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 February 22, 2007
Socially Responsible Investing: Myth vs. Reality

 (by Steven Schueth) - There are a number of persistent myths that we in the socially responsible investment community must face down every day. The list of common misperceptions includes the belief that socially responsible portfolios must underperform, and the idea that socially conscious investors are anti-capitalist.

Notwithstanding these widely held and terribly misguided beliefs, a large and growing group of investors are focusing on the bigger picture and the longer term-choosing to direct investment capital in ways that reflect their personal, moral, and ethical values, while helping to foster a more socially just and environmentally sustainable society. Guest columnist Harry Moran speaks to the topic of "persistent myths" from his perspective as a financial planner working with individual clients.

It's fairly common for some of the larger, conventional mutual fund companies and money management firms to dismiss socially responsible investing as nothing more than a marketing gimmick. This persistent perception of limitation and risk offers a wonderful opportunity to provide a reality check.

Those who attended business school anytime in the past 40 years emerged with a concept etched on the most resilient part of our brains which forms the basis for the mother of all investment myths-that limiting the investment universe will limit the potential for investment return.

The reality is that all investment strategies embrace some sort of process that seeks to narrow the vast array of investment choices and ultimately produce a portfolio that is some subset of the full investment universe. Theoretically, an investor could establish a passive indexing strategy in which the portfolio would own a proportionate piece of every investment around the world, but to implement such a strategy would require a huge investment portfolio.

Active money managers attempt to add value by creating dynamic portfolios that are somewhat concentrated. With virtually any active management strategy, the question is whether the investments being chosen (or eliminated) for economic, financial, social, or environmental reasons are likely to enhance returns or reduce risk. Most active managers believe that at some point additional diversification will neither enhance potential return nor substantially decrease portfolio risk.

The limited investment universe myth leads directly to the myth of underperformance. Fortunately, there is a significant body of empirical evidence that shows a clear and measurable link between intangible environmental, social, and governance factors (ESG) and bottom line financial performance. Recent academic research strongly suggests that good management of ESG factors can potentially increase long-term performance and reduce certain types of portfolio risks (e.g. The Journal of Investing, fall 2005, "Answers To Four Questions" by Lloyd Kurtz).

The most ironic of all myths is wrapped in the belief that socially conscious investors are anti-capitalism. On the contrary, as owners of stocks, bonds and mutual funds, we are heavily invested in the market-based capitalist system. In fact, every SRI-oriented investor I know loves capitalism. We would love it even more if it were a more caring kind of capitalism. So part of the motivation of a socially conscious investor is to serve as a catalyst in a shift to what Patricia Aburdene, author of Megatrends 2010, calls "conscious capitalism."

Another persistent myth: it's better to invest for maximum profit and then donate some of those profits to help organizations doing good work. While this may seem like a sensible approach, the logic is terribly flawed.

For example, most Americans don't smoke, don't want their children to smoke, and don't want to be in a room with smokers. Many are also choosing not to profit from companies that make products which, when used as directed, result in the death of approximately 400,000 people annually in the U.S. alone. No amount of donations to the American Cancer Society will undo this damage.

Tell me, is a strategy of investing in a company with egregious environmental problems and then donating some of the profits to environmental causes more or less effective than withholding capital and working to improve the company's environmental impact? The strategy of investing for maximum profit and then using philanthropy to attempt to correct the problems created is both ineffective and unpalatable for many investors today.

Business cannot be exclusively about profits. The more successful businesses are beginning to realize they must manage the impact they have on all stakeholders-customers, employees, and suppliers, as well as the communities in which they operate and the environment on which we all rely for life. For many, the definition of "profits" is expanding from a narrow focus on short-term monetary gain (living and dying by the quarterly numbers), to the enhancement of shareholder value over the longer term.

Even the largest companies run the risk of becoming extinct if they cannot adapt to a changing market environment. Look at the big oil companies that are putting resources into research and development on alternative fuels. Some of them are beginning to redefine themselves as "energy companies" rather than oil companies.

Every day, as more companies recognize that issues like environmental degradation and global climate change are impacting their businesses, the wisdom inherent in taking a socially responsible approach to investing is reinforced. And, typically, as individuals become more aware of the results of how their money works in the world, both their investing and consuming habits change in very positive ways. I am proud to be a part of that process.