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 September 05, 2007
From Socially Responsible Investing to Sustainable Investing

  This article originally appeared in Green Money Journal's 15th anniversary issue.

Over the next 15 years, I think we will see a transition from the old world of socially responsible investing (SRI) to the new world of sustainable investing. By sustainable investing, I mean the full integration of environmental, social and governance (ESG) factors into financial analysis and decision-making. This transition is critical if our industry is to broaden its market and maximize its impact on corporate behavior, on financial markets, and on global society itself.

The transition from "socially responsible" to "sustainable" investing isn't just semantics. While it is to some degree a question of framing, framing is more than just words -- it's definitional -- and I believe such a re-framing is necessary if our industry is to reach its potential.

There are also substantive distinctions between socially responsible investing, as historically framed, and the more contemporary notion of sustainable investing. Socially responsible investing is largely understood as an alternative investment strategy for those who choose to invest with their values. Sustainable investing, I believe, has the potential to be a transformative investment strategy that revolutionizes investing itself -- at a time when market capitalism must of necessity undergo a sustainability revolution equal in significance to the industrial revolution that ushered in the modern period.

Let me be more specific about the differences, as I see them, between socially responsible and sustainable investing:
  • Historically, socially responsible investing was defined negatively -- the exclusionary screening of "sin stocks" and problematic industries from investment portfolios. Sustainable investing, by contrast, is defined positively: investing in companies that meet positive environmental, social and governance ( i.e., sustainability) criteria. It's about what you do invest in, not about what you don't invest in.

  • When it comes to financial performance, SRI's posture has been defensive, even apologetic -- "you don't have to sacrifice performance." Sustainable investing takes a more proactive stance: the full integration of ESG criteria into investment decisions is a strategy for identifying better-managed, more forward-thinking companies with better long-term financial prospects.

  • SRI's historical definition was essentially non-financial. Unlike other investment approaches, there was no common financial perspective other than the defensive, performance-neutral posture referenced above. Sustainable investing, by contrast, does have a financial perspective: ESG criteria are performance criteria, and sustainable investing can make a case for being a superior long-term investment strategy.

  • SRI's message is counterintuitive -- shrinking the universe of potential investments based on moral judgments is widely believed to penalize performance. Sustainable investing, on the other hand, makes intuitive sense -- strong ESG performance characterizes better-managed, more innovative companies that are better positioned than their less enlightened competitors to deliver long-term performance.

  • SRI is apolitical -- although it's "investing with values," those values are nowhere defined. They can be liberal or conservative, secular or religious, and include such issues as alcohol, gambling, tobacco, corporate governance, diversity, genetically modified organisms, contraception and abortion, usury, pro-gay rights, anti-gay rights, Burma, Internet privacy, -- you name it. SRI takes a neutral stance with respect to these value choices, meaning there is no uniform perspective or common goals that unite "social" investors (though they often collaborate on shareholder and public policy initiatives where they are in agreement). Sustainable investing, by contrast, is explicitly progressive: it holds that the best companies (and the best investments) are those that act in the public interest; that serve all their stakeholders, not just shareholders; that do not externalize their costs onto society; and that pursue wealth creation strategies focused on the long term. Moreover, government (i.e., the public) has a positive role to play in regulating corporations and markets to redress social imbalances and optimize social outcomes.

  • The market for SRI -- as historically framed -- is necessarily limited; it is a narrow, niche market. Sustainable investing, by contrast, has potentially broad, mainstream appeal.
Although the conventional wisdom is that socially responsible investing has grown rapidly, in my view it has grown very slowly, and this slow growth is due in part to the way it has been framed and presented to the public. I believe there is a much broader market for a socially engaged investment approach if:
  • it is defined positively rather than negatively;
  • its perspective on performance is proactive rather than defensive;
  • it defines itself as a financial discipline rather than as something else;
  • its premise makes intuitive sense;
  • it focuses on investing in progressive, forward-thinking companies; and
  • it takes a sustainability message to a broad, mainstream market rather than a quasi-religious, values-based message to a narrow, niche market.
The Case for Sustainable Investing

The case for sustainable investing is compelling. A growing body of evidence demonstrates positive links between ESG performance and financial performance. See, e.g., Marjorie Kelly's article, "Holy Grail Found: Absolute, positive, definitive proof CSR pays off financially," Business Ethics magazine, (vol. 18, no. 4, Winter 2004), summarizing recent meta-studies demonstrating a positive correlation between corporate social performance and financial performance. A recent UNEP FI report, Show Me the Money, [PDF] concluded with CRA RogersCasey commentary stating: "[W]e were impressed by the quantity of reports that showed a strong link between ESG issues, profits, business activities and, ultimately, stock prices."

