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SRI investing: What you need to know

Should you ever wake up in the night thinking the world is a big, screwed-up mess and you’d rather not add to it anymore than you already do1 [1], then know that you are not alone.

SRI investing – variously known as Socially Responsible Investing or Sustainable, Responsible, Impact Investing – is a growing market movement, enabling investors to put their pounds into the collection boxes of the good versus the G-strings of the bad.

By choosing an SRI-themed fund,2 [2] you are buying into firms with a positive environmental, social and corporate governance (ESG [3]) agenda [Caveat Alert] while steering clear of sleazy capitalists who profit from gambling, porn, booze, fags, guns, and generally exploiting the planet and its denizens [Caveat Alert].

Hold up. What’s all this ‘Caveat Alert’ business?

Well, it turns out that investing on behalf of your conscience is no simple matter. It requires you (or someone else) to make active choices about what counts as vice or virtue.

And what about a firm that’s good and bad? Say a company is really good at employing a diverse workforce with generous pay packages – but really bad at resisting the temptation to strip-mine virgin rainforests?

Do you want your fund to be an active shareholder that lobbies management to work harder at not screwing over their workforce, employing children, contaminating the water supply, avoiding tax, corrupting local politicians…

SRI is a broad church. And you can just invest in a fund that slaps a friendly label on – like an egg box that claims its chickens are deeply-loved – or you can do some digging, and find out who you’re actually supporting.

Choosing SRI funds

Fortunately there are some people out there who can help you navigate the moral maze.

At the very simplest level you can stick ‘SRI’ into Morningstar’s [4] search box3 [5] to dial up a list of funds [6] and ETFs [7] designated ‘SRI’. You can then invest in a vehicle that’s a sweet-smelling version of one of your regular asset allocation picks.

For example, you’d stop stinking up the place with a standard global equity fund – neck deep in fossil fuels, cluster bombs, and god knows what else – and replace it with a global equity SRI fund instead.

Job done. It only remains to celebrate with an Uber ride down the pub, puff on a big Cuban and test-fire some nukes using a coal-powered launch system.

Alternatively, you can refine your choice by paying some attention to Morningstar’s Sustainability Rating [8] and Sustainability Score. These metrics are meant to indicate how well the companies in a fund walk the ESG walk in comparison to the holdings in similar funds.

The Sustainability Rating can be found on a fund’s overview page [9] on Morningstar, and as many as five globes can be awarded for good behaviour. The globes look like this:

Morningstar Sustainability Rating [10]

But how do you know whether companies really are playing nice? Well, let’s just say the level of scrutiny is not going to be up there with St Peter at the Pearly Gates or even Santa’s Elf On A Shelf.

Like buying Fairtrade chocolate, a lot must be taken on trust.

For example, companies are partly ranked according to their own documentation of their ESG policies. Performance measures like absenteeism and staff turnover play into their social rating. Carbon footprint can feed into the environmental side. The more you think about it, the more you realise that independently verifying this data must be a nightmare.

It’s also interesting to note that the company – Sustainalytics – whose data underpins the ratings does not seem to win many rave reviews from its former employees on GlassDoor [11].

That said, the metric enables us to see that, for example, the iShares MSCI Emerging Markets SRI ETF [9] gets a Sustainability Rating of five globes. That puts it in the top 10% of funds for ESG in Morningstar’s Global Emerging Market Equity category.

Meanwhile, iShares Core MSCI Emerging Markets IMI ETF [12] only gets two globes. That puts it in the bottom third of the Global Emerging Market Equity category.

You’ll notice the latter ETF is not SRI-focussed. Yes, Morningstar’s Sustainability Rating enables you to gauge the ethical tilt of funds that are not explicitly SRI. That’s handy because it allows us to cast our net wider. We can try to still invest in the most diversified funds while balancing our desire to make a difference.

Also note that all this globage tells us nothing about how funds compare against any other category. Five globes in Emerging Markets may not be as virtuous as three globes for a Clean Energy fund in the Equity Alternative Energy category, for instance.

And if a fund doesn’t notch a single globe then it doesn’t mean you’re investing in a bunch of companies with Sith Lords for CEOs. It simply means there isn’t enough data to generate a meaningful rating.

The long morality tail

If you want to shine a brighter light on your options then try Fund EcoMarket [13]. Its search tool helps you find funds on all points of the moral compass (except the one that points down).

Tick a box if you want to tilt towards:

These are just examples of the site’s breadth. It does an excellent job of breaking down and explaining the many granules of SRI.

