What is “Socially Responsible Investing (SRI)”?

Socially Responsible Investing (SRI) is an investment philosophy that seeks to invest in companies that are not only good businesses but also positively contribute to society. Typically, SRI investors consider various factors that can have such an impact, but most importantly environmental, social and governance (ESG) factors. For example, companies that operate in the renewable energy space, those that offer fair and safe working conditions, and businesses that align executive pay with shareholder interests are all potential candidates for inclusion in an SRI portfolio.

Key Learning Points

  • SRI is an investment strategy that invests in companies not only based on their share price growth potential, but also on their ability to deliver a positive impact to society.
  • With the evolution of ESG (environmental, social, and governance) investing, investors are now able to consider multiple factors when analyzing a company and can even exclude whole sectors that might have a negative impact on society – for example, tobacco, gambling, and alcohol.
  • Historically, negative screening (or exclusion of companies) has been the dominant strategy in ESG investing, but interest in other approaches such as best in class has also increased
  • According to Morningstar data, in 2020 alone ESG funds captured $51.1 billion in net new money from investors, which was a record and more than double the prior year’s total.

How Does SRI Work in Practice?

Although there is no universal rule, SRI strategies commonly use exclusionary screening to avoid businesses that might have a negative impact on society or the environment. For example, a typical SRI portfolio would likely exclude entire sectors like tobacco or defense. Then, selecting stocks from the filtered universe would be based on both financial and non-financial characteristics. To integrate ESG factors into investment decision-making, portfolio managers tend to use tools like score cards that allow them to use quantifiable metrics. This assessment is then factored into the company’s forward-looking estimates. For example, if the company CEO’s bonus is not linked to key performance indicators (KPIs) and represents a large part of the total remuneration package, there should be an upward adjustment to the company’s forward-looking cost of capital to reflect that.

Along with the exclusionary screening, there are a number of additional tools at the investor’s disposal, including divestment or shareholder activism. However, criteria can be quite subjective and those who seek to invest in values-based portfolios should be aware that one size doesn’t fit all. Different strategies emphasize different values; investors primarily concerned with carbon footprint and the environment may not achieve the desired outcome from a portfolio invested in names focused on community well-being and social aspects.

Example of Socially Responsible Investing

Historically, SRI was most popular with belief-based investors but it has moved into the mainstream and is gaining visibility. Community investing is one example of SRI, with funds going directly to organizations with strong track records of delivering for communities. Capital supports these organizations in providing essential services, for example, affordable housing,  to their communities. The objective is to make a positive impact by reducing the reliance on government funding and improving the overall quality of life in that community.

Types of Socially Responsible Investing

The number of approaches to SRI investing varies, but actively managed mutual funds may offer suitable solutions for the average investor. Active management allows portfolio managers to add value through qualitative assessment (that can be quantified to adjust/inform company valuation) of socially responsible characteristics. The lack of data, particularly for smaller companies, is a challenge that cannot be eliminated. However, active managers can engage with companies and request additional information while passively managed funds take into account only existing data. Nevertheless, as technology develops and the quality of data improves,  ETFs are likely to assume a more significant presence in this market.

What Are the Differences Between SRI, ESG, and Impact Investing?

Socially Responsible Investing vs ESG

ESG is considered to be the broader approach that focuses on the risks and opportunities in terms of environmental, social, and governance factors and functions as a supplement to traditional analysis. While ESG predominantly seeks to protect the investors’ portfolio from operational or reputational risk, SRI investors go one step further and select securities based on specific considerations through either negative or positive screening.

Is ESG Investing the same as Impact Investing?

No. Impact investing (which largely overlaps with thematic investing) aims to achieve positive and measurable outcomes. Therefore, producing tangible outcomes is the primary focus – investors provide funds and support to businesses aiming to deliver on specific goals that benefit society or the environment. For example, an impact fund may choose to invest in companies working to mitigate climate change and support a net-zero economy. One way to measure the outcome would be through the carbon footprint of the overall portfolio.

What Does It Mean for Financial Returns?

There are multiple academic studies that illustrate the positive correlation between good businesses run in a socially conscious manner and financial gains over the long term. While such an approach may shrink the potential investment universe since certain sectors are avoided, investors can expect better downside protection and better risk-adjusted returns due to the quality of the stocks.

Which Investment Firms Practice SRI?

ESG investing is already widely practiced by most institutional investors in Europe, and other regions such as Asia are moving in a similar direction. However, SRI investing is a more specialized area since the outcomes are not necessarily required to be tangible, whereas impact investing mandates tangible positive outcomes. Therefore, institutional investors that have significant resources, knowledge, and expertise in the field are usually best placed to deliver on socially responsible mandates. These investors include global firms like BlackRock and JP Morgan Chase, or specialist boutiques like EdenTree Investment Management.

SRI Investing Screenshot

Additional Resources

ESG Funds

ESG in Credit Analysis

ESG Integration

Ethical Investing