labour practices, better corporate governance and business accountability, and more.
And while some critics claim SRI isn’t as profitable, the evidence suggests that responsibly invested funds generate responsible returns, meaning investors can make a profit while fuelling the change they want to see in the world.
Disclaimer: Please note that these are the views of the writer, Jodi Pettersen, Investor Relations at eInvest, and is not financial advice. To find out how to invest in our active ETFs, visit here. The product disclosure statement, TMD, and more can be found at www.einvest.com.au. If you’d like to keep learning further, please feel free to follow any of our socials listed below.