Several clients have recently asked me about Socially Responsibility Investing (SRI), so I thought I’d share my thoughts. In case you are in a hurry, the executive summary of my critique is to avoid SRI because it is largely a marketing ploy that creates mutual funds that are expensive, not very diversified, generally perform poorly and may only imperfectly reflect the values that prompted you to consider SRI in the first place. If you are interested in details, read on…
Socially responsible investing attempts to align investors’ values with their investing choices. People generally approach SRI from one of two general perspectives:
- Social concerns (environmental issues, sustainability of resources, animal rights, women’s issues, conditions of workers, governance issues, etc.).
- Religious concerns (Christian, or Judeo-Christian values)
It is possible to invest in alignment with your values in a way that has a positive and meaningful impact and that doesn’t harm returns? Unfortunately, the answer is no as the spoiler above gave away, because there are three main problems with SRI.
The first problem SRI is one of definition. Everyone has a different set of values and a different way on putting those values into practice. This makes it extremely difficult to decide which companies to include or exclude from your investing criteria. Consequently, it makes it nearly impossible to pick an SRI mutual fund whose fund managers actually invest in a way that aligns with your values. I have encountered many investors who invest in SRI funds, and when I show them the actual companies that are included and excluded in the fund, and then ask them if that matches their values, I have never heard a resounding “yes”.
The second problem with SRI is performance. Just like actively managed funds, SRI funds tend to be expensive, have high turnover, and underperform the area of the market they are targeting. When you apply any SRI “screen” to a batch of companies and exclude some, by definition you decrease your diversification and increase your cost (because it takes resources and trading to put those screens into practice). The main, big SRI funds tend to focus their efforts on large, US growth stocks, so most end up looking like and acting like S&P 500 funds (most of them just exclude some oil stocks, or some tobacco or alcohol related companies depending on their SRI criteria). Holding only a subset of “appropriate” large US growth companies is hardly a diversified portfolio.
The third problem involves the mechanics of investing. When you buy a share of a stock (unless in an initial public offering (IPO)) none of that money goes directly to the company. It goes to the investor who sold their share. Companies don’t care who owns their shares or how often they are transferred (bought and sold) among investors. Therefore, the impact of excluding companies from your investment criteria is limited.
My recommendation is to avoid SRI and instead invest prudently in a broad based diversified fashion based on academic principles to maximize your long-term returns. You can then use your personal resources (time and money) to advance public policy and to support organizations and charities that align with your values.