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Thinking responsibly about socially responsible investing

June 13, 2018

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Thinking responsibly about socially responsible investing

Market Insights

“Do the right thing.” That’s the new corporate motto for Alphabet, Google’s parent company, putting a more proactive spin on Google’s “Don’t Be Evil.” But what does the new motto mean, exactly? That motto – and that overly simplistic approach is also what’s tripping up investors when it comes to Socially Responsible Investing (SRI).

SRI can be a great thing for investors. According to a Deutsche Bank study of more than a decade’s worth of data, ethical funds perform very well, indeed. That performance-plus-values formula explains why assets in Canada managed using one or more responsible investing strategies adds up to $1.5 trillion.

While the Responsible Investment Association noted individual investors’ responsible investment assets were up 91% in two years, a large chunk of that $1.5 trillion comes from institutional investors. That’s a good sign that the smart money is definitely aligned with fighting climate change, promoting human rights and admirable causes.

That enthusiasm is only likely to grow, assuming the younger generation keeps up their habits. Millennials are twice as likely as baby boomers to pick investments if they help solve social or environmental problems, according to a recent Ipsos survey cited in Business in Vancouver. The same report noted “about 38% of the US$5 trillion global public equity market is subject to some level of investment “screening”.”

Demand is there. But for SRI, the devil is in the details.

Green oil companies, dark tech firms and shades of grey in SRI

What does SRI boil down to for a lot of investors and portfolio managers? Guns and tobacco, bad. Organic food retailers, good. Dirty, fossil-fuel-extracting drillers, bad. Silicon Valley tech companies, good. And on and on it goes.

There’s nothing wrong with trying to create simple investment categories. That’s particularly true for retail investors. Realistically, they might want to devote the bare minimum of time examining the holdings of various portfolios.

Nothing wrong with the intent, anyway. But execution is tricky.

Clean, green oil?

For instance, those giant fossil fueled energy dinosaurs like Exxon and Shell? This sector has spent billions on cleantech. It’s in their interest to go lean and green, making their operations ever-more-efficient. Certainly, US and Canadian energy companies have stakeholders demanding higher standards, compared with Mideast producers. When Big Oil is also Clean(er) Oil, isn’t it a bit perverse for ethical investors to stay away?

And of course, if the whole purpose of investing is to get a good return, that decision to turn away from this sector would seem downright irresponsible when oil is on a tear. Yes, green energy is the future… but investors want returns now, not just 10 or 20 years from now.

Socially responsible investors often risk unintended consequences. Another kind of oil (not the kind you put in your car), palm oil, went big a few years back. It was seen as a kind of superfood and made its way into a bevy of edible and beauty products. It was a clean, organic product… and then people realized that its cultivation was actually harmful to rainforests that got cleared for palm oil production.

Don’t be evil (or just kind-of-evil)… wink, wink, Facebook, Apple, etc.

The much-celebrated FAANG stocks represent the profitable innovation of Silicon Valley (Facebook, Amazon, Apple, Netflix, Google). Their leaders are seen as visionaries. The legions of smart people who work for these firms have created products that add immeasurably to the convenience and comfort of modern living. Their gleaming campus-sized, solar-powered, people-friendly office spaces are surely the opposite of the “satanic mills” of the coal-powered, mutilating sweatshops of the industrial era. Until quite recently (and coming soon once more), they were the stars of investor portfolios.

And yet… Facebook’s recent data scandal (in which the US Congress and the rest of the world seem to have finally woken up to the company’s longstanding business model) has people questioning its socially responsible credentials. Amazon has faced criticism of how it treats workers. Apple’s Chinese manufacturing workers earn $2/hour operating under hazardous working conditions. These shiny tech giants have lost their sheen.

Bottom line: even the ‘easy answers’ of which companies look like good bets for socially progressive investors aren’t looking so easy.

Clearly, we need to be realistic about how “responsible” a given set of SRI holdings can be. Perfect can’t be an enemy of the good — though investors can always strive for it.

Beware of the SRI label: Positive vs. negative screening

Why bother with all this analysis if there is an index we can invest in and be done with it?

Most SRI indices are negatively screened. That means that they did not go out and pick companies that are particularly good. They just excluded the sectors that are particularly bad.

The famous trio to negatively screen against are tobacco, weapons dealing/contracting and nuclear energy. It is puzzling that when polar ice caps are melting and we are experiencing flooding and mudslides, that some SRI funds still avoid nuclear energy.

Then there are fast fashion firms employing sweatshops, less progressive oil and coal companies, pornography purveyor. There are sectors that are infamous for their work practices. But because they aren’t screened out, their environmental impacts and human rights issues can affect the ‘social quotient’ of a fund.

Positive screening is a much more effective way to achieve socially responsible portfolio. Pick a company or sector that is particularly good and support it. Of course, you don’t have to do it on your own.

Responsible investing is hard. But that’s where a responsible portfolio manager comes in

The realistic objective for SRI investors, need to rely on financial advisers (and in turn, portfolio managers) who can look deeper at opportunities through positive screening.

For example, that’s the path we took when we created a Cleantech add-on for WealthBar investors. Clients could add the PowerShares PZD Portfolio to their overall investment mix. PZD invests in companies focused on renewable energy, water purification, logistics and transportation, reducing environmental impact across industries. If subjected to negative screening, some of those sectors would have been cut out, which would have been a mistake.

And again, investors didn’t need to sacrifice performance for progress: the PZD Cleantech ETF returned over 30 percent last year. That significantly beat the TSX Composite, which is focused on an oil-centric Canadian market and had just a 9 percent return. Protecting the planet pays off.

Of course, the vast majority of retail investors can’t be expected to do that level of analysis to find responsible winners on their own.

3 questions to ask your advisor to ensure a nuanced approach to SRI

  • Is this strategy positively or negatively screened? If it’s negatively screened, what sectors or companies are being avoided?
  • Let’s say there is a particular sector you want to avoid or particular sector you want to support. Will this strategy actually align with your values?
  • What are the fees vs. risk adjusted return? Socially responsible portfolios can carry higher fees, so make sure that they are inline with what you intended to pay for the results that they can provide.
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