Socially Responsible Investing:

Socially Responsible Investing: An Introduction to SRI in the Defined Contribution Arena Executive Summary As plan sponsors assess investment options for their participants, they consider participants age, demographic, level of financial education, and other types of quantifiable data. And increasingly, plan sponsors are considering their participants societal values when developing investment menus to craft the best array of options for their employees. Socially Responsible Investing, or SRI, is a growing area in the investing arena. SRI is generally associated with environmental, social, and government investing (ESG), and the two acronyms are often used interchangeably. Regardless of title, investments with socially conscious intentions are a way for participants to put their money where their mouths are, and to make a societal impact as they save for retirement. As plan sponsors choose to move in this direction though, it is critical for them to bear in mind their duty to maintain their sense of fiduciary duty as well. Present Day Tenants of Socially Responsible Investing Are energy and materials usage efficient and low waste? Are products safe? Is necessary product information available? Are employees well treated and appropriately compensated? Do the workplace and company output value a diverse demographic? Does the company take an active role in bettering their community? SRI in Context Religious values formed a basis for the world s earliest forms of socially responsible investing as far back as the 14th century. Leaping forward to the middle of the 20th century, heightened political, social, and 1

environmental awareness catalyzed the growth of SRI in the finance world. Controversies concerning the hot and cold wars of the period caused some investors to shift funds away from the companies producing weapons. The Civil Rights movement triggered stockholder scrutiny of corporation labor policies in regards to workplace discrimination against women and minorities. Then, in the 1980s, many groups divested from the South African economy in protest of the apartheid system, which further raised corporate awareness of ESG strategies. Furthermore, events like the Exxon-Valdez oil spill carried environmental issues to the forefront and a number of investors began supporting companies focused on sustainability of resources. The graphic above demonstrates the modern issues the SRI generally encompasses today. Prevalence in Today s Market $4,000 $3,500 Growth of Sustainable and Responsible Investment (1995-2012) $3,000 US $ Billions $2,500 $2,000 $1,500 $1,000 $500 $0 1995 1997 1999 2001 2003 2005 2007 2010 2012 Figure 1. Source: US SIF In 1982, Calvert Investments introduced the Calvert Social Investment Fund, the first major group of portfolios to focus solely on ESG criteria. In 1984, Parnassus Investments, another leader amongst socially responsible investment managers, was founded and now operates seven SRI funds. According to the Forum for Sustainable and Responsible Investing (US SIF), the number of SRI mutual funds grew from 55 in 1995 to 333 in 2011. There are a number of firms at the forefront of today s SRI markets, and these managers take specific social concerns into account in their investment objectives, employing a variety of strategies to build conscientious options for stakeholders. The figure above demonstrates this monetary growth of SRI investments between 1995 and 2012. The US SIF publishes a biennial analysis on SRI trends, and at the time of its last report, $3.7 trillion (or about 11% of all investment dollars under professional management) were invested according to SRI strategies. This growth helped motivate the United Nations to collaborate with a large group of institutional investors and launch the Principles of Responsible Investment (PRI) in 2006. Working together, they created six 2

principles highlighting ESG incorporation, active investing, and transparent reporting, to which corporate signatories must promise to adhere. At present, PRI has more than 1,200 international signatories with a combined net worth in excess of $34 trillion, though not all of their funds are directly invested in SRI. The graph of PRI s growth (below) mirrors the patterns of the previous chart and again emphasizes the recent and continued growth of the socially responsible investing market. Why are we seeing such a large growth in this field of investing? Analysts point to new generations entering the investment world. A study published by Spectrem s Millionaire Corner found a correlation between the age of the investor and the importance of SRI when selecting their investments. The figure below illustrates the percentage of respondents who indicate a high probability that they have or will consider societal impact when making investment decisions. As the Figure 2 reflects, younger investors are far more likely to commit to SRI than their older counterparts. The United Nations Responsible Investing Initiative also reports that people seek to incorporate ESG factors into their investment choices because of increasing public policy measures requiring investors to exercise their rights and responsibilities as owners, including expectations around voting and engagement. Trends in the SRI Approach In the past, socially responsible investing has largely been identified by its Negative Screening process: avoiding investments and companies within specific industries deemed harmful by the investor or fund manager (e.g. alcohol, tobacco, gambling, etc.). However, this is only one very basic tactic amongst a number of approaches to invest for the greater good. Another approach is the Positive Screen, making a conscious decision to invest in companies that are involved in promoting a specific cause. Several broader-level examples of screens fitting this category include transparency about company policies, exceptional environmental policies and compliance with regulations, and promotion of health and safety in the workplace. In recent years, many managers have chosen to build funds that combine both positive and negative screens. 3

