Socially responsible investing (SRI) has exploded in popularity in recent years and is now one of the most discussed topics in money management. The method’s emergence is fueled by multiple trends, including shifts in investor attitudes and the proliferation of financial products that cater to conscientious investors.
In 2020 (and beyond), the hype surrounding SRI shows no signs of slowing. While SRI strategies still have plenty of critics, the benefits of socially responsible investing — particularly in light of the market volatility that’s defined the past several quarters — have become evident. As a result, socially responsible approaches like ESG (environmental, social, and governance) investing and other values-based investing tactics have shifted from “satellite” portfolio components to “core” investment strategies.
Why are SRI strategies so appealing to modern investors? These investments allow people to do good while earning stable profits.
Good Investments Produce Great Results
The arguments against socially responsible investing generally focus on the myth that SRI strategies underperform compared with more traditional investments. By now, that fallacy has been all but debunked.
Last year, Morgan Stanley assessed investment performance data across nearly 11,000 mutual funds from 2004 to 2018. That analysis revealed that ESG-focused mutual and exchange-traded funds (ETFs) achieved the same level of returns as more traditional investment products while also providing increased downside risk protection. The fact that mutual fund managers whose portfolios align with their values tend to be more even-keeled during periods of heightened volatility may explain a lot of SRI’s success.
Likewise, the fundamental analysis techniques used by socially responsible investing proponents may make these investments more objectively stable. For instance, ESG investors tend to avoid companies that face inherent structural risks (e.g., major fossil fuel companies) and favor those that demonstrate strong governance. From a logic standpoint, responsible company management breeds confidence in turbulent times and should yield better long-term performance.
Even so, investors looking to construct their own socially responsible portfolios will face several significant challenges, including:
- Pervasive misinformation. “Greenwashing” (i.e., when companies misrepresent how environmentally conscious they are) has grown more prevalent amid heightened investor scrutiny. Separating fact from fiction in corporate communications — or finding a financial advisor who can do it confidently — isn’t always a straightforward process. Learning to discern between investments with altruistic intentions and ones that just want to appear so requires patience and persistence.
- Misleading products. Socially responsible investing’s surge in popularity has led to a proliferation of funds claiming to cater to values-based investment strategies. However, just because a fund has the “sustainable” or “socially responsible” tag attached to it doesn’t mean all of its holdings will align with investor values. Investors must carefully research fund mandates and activities if they want to make sure those products meet their objectives.
- Lack of diversification. ESG and sustainable funds are often disproportionately weighted toward large, domestic, and growth-oriented technology companies. That’s great when these companies outperform the market, but a portfolio that’s too heavily focused on one sector, business model, or market cap offers little downside protection.
All investors should ensure their holdings are adequately diversified and appropriately hedged. Constructing a portfolio that meets these criteria while aligning with personal values often requires specialized expertise.
There are countless socially responsible investing strategies and products available to the public. Even the most discerning investors should be able to find one that fits their objectives. That said, traditional wealth management strategies might still be a better option for some.
To read more about the potential challenges and benefits of socially responsible investing, click here to read our latest whitepaper. And to learn more about how Pekin Hardy Strauss Wealth Management helps clients align their portfolios with their values, visit us here.
This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this article, and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future. Because the application of ESG (environmental, social, governance) screens eliminate certain securities as investments, it may cause performance to behave either positively or negatively compared to strategies that do not apply ESG screens. Because the application of Socially Responsible Investing (SRI) eliminates certain securities as investments, it may cause performance to behave either positively or negatively compared to strategies that do not screen for SRI criteria.