Socially Responsible Fund Investing: What's The Deal?

Socially responsible investing (SRI) is an investment strategy that aims to generate both social change and financial returns for an investor. It involves investing in companies that promote positive social and environmental outcomes, while also generating positive investment returns. SRI investors typically avoid investing in businesses with negative social impacts, such as those involved in the production or sale of addictive substances, weapons, or fossil fuels. Instead, they seek out companies engaged in social justice, environmental sustainability, and alternative energy efforts. SRI has gained popularity in recent years, with more investors seeking to align their money with their values and make a positive impact.

Socially responsible investing (SRI)

SRI can also be referred to as values-based investing, sustainable investing, ethical investing, or impact investing. The latter is considered a subset of SRI and is more proactive and focused on the conscious creation of social or environmental impact through investment.

SRI investors encourage corporate practices that promote environmental stewardship, consumer protection, human rights, and racial or gender diversity. They also avoid investing in businesses with negative social effects, such as alcohol, tobacco, gambling, pornography, weapons, fossil fuel production, or the military.

SRI is often considered through the lens of environmental, social, and governance (ESG) factors. This approach focuses on the company's management practices and whether they tend toward sustainability and community improvement.

SRI has been growing in popularity in recent years, with more and more funds and investment vehicles becoming available for retail investors. Mutual funds and ETFs provide the added advantage of exposing investors to multiple companies across many sectors with a single investment.

There are two inherent goals of SRI: social impact and financial gain. These do not always go hand in hand, and investors must assess the financial outlook of an investment while trying to gauge its social value.

SRI is not just about the companies and industries to avoid but also about actively seeking out companies that create positive social and environmental impacts. This includes investments in renewable energy, affordable housing, education technology startups, healthcare innovations, and sustainable agriculture initiatives.

SRI is a global phenomenon, with international investment products and opportunities expanding. As of 2018, sustainable investing assets in the five major markets (Europe, the United States, Japan, Canada, and Australia/New Zealand) stood at US$30.7 trillion. A 2020 global analysis from Morningstar indicated that assets in sustainable funds reached nearly $1.7 trillion.

Environmental, social and governance (ESG) criteria

Environmental, social, and governance (ESG) criteria are standards used to evaluate a company's operations and impact in three key areas.

Environmental Criteria

These criteria serve as tools to assess a company's environmental risks and potential damage to the ecosystem. They encompass critical challenges such as climate change, water security, environmental health hazards, waste management, biodiversity loss, and potential extinctions. Companies can address these risks through proactive management and sustainability initiatives, thereby contributing to both environmental protection and long-term business success. Examples of environmental criteria include:

• Initiatives to reduce carbon emissions and mitigate climate impact, such as adopting renewable energy sources and setting science-based emission reduction targets.
• Practices to enhance energy efficiency and reduce consumption, including investing in energy-efficient technologies and implementing smart energy management systems.
• Strategies to address water scarcity and ensure sustainable water use, such as water recycling and implementing water-efficient processes.
• Efforts to combat air and water pollution, including the use of non-toxic materials and adherence to environmental regulations.
• Waste and resource management, promoting a circular economy approach and reducing single-use plastics.
• Deforestation prevention and reforestation initiatives to support sustainable forestry practices.
• Biodiversity protection through the preservation of natural habitats and the promotion of sustainable land use practices.

Social Criteria

Social ESG criteria encompass a company's engagement and interaction with various groups, including employees, customers, investors, suppliers, and local communities. These criteria may include efforts to reduce inequalities, uphold human rights, and safeguard the health and safety of workers and surrounding communities. Examples of social criteria include:

• Ensuring fair and ethical treatment of all individuals, both within and outside the organisation.
• Adhering to labour standards and regulations that promote fair wages, safe working conditions, and workers' rights.
• Implementing strategies to understand and enhance customer satisfaction.
• Protecting personal and sensitive information through robust data security measures and privacy policies.
• Fostering an inclusive workplace by supporting equal opportunities and representation for all genders and diverse groups.
• Encouraging employee engagement and well-being through various programmes.
• Building and maintaining positive relationships with local communities through engagement and support activities.

Governance Criteria

The third component of ESG criteria focuses on business leadership and transparency mechanisms. This includes policies that promote a diverse board of directors, uphold stringent corporate accounting standards, govern executive compensation, ensure public disclosure, manage conflicts of interest, and address legal and ethical considerations. Examples of governance criteria include:

• Establishing fair and transparent policies for executive compensation, aligning their incentives with the company's long-term goals.
• Ensuring a diverse and balanced board of directors with a range of skills, experiences, and perspectives to enhance decision-making.
• Implementing strict anti-bribery and corruption measures and procedures within the organisation.
• Adhering to ethical guidelines and legal requirements regarding lobbying activities and ensuring transparency.
• Monitoring and regulating political contributions to avoid conflicts of interest and ensure alignment with the company's values and policies.
• Establishing secure channels for employees to report unethical or illegal activities without fear of retaliation.
• Creating a robust audit committee to oversee financial reporting, internal controls, and compliance with laws and regulations, ensuring the integrity of financial practices.

