Socially responsible investing

Government-controlled funds such as pension funds are often very large players in the investment field, and are being pressured by the citizenry and by activist groups to adopt investment policies which encourage ethical corporate behavior, respect the rights of workers, consider environmental concerns, and avoid violations of human rights. One outstanding endorsement of such policies is The Government Pension Fund of Norway, which is mandated to avoid "investments which constitute an unacceptable risk that the Fund may contribute to unethical acts or omissions, such as violations of fundamental humanitarian principles, serious violations of human rights, gross corruption or severe environmental damages".[20]

In the 2000s and 2010s, pension funds were under pressure to disinvest from the arms company BAE Systems, partially due to a campaign run by the Campaign Against Arms Trade (CAAT).[21] Liverpool City Council has passed a successful resolution to disinvest from the company,[22] but a similar attempt by the Scottish Green Party in Edinburgh City Council was blocked by the Liberal Democrats.[23]

Socially responsible mutual funds counted by the 2014 Trends Report increased in number to 415 in 2014, up from 333 in 2012, 250 in 2010, 173 in 2005 & 2007, 189 in 2003, and 167 in 2001. The overall number of mutual funds incorporating environmental, social and corporate governance (ESG) has increased four-fold since 2012. Additionally, 20 exchange-traded funds (ETFs) that incorporate ESG criteria were identified with $3.5 billion in assets at the end of 2011, an increase from the 8 ETFs with $2.25 billion in net assets identified in its 2007 report—the first Trends report to track ETFs [11]. Unlike the Employee Retirement Income Security Act of 1974 (ERISA), which severely limits the extent to which socially responsible goals can be considered in managing corporate and Taft-Hartley pension assets (due to ERISA's overriding goal of protecting employees' pensions),[24] registered investment companies can take these factors into account so long as the disclosure and other requirements of the Investment Company Act of 1940 are met.[25] US SIF maintains charts describing the socially responsible mutual funds offered by its member firms.

Key: X = No investment; P = Positive investment; R = Restricted investment; NS = No screens.

According to the 2014 Report on US Sustainable, Responsible and Impact Investing Trends, among separate account managers, 214 distinctive separate account vehicles or strategies, with $433 billion in assets, incorporated ESG factors into investment analysis. Where a separate account is subject to ERISA, there are legal limitations on the extent to which investment decisions can be based on factors other than maximizing plan participants' economic returns.[24]

Shareholder resolutions are filed by a wide variety of institutional investors, including public pension funds, faith-based investors, socially responsible mutual funds, and labor unions. In 2004, faith-based organizations filed 129 resolutions, while socially responsible funds filed 56 resolutions.[29]

Regulations governing shareholder resolutions vary from country to country. In the United States, they are determined primarily by the Securities and Exchange Commission, which regulates mutual funds and applies the 1940 Act[30] and by the Department of Labor, which regulates certain plans and applies ERISA.[31]

These regulatory regimes require pension plans and mutual funds to disclose how they voted on behalf of their investors.[32] U.S. shareholders have organized various groups to facilitate jointly filing resolutions. These include the Council of Institutional Investors, the Interfaith Center on Corporate Responsibility, and the US SIF.

From 2012 to 2014, more than 200 US institutions and investment management firms filed or co-filed proposals. These institutions and money managers collectively controlled $1.72 trillion in assets at the end of 2013. The top categories of environmental and social issues from 2012 to 2014 were political contributions and climate change and environmental issues.[33]

Community investing, a subset of socially responsible investing, allows for investment directly into community-based organizations. Community investing institutions use investor capital to finance or guarantee loans to individuals and organizations that have historically been denied access to capital by traditional financial institutions. These loans are used for housing, small business creation, and education or personal development in the US and UK,[34] or are made available to local financial institutions abroad to finance international community development. The community investing institution typically provides training and other types of support and expertise to ensure the success of the loan and its returns for investors.[35]

Community investing grew almost 5% from 2012 to 2014. Assets held and invested locally by community development financial institutions (CDFIs) based in the US totaled $64.3 billion at the start of 2014, up from $61.4 billion in 2012.