There is mounting empirical evidence that companies with better corporate governance practices carry less risk and outperform poorly governed companies over time; that companies with strong environmental performance carry less risk and outperform environmental laggards over time; that companies with good workplace practices enjoy higher productivity, higher morale, lower turnover and increased profitability.

Therefore, wouldn't an investment approach that seeks out such companies for investment -- and, once invested, actively engages those companies to improve their performance even further -- be in a position to make a strong case that it is simply a better, smarter way to invest over the long term?

I think so. But SRI by definition can't make this case. As an alternative investment approach for those "investing with values," it defines itself largely through negative screens emphasizing what it doesn't invest in rather than what it does invest in. Moreover, its agnosticism with respect to "values" results in social screens that are all over the map -- and silly arguments about what constitutes a "socially responsible" company . There is simply no singular lesson that can be derived from the performance -- good, bad or ugly -- of SRI funds. There is no commonality, -- nothing to measure. (I think that's one reason there are so many studies of corporate social responsibility (CSR), and of companies' ESG performance, but so few studies of SRI.)

SRI really isn't a financial discipline at all, but rather the marrying of various financial disciplines with various values based on the premise that "you don't have to sacrifice performance" in order to do so.

Sustainable investing, by contrast, is a financial discipline. It's about performance. It's about aligning ESG performance with financial performance -- combining rigorous financial analysis with equally rigorous environmental, social and governance analysis in order to invest in forward-thinking companies with sustainable business models.

Moreover, as ESG research and analytics become more robust, rigorous and quantitative, sustainable investing will lend itself to sophisticated attribution analysis that I believe will demonstrate its superiority as a long-term investing approach. Given an equal playing field, companies that integrate strong ESG performance into their business models will be more likely to outperform their less enlightened competitors over the long term. I am convinced of that, and sustainable investing, in a sense, is based on that premise.

Not that it's only about money. I am not saying that the only way to judge an investment approach is whether it produces higher returns, or that growth at any cost is a value our civilization should continue to espouse. (Indeed, it will be our undoing unless we change course.) So, although it's essential for any investment approach to make a compelling financial case -- and sustainable investing (unlike SRI) is able to do this -- I think the concept of sustainability is actually much richer than this. In fact, I think the notion of sustainability implies a new conception of wealth, and may even offer a solution to the crisis of capitalism.

Why? Because it insists on an alignment of financial outcomes with environmental, social and governance outcomes -- not with "values" mind you, but with outcomes. The sustainability imperative requires that corporations and markets behave differently; it demands that wealth-creation strategies be made, well, sustainable -- that we no longer tolerate poverty and injustice and environmental degradation as the necessary byproducts of market capitalism.

Every few generations, market capitalism undergoes a period of transformation -- Populism, the Progressive Era, the New Deal, the Great Society. These great periods of reform yielded child labor laws, the minimum wage, the eight-hour day, workers compensation laws, unemployment insurance, antitrust and securities regulations, Social Security, Medicare, the Community Reinvestment Act, the Clean Air Act, Clean Water Act, Environmental Protection Agency, etc. All of these reforms were essentially public and stakeholder attempts to address the worst excesses of corporate capitalism. The next great period of reform will be the Sustainability Revolution, and it will be greater than any of these -- indeed, it will be akin to a second industrial revolution that transforms human society itself.

The Sustainability Revolution is coming. It will be felt in architecture and urban design, energy policy and tax policy, transportation and water use. Our task over the next 15 years is to make sure it is felt in investing as well, and that our industry plays a leading role in ushering in this great transformation. SRI paved the way but it now needs to transform itself. Sustainable investing -- the full integration of environmental, social and governance (ESG) factors into financial analysis and decision-making -- is the natural successor to SRI, and our goal should be nothing less than the transformation of investing itself.

Joe Keefe is the President and CEO of Pax World Management Corp. and Pax World Funds. This article originally appeared in Green Money Journal's 15th anniversary issue, and is reprinted with permission.