Shareholder activism

According to a meta-analysis, approximately 90% of studies on ESG show a non-negative relationship between ESG and financial performance, with a majority indicating positive correlations. This evidence suggests that ESG considerations can lead to improved risk management, cost savings, and access to capital, thus enhancing overall financial health.

A notable example of shareholder activism is Jana Partners' campaign calling on Apple to recognise the potential dangers of excessive social media use by children and teenagers. Jana also announced that it was planning to raise a new fund, Jana Impact Capital, which would invest in companies that "are good bets but could do better for the world".

Another example is the use of sharply written letters by Daniel Loeb, head of Third Point Management, directed towards the CEOs of his target companies.

History of Shareholder Activism

During the 1980s, activist investors such as Carl Icahn gained international notoriety and were often perceived as "corporate raiders". More recently, activist investor Phillip Goldstein suggested that the role of the activist investor has evolved from greenmail to being a catalyst to unlock value in securities.

Forms of Shareholder Activism

Proxy Battles

Proxy battles involve competing slates of candidates for the board of directors, with shareholders voting on their preferred candidates. This is a common tactic used by activist investors to gain control of the board and implement changes in the company's strategy or management.

Publicity Campaigns

Publicity campaigns involve using media outlets to bring attention to an issue and pressure the company to make changes. This can include press releases, social media campaigns, and other forms of public communication.

Shareholder Resolutions

Shareholder resolutions are proposals submitted by shareholders for a vote at the company's annual general meeting. These resolutions can address a variety of issues, such as executive compensation, environmental policies, or social responsibilities.

Litigation

In some cases, shareholder activists may resort to legal action if they believe the company's management is acting against the best interests of the shareholders. This could involve lawsuits, injunctions, or other legal means to force changes in the company's policies or practices.

Negotiations with Management

Shareholder activists may also engage in direct negotiations with the company's management to address their concerns. This could involve meetings, discussions, and compromise to reach an agreement that satisfies both parties.

Impact investing

The impact investing market provides capital to address global challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services, including housing, healthcare, and education.

Core Characteristics of Impact Investing

• An intention to have a positive social and/or environmental impact: The core of impact investing is the investor's intention to create positive social and environmental change through their investments.
• Investment with return expectations: Impact investments aim to generate financial returns or, at a minimum, a return of capital.
• Range of return expectations and asset classes: Impact investments can target financial returns below market rate, risk-adjusted market rate, or higher, and can be made across various asset classes, including cash equivalents, fixed income, venture capital, and private equity.
• Measurement and transparency: A key feature of impact investing is the commitment to measure, report, and ensure transparency regarding the social and environmental performance of underlying investments.

Who is Making Impact Investments?

Financial Performance of Impact Investments

Impact investors have varying financial return expectations. Some aim for below-market-rate returns, while others seek market-competitive or market-beating returns. Most investors surveyed in the GIIN's 2023 Annual Impact Investor Survey pursue competitive, market-rate returns.

The performance of impact investments generally meets or exceeds investor expectations for both social and environmental impact and financial returns. While there are risks associated with impact investing, the most commonly cited contributor to risk is business model execution and management.

Examples of Impact Investing in Practice

• Acumen and Everytable: Acumen, an impact investment firm, partnered with Everytable, a food company, to increase access to healthy and affordable meals in underserved communities across the United States.
• LeapFrog and Bima: LeapFrog Investments, a specialist impact investor, provided growth capital to Bima, a microinsurance company, to expand access to insurance for low-income individuals and their families in Africa and Asia.
• Patamar Capital and Kinara Capital: Patamar Capital, an impact investment firm, invested in Kinara Capital, a fintech company, to provide loans to small and medium-sized businesses in India, promoting financial inclusion and economic growth.

Benefits of Impact Investing

• Encouraging corporate practices that align with personal and philanthropic values, such as fair labor practices, environmental stewardship, and human rights.
• Using resources beyond charitable donations to support social and environmental issues.
• Supporting sustainable approaches to addressing societal challenges, reducing reliance on philanthropic funds alone.
• Achieving financial returns while creating positive social impact.

How to Participate in Impact Investing

There are several ways to get involved in impact investing:

• Invest in ESG funds: One of the simplest ways to start is by investing in environmental, social, and governance (ESG) funds, which consider social and environmental factors in addition to financial returns.
• Donate to impact-investing nonprofits: You can support organizations that blend charitable donations with investment capital to undertake higher-risk projects that may not be financially viable otherwise.
• Invest directly in private companies: You can invest in private companies or funds with explicit social or environmental missions, such as those focused on renewable energy or carbon sequestration.
• Lend to nonprofits: You can lend to nonprofit organizations whose missions you want to support through nonprofit loan funds, which pool capital from multiple lenders to reduce risk.
• Utilize donor-advised funds: Donor-advised funds, like the Giving Account at Fidelity Charitable, allow you to make irrevocable contributions, receive immediate tax deductions, and recommend grants over time. You can recommend investing these funds for tax-free growth in impact investing options.
• Explore more sophisticated strategies: For those with more knowledge and expertise, you can explore investing in individual companies or lending directly to nonprofits, which can be more complex.

Community investing

Community investments are not donations. They allow investors to give to a community in need while making a return on their investment. Many community investments are put toward community development banks in developing countries or in lower-income areas of the United States to be used for affordable housing and venture capital.

Frequently asked questions