Social investors use several strategies to maximize financial return and attempt to maximize social good. These strategies seek to create change by shifting the cost of capital down for sustainable firms and up for the non-sustainable ones. The proponents argue that access to capital is what drives the future direction of development. A growing number of rating agencies collects both raw data the ESG behaviour of firms as well as aggregates this data in indices.[36] After several years of growth the rating agency industry has recently been subject to a consolidation phase that has reduced the number of genesis through mergers and acquisitions.[37]

ESG integration is one of the most common responsible investment strategies and entails the incorporation of environmental, social and governance ("ESG") criteria into the fundamental analysis of equity investments. According to the non-profit Investor Responsibility Research Center institute (IRRCi), approaches to ESG integration vary greatly among asset managers depending on:[38]

• Management: Who is responsible for ESG integration within the organization?
• Research: What ESG criteria and factors are being considered in the analysis?
• Application: How are the ESG criteria being applied in practice?

Negative screening excludes certain securities from investment consideration based on social or environmental criteria. For example, many socially responsible investors screen out tobacco company investments.

The longest-running SRI index, the Domini 400—now the MSCI KLD 400—was started in May 1990. It has continued to perform competitively —with average annualized total returns of 9.51% through December 2009 compared with 8.66% for the S&P 500.[39]

Despite this impressive growth, it has long been commonly perceived that SRI brings smaller returns than unrestricted investing. So-called "sin stocks", including purveyors of tobacco, alcohol, gambling and defense contractors, were banned from portfolios on moral or ethical grounds. And shutting out entire industries hurts performance, the critics said.[40] However, in a comprehensive study, financial economists Lobe, Roithmeier, and Walkshäusl taking the position of the advocatus diaboli, answer the question whether to invest in a socially responsible way – or not? They create a set of global and domestic sin indexes consisting of 755 publicly traded socially irresponsible stocks around the world belonging to the Sextet of Sin: adult entertainment, alcohol, gambling, nuclear power, tobacco, and weapons. They compare their stock market performance directly with a set of virtue comparables consisting of the most important international socially responsible investment indexes. They find no compelling evidence that ethical and unethical screens lead to a significant difference in their financial performance, which is in contrast with the results of prior studies on sinful investing.[41]

Divesting is the act of removing stocks from a portfolio based on mainly ethical, non-financial objections to certain business activities of a corporation. Recently, CalSTRS (California State Teachers' Retirement System) announced the removal of more than $237 million in tobacco holdings from its investment portfolio after 6 months of financial analysis and deliberations.

Shareholder activism efforts attempt to positively influence corporate behavior.[42] These efforts include initiating conversations with corporate management on issues of concern, and submitting and voting proxy resolutions. These activities are undertaken with the belief that social investors, working cooperatively, can steer management on a course that will improve financial performance over time and enhance the well being of the stockholders, customers, employees, vendors, and communities. Recent movements have also been reported of "investor relations activism", in which investor relations firms assist groups of shareholder activists in an organized push for change within a corporation; this is done typically by leveraging their enhanced knowledge of the corporation, its management (often via direct relationships), and the securities laws as a whole.[43] Hedge funds are also major activist investors; while some pursue socially responsible investing goals, many simply are seeking to maximize fund returns.[44] Pension plans subject to ERISA are somewhat more constrained in their ability to engage in shareholder activism or the use of plan assets to promote public policy positions; any expenditure of plan assets must be aimed at enhancing participants' retirement income.[45]

A less vocal subtype of shareholder activism, shareholder engagement requires extensive monitoring of the non-financial performance of all portfolio companies. In shareholder engagement dialogues, investees receive constructive feedback on how to improve ESG issues within their sphere of influence.[46]

Positive investing is the new generation of socially responsible investing.[40] It involves making investments in activities and companies believed to have a positive social impact. Positive investing suggested a broad revamping of the industry's methodology for driving change through investments.[47] This investment approach allows investors to positively express their values on corporate behavior issues such as social justice and the environment through stock selection – without sacrificing portfolio diversification or long-term performance.[48] Positive screening pushes the idea of sustainability, not just in the narrow environmental or humanitarian sense, but also in the sense of a company's long-term potential to compete and succeed.[40] In 2015, Morgan Stanley conducted a review of 10,000 funds and concluded "strong sustainability" investments outperformed weak sustainability investments,[49] tackling the idea of a trade-off between positive impact and financial return.[50] while the Global Impact Investing Network's 2015 report on benchmarks and returns in impact investing in private equity and venture capital found market-rate or market-beating returns were common in impact investments.[51]

