Global Capital Markets.
Stocks and Bonds.
What meaning comes to mind when you consider these words and phrases? If you're anything like me, the brain instantly thinks of one thing, and one thing only: $$$.
For most of us, it's a simple equation -- money goes in, we wait, and after a while, (hopefully) more money comes out. There's not a whole lot, if any, emphasis on what happens in-between. In a lot of ways, finance is thought of much like the late Andy Grove's "Black Box" model of production process: There's an input (money), some kind of labor applied to the input (time), and an eventual output (more money!).
No one really takes too much of a look inside the black box. Other than the occasional check of our portfolio's performance, we're collectively uninterested in how our investment dollars are being spent, what purpose our money will serve, or the character of the companies we invest in.
And why don't we bother? A cynic could certainly argue that human selfishness and greed is at play. As long as our retirement accounts are growing steadily each year, why should we care how the investment capital is being used, right?
But, I think the answer is more complex. The problem may lie in our collective understanding of what finance is and what our relationship with investing should be, not that we're greedy and uninterested. After all, a growing number of people in 2016 bring re-usable bags to the grocery store, drive electric cars, or volunteer their time helping the less fortunate. We may not even be aware that there's an alternative to viewing our own personal investments as anything besides the black box of dollars.
Audrey Choi is the CEO of Morgan Stanley's Institute for Sustainable Investing and describes our relationship with the markets this way:
We believe that the markets is this magic pot that obeys only one command: make more money. Only those words said exactly that way will make the pot fill up with gold. Add in some extra words like "protect the environment," the spell might not work. Put in the wrong words like "promote social justice," and you might see your gold coins shrink or even vanish entirely, according to this fable.
But is there more to the magic pot of investing than we currently perceive? Perhaps it is finally time to re-examine our age-old view of capital markets. Is there, in fact, an opportunity and responsibility to look inside the black box? To leverage the nearly $290 trillion invested in stocks and bonds worldwide to drive positive social change in addition to financial growth 1? Can we put our hard-earned money to work to simultaneously provide a positive return and solve some of humanity's toughest problems?
A new approach
Choi, and a growing number of investors are pursuing Socially Responsible Investing (SRI) or sustainable investing, a strategy that takes into account environmental, social and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact2.
Once you get past the acronyms, the concept is really quite simple -- evaluating investment opportunities for both the prospect of economic gain and positive social change.
While the concept of Socially Responsible Investing certainly isn't new, the last few years have brought an exploding interest and attention to the discipline. This has lead to more formal definitions and regulations around SRI, and the creation of sustainable investment products that serve to standardize what this new investing paradigm means and how to participate in the movement.
SRI is growing so quickly, in fact, it may seem that the future I'm describing is already here for many investors. The total volume of US sustainable investments has nearly doubled to over $6.5 trillion over the past two reported years:
Today, one in six dollars that is professionally managed in the United States is considered a sustainable investment. Much of this growth in sustainable investing can be attributed to the coming of age of the millenials, many of which are starting their own portfolios as they make the transition into adulthood.
A study done by Morgan Stanley showed that, compared to other investors, millenials were:
- 3x more likely to seek employment with a company because of their stance on social and/or environmental issues
- 2x more likely to invest in companies or funds that target specific social or environmental causes
- 2x more likely to exit an investment position because of objectionable corporate activity3
With millenials shaking up the moral fiber of society, it's no surprise that the financial industry is adapting to accommodate a new kind of investor that balances their own individual gain with the welbeing of the world around them.
What is sustainable investing, really?
When you're trying to define something that deals with social good, you're inherently entering into subjective territory. How does one accurately label an investment as truly sustainable in our world filled with shades of gray?
To tackle this difficult question, sustainable investing funds align on a screening methodology to both select and exclude potential investing opportunities.
Positive Investments are those types of investing opportunities in which a fund agrees to seek out in the marketplace.
On the flipside, Restricted or Exclusionary Investments are those positions considered to be off-the-table due to the perceived negative use of the invested capital.
The combination of positive and restricted investments shape the fund's investing strategy, and in turn the fund's opinion on what is sustainable and what is not.
Let's look at an example sustainable mutual fund, the Boston Common International Fund. Here's how the fund managers describe their strategy:
The Fund seeks to integrate environmental, social, and governance (“ESG”) criteria into the stock selection process and expresses a preference for best-in-class firms that they believe possess innovative approaches to the environmental and social challenges their industries, society, and the world as a whole face. Boston Common endeavors to integrate financial and sustainability factors into its investment process because they believe ESG research helps them identify companies that will be successful over the long-term.5
Some of the fund's positive investments include:
- Community Development: The Fund seeks to invest in companies that demonstrate high levels of accountability in their involvement with the communities in which they operate.
- Pollution / Toxics: The Fund seeks companies with superior records in environmental responsibility.
- Diversity & Equal Employment Opportunity: The Fund seeks companies that have strong programs to promote diversity and demonstrate support for work/life balance initiatives.
Some of the fund's restricted investments include:
- Gambling: The Fund excludes companies that receive significant revenues or have leading market share from gambling devices or activities including lotteries and hotels with casinos.
- Tobacco: The Fund excludes companies that receive significant revenues or have leading market share in production and marketing or tobacco products, including components.
- Sudan: The Fund avoids companies that have significant, direct operations in the Sudan.6
With this "north star" of investing strategy, you can get a sense of what kinds of opportunities the fund would consider, and which investments would be avoided.
Does this even work?
I'm sure you're thinking to yourself: OK, all of this probably sounds good in theory, but when the tires hit the road does this strategy really work? As in, will I sacrifice my financial returns to "do good" for the world?
A study done by Choi's team at Morgan Stanley found that 54% of investors still believe that there is a tradeoff they would have to make between profitability and social impact when making their investing decisions.
But does this actually align with reality? Do we really have to make this tradeoff?
Janet Brown, president of FundX Investment Group and seasoned mutual fund expert, doesn't think so:
When I first began managing SRI portfolios 20 years ago, they often lagged conventional portfolios...In the last few years, however, their SRI portfolios have performed right in line with the other portfolios I manage–a sign that investors can generate long-term competitive financial returns and make a positive societal impact at the same time.
And the numbers don't lie either: A Harvard Business School study compared investment performance of companies that were classified as High Sustainability vs. Low Sustainability. High Sustainability companies had made corporate-level commitments to enhance environmental and social performance in addition to profit, while Low Sustainability companies made no such commitments.
The results of the study found that over the course of a 17-year period (1993-2010), investing $1 in a company in the High Sustainability group would have grown to $22.60. The same $1 put into a Low Sustainability company would only be worth $15.40. That's nearly a 50% greater ROI.4
So it appears, in fact, that the opposite of conventional wisdom is true. Companies with a focus on the double-bottom-line actually outperform those who are just focused on profit maximization.
Great, but how do I start?
In today's financial markets, there are no shortage of sustainable investing opportunities. SRI funds are available in multiple sizes: large, small, and mid-cap. SRI funds can target domestic, foreign, or global opportunities. Some SRI funds focus on "growth" stocks, while other focus on "value" stocks. You get the idea.
A great place to start learning more about SRI is the Forum for Sustainable and Responsible Investing. There is a lot of useful info on SRI, including:
- A primer on SRI Basics
- A list of sustainable and responsible mutual funds
- Research and publications on SRI
Another useful primer on SRI is Audrey Choi's TED talk, entitled: "How to make a profit while making a difference":