So who are the moral guardians behind Fund EcoMarket? You can read all about them [14], but in short they are sponsored by wealth managers and fund providers who offer SRI services. Which makes sense because it’s not easy to research SRI investments right now. They freely admit they supply information as it’s provided by the product providers and I didn’t feel unduly funneled towards the sponsors’ products. In fact it’s the most useful UK SRI site I’ve found so far.

Fund EcoMarket’s search tool enables you to tick for index funds but it doesn’t currently include ETFs. As in the amoral fund space, SRI funds are dominated by active management, which is fine if you personally accept that’s a price worth paying.

Passive investors will be better served using the Morningstar link above and justETF’s search tool [15] with the social / environmental dropdown activated.

Here you can pour over specialised trackers like the Amundi MSCI World Low Carbon ETF or the iShares Dow Jones Global Sustainability Screened ETF. Remember that niche ETFs are risky because they are liable to concentrate on a narrow range of companies or sectors. They probably shouldn’t be more than a 5-10% complement to your portfolio and are not a replacement for broader asset classes [16].

The US market tends to innovate at a faster pace, so if you’re truly passionate about certain causes then you could research American products like the SDPR SSGA Gender Diversity Index ETF via platforms such as DeGiro or Interactive Brokers.

But be aware that going off the beaten path can take you deep into the woods and requires a level of research way beyond the scope of this article.

The wages of sin

I’ve deliberately left to last the really big question: Whether good can triumph over evil in a, y’know, Earthly riches sense.

Surely the Dark Side is the quick and easy path to financial freedom?

Well, unless the Minions of Evil are the ones doing all the research it’s impossible to give you a straight answer. The literature cuts both ways and much depends on how you mine the data. Sometimes the saints can beat the sinners, but the most likely story according to financial theory is articulated by the renowned trio of Dimson, Marsh, and Staunton from the London Business School.

These academics reviewed several SRI studies for their Credit Suisse Global Investment Returns Yearbook 2015 and declared [17]:

We show in this article that ‘sin’ can pay, not least because those choosing to exit ‘sinful’ stocks can cause them to offer higher returns to those less troubled by ethical considerations.

However, the expected financial impact of modest exclusions is generally small. We also provide evidence that corporate engagement can pay, whether the focus is on environmental and social issues or on corporate governance.

You see, as with any risky investment, if enough investors shun a firm you can expect its share price to fall below its fundamental value [18]. This sets the stage for future excess returns. Even if the saintly investors continue to reject vice, Dimson, Marsh, and Staunton theorise that:

If the ‘sin’ discount stays constant, the expected capital gain is the same for sin and non-sin stocks: the excess returns to sin stocks should then come in the form of higher dividends over time.

In other words, you pay a lower price for the dividends of sin which should improve your returns versus less dubious shares.

Yet even those who pursue Earthly pleasures should know that shareholders can drive returns by forcing management to clean up. Improved corporate behaviour lowers perceived risks, which means that reformed companies:

[Are] likely to attract additional investors, avoid environmental and social mishaps, and sell at a higher multiple.

Which according to Dimson, Marsh, and Staunton could lead to an interesting SRI strategy:

A large investor can generate continuing outperformance by buying non-responsible companies and turning them into more responsible businesses. After they have been cleaned up, the shares may then be sold at a price that reflects the accomplishments of the activist.

Whether or not you think this motive springs from the purest of ideals, it does suggest that SRI investing can make a positive difference to the world without leaving you poor as a church mouse.

Can you put a price on your principles?

Just in case you think all this socially responsible stuff is a bunch of hippy crap, Morningstar quotes figures that estimate 30% of global managed assets were devoted to sustainable investing in 2014 [19].4 [20]

It’s an area we’ve been asked to write more about by dozens of readers over the years, too.

The sight of human beings coming together to change the world is truly moving. It may be slow, it may be imperfect, but it is happening.

However, the purpose of this piece is not for me to tell you what to do. It’s to tell you what you can do.

Take it steady,

The Accumulator

P.S. This SRI business has more labels than a Formula One driver’s jumpsuit. Here’s an non-exhaustive list. Please add any more you find in the comments below!

(I may have made one of these up).

  1. …living your life of Western decadence at the nexus of a vast network of exploitation and inequity just so you can buy cheap trainers and neck chicken McNuggets in front of a giant TV that broadcasts more colours than you can actually see! AAAAARGH! [*Blows brains out*] [ [25]]
  2. I’m going to use the term ‘fund’ as a catch all for diversified collective investment vehicles including ETFs and Investment Trusts, but not just passive products, throughout this piece. [ [26]]
  3. Morningstar is a reputable financial data firm that provides useful tools for finding funds. [ [27]]
  4. See page 42. [ [28]]