Impact Investing is the alternative investment (i.e. private equity) approach to Positive investing. In 2014, the UK's presidency of the G8 created a Social Impact Investment Task Force which produced a series of reports that defined impact investing as "those that intentionally target specific social objectives along with a financial return and measure the achievement of both".[52] Impact investing, capitalizes businesses that potentially provide social or environmental impact at a scale that purely philanthropic interventions usually cannot reach.[53] This capital may be in a range of forms including private equity, debt, working capital lines of credit, and loan guarantees. Examples in recent decades include many investments in microfinance, community development finance, and clean technology. Impacting investing has its roots in the venture capital community, and an investor will often take active role mentoring or leading the growth of the company or start-up.

By investing directly in an institution, rather than purchasing stock, an investor is able to create a greater social impact: money spent purchasing stock in the secondary market accrues to the stock's previous owner and may not generate social good, while money invested in a community institution is put to work. For example, money invested in a Community Development Financial Institution may be used by that institution to alleviate poverty or inequality, spread access to capital to under-served communities, support economic development or green business, or create other social good. In 1984, Trillium Asset Management's founder, Joan Bavaria, invited Chuck Matthei of the Institute for Community Economics (ICE), an organization that helps communities create and sustain land trusts, to a meeting of US SIF. It is likely that this was the first time a nonprofit organization with a loan fund would meet directly with SRI managers. Trillium clients began investing in ICE later that year.

Several studies in various places have analysed the performance of socially responsible investing (SRI) and conventional investing (CI) using different models and methodologies for measuring performance. Using the Carhart four-factor model,[63] found that an approach where stocks with high SRI scores are bought while those with low SRI scores are sold off produced a positive abnormal performance of up to 8.7% per annum, suggesting that investors can achieve their ethical goals without hurting their financial performance.[64] also using the Carhart four-factor model, noted an excess return of 7% for environmentally-friendly firms. However,[65] using a similar approach found the performance of SRI stocks to be not statistically different from those of conventional stocks. In contrast,[66] also using the Carhart four-factor model found a portfolio which included "sin stocks" (alcohol, tobacco, gaming) to be significantly outperforming similar comparable stocks, which indicates that investors in SRI stocks might be losing. However, after controlling for managerial skills, transaction costs and fees,[67] found no outperformance between portfolios which include "sin" stocks and comparable SR portfolios. Some other studies have compared the performance of SRI funds with conventional funds. While some studies used only the capital asset pricing model to compare performance[68][69]), others used multifactor models such as the Fama–French three-factor model and Carhart four-factor model.[70][71][72][73][74][75][76] These studies found no statistically significant difference in performance between the SRI and conventional funds.

Considering that difference in performance of funds may be due to portfolio selection/construction process and/or the ability of fund managers and not necessarily on the nature of investments themselves, some studies have compared the performance of indices instead. Two of the pioneer studies compared the performance of the Domini 400 Social Index with the S&P 500.[77][78] The Sharpe ratio and the capital asset pricing model were used to estimate Jensen's alpha for the comparison and no significant difference was found in the performance of the two indices. A follow-up study compared the performance of four SRI indices (Domini 400 Social Index, Calvert Social Index, Citizen's Index and Dow Jones Sustainability Indices US Index) with the S&P 500 index between 1990 and 2004 and found that returns on the SRI indices exceeded returns on S&P 500 even though they were not statistically significant.[79] Others focused only on the US[79] and on outside the US by studying the performance of 29 SRI indices globally.[80] Using the capital asset pricing model to estimate Jensen's alpha as the performance indicator, no significant evidence of under/over performance was found. A comparison of the performance of SR indices with conventional indices on a global scale using marginal conditional stochastic dominance found there is "strong evidence that there is a financial price to be paid for socially responsible investing."[81]

A more recent study showed that "improvements in CSR reputation enhance profits".[82]