Another alternative is the Restrictive Screen where investments are limited to corporations whose overall actions are desirable, though they may have a small number of holdings in sectors that are viewed as less acceptable. As businesses today are so intertwined, it is often difficult to draw a clear line between companies that do meet a set of SRI standards and those who do not. The Restrictive Screen helps to mediate this process. Another way shareholders interested in socially responsible investments influence the organizational behavior of corporations is through discourse with company representatives, proxy votes, and shareholder resolutions. As mentioned above, public policy increasingly urges investors to take a more active stance as partial owners of a company. Shareholder advocacy and corporate governance are effective ways for investors to ensure that their capital is being put to good use, in terms of both profitability and social good. For impact at the local level, community investing is a powerful way to bolster smaller organizations overlooked or underserved by macro-lending establishments. Forbes reports that about $61.4 billion in managed assets are at work today in the community-investing segment of SRI. Investment in a community goes beyond capital investing to include educational services, housing, and municipal development initiatives. The figure below demonstrates how a sample of investors using SRI methods chose to allocate strategies for social investment. While the figure shows that investment screening is the most common tactic, it also indicates that many investors use multiple approaches to achieve the highest level of impact while also investing wisely. 80% 70% 60% 50% 40% 30% 20% 10% 0% PorOolio SelecPon and Screening Social Investment Strategies Shareholder Advocacy Community InvesPng Investment Screening Specific Mandate Proxy VoGng Shareholder ResoluGons Company Engagement Community InvesGng Fgure 3. Source: BNY Mellon Risk, Return, and SRI Like any and all investments, socially responsible investments hold risk. Researchers have been attempting to quantify the risks and returns from SRI and compare these metrics with those of traditional investments for years. UN PRI points out that investors often associate a company s positive societal impact with highfunctioning management practices and a well-oiled corporate structure, and thus a likeliness to provide 4

low-risk, high-return investment options. While this is simply an inference, projects like a UC Berkeley 2004 empirical study demonstrate that the relationship between corporate social responsibility and financial performance are positive and statistically significant, supporting the view that socially responsible corporate performance can be associated with a series of bottom-line benefits. That being said, choosing to avoid certain sectors of the market may mean foregoing some highperforming assets. Though many SRI firms do not often severely limit the companies in which they choose to invest, it is common that several key sectors are excluded from SRI portfolios, resulting in returns that are sometimes lower than their non-socially-screened counterparts. However, firms who offer SRI investing still have a responsibility to their constituents to provide a competitive edge on the market, and thus work to maintain a level of return analogous to funds that do not consider ESG factors. Therefore, it is important to reflect on the performance and underlying risk-return characteristics of any socially responsible investment option one might be considering. If its returns and other performance metrics are not competitive, it cannot be considered a feasible investment choice, regardless of how it addresses ESG concerns. To date, there is not a consensus among financiers on the most accurate way of measuring SRI performance. They can be compared to a specific social index, to a traditional index, or to a custom index, but each of these appraisals will warrant different results. Consequently, it is the responsibility of a plan sponsor to vigilantly assess each SRI consideration, just as they would with any other type of traditional investment. Conclusion As financial markets grow ever more complex and intertwined, it is fortunate that plan sponsors, advisors, and participants are still able to consider such a wide range of investment opportunities. As new generations invest, socially responsible investing has taken large steps toward establishment as a mainstay in financial markets. Available options for SRI continue to grow extensively, allowing plan sponsors and participants to choose from a variety of investment strategies. Regardless of the strategy selected, it is important to maintain the fiduciary obligation to plan participants by offering financially competitive investments at the forefront. When incorporating SRI investments, the same qualitative and quantitative guidelines should be applied as when considering non-sri selections. 5