Is Socially Responsible Investing Possible?

Is Socially Responsible Investing Possible?

socially responsible investing

[Hey hey! Bringing you a post today from an up and coming blogger on the scene, Tom of HighIncomeParents.com. Been really enjoying his blog lately, so it was a nice surprise to get a fresh article from him to post up on our site here :) Check it out and let me know what you think in the comments! I had NO IDEA about some of the stuff he mentions in the IPO/stock market area??]

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When I first thought about this topic, I was conflicted. I care about this earth and its amazing natural beauty. I care about the people that live on it. I’ve devoted my life to treating these people medically and helping them to be healthier so that they can live a more fulfilling and enjoyable life. (I’m a physician)

When I get a chance to stand at the North Rim of the Grand Canyon or hike to the top of the Mist Trail in Yosemite, I thank the people before me who thought to preserve places like that for generations to come. Buying a meal for someone in need or teaching others to care for their health brings me joy.

I want to leave this earth a better place than when I came into it. As I’ve worked for and had the fortune to gain more and more wealth, I want to use that wealth to improve the people and the world around me.

Naturally, I look for the best way to use the money I’ve earned to promote these ideals and values. I start to look into companies that share my ideas and values. I know there are people all around me that don’t hold every one of my values. In fact, I would be surprised if there is another person, let alone a company on this Earth that matches me idea for idea.

I want to invest in a way that promotes my ideas, but the more I look into this, the more difficult it becomes to achieve.

When I sat down to develop my investor policy statement, I wanted to find investments that meet my values. I started to look into socially responsible investing.

What is socially responsible investing?

Socially responsibility investing (SRI) is a strategy where an investor preferentially only buys stocks or other investments that support a more socially contentious idea. This could consist of companies that promote women or other underrepresented groups in leadership roles. This could be mutual funds that buy companies with a commitment to improving environment factors. Ethical Corporate Governance in business practices is another value frequently cited.

You could exclude companies considered evil, whatever evil is to you. You could only invest in companies that promote good, whatever good is to you.

It is difficult to pinpoint an exact definition. Overall, it’s a strategy that makes an investor feel better about the money she is handing over to different funds. The funds then invest in corporations to earn her more money and promote her beliefs.

What is the purpose of SRI?

I think the purpose of SRI is two-fold. When we invest, the idea is to make money. Why invest if you don’t want to make money? If you want to affect so much change that free markets and making money is not your ideal, then no need to bother investing in the first place. Increasing your net worth has to be number one when investing. The second is to promote your values and beliefs by investing in companies that will further those beliefs.

Can we really do that?

Let’s look at the process of investing in a company. A company grows large enough that its administration wants to take the company public. They go to an investment bank (like Morgan Stanley or Goldman Sachs) and make sure they meet all the criteria to make an initial public offering (IPO).

The investment bank does its due diligence and values the company. They make a bid and underwrite a valuation of the entire company or set up a syndication of several investment banks that will each underwrite a portion of the financial commitment to the company. This diversifies the risk. Then the investment banks market the IPO. They try to create awareness and buzz so that when they offer the stock to the public, the bank gets a high price.

The investment bank has already bought the shares from a company before they even go to IPO. Even if an investor buys the shares at IPO, he is buying them from the investment bank. The investment bank makes money on the difference in the shares they bought from the company and the sale to the public.

Unless you are a big time trader with an inside track to the investment company, there is never an opportunity to buy shares from the company itself.

Then all the shares that are traded on the exchanges are from institution to institution or individual investor to investor. The only time a company may make more money from selling stock is if they do a secondary offering. Of course, the investment banks underwrite those too.

So your money never goes directly to the company you’re investing in?

Nope. Okay, so maybe you say, “Fine, but if I don’t buy an evil company, their stock will go down and maybe the company will go out of business.”

Unfortunately that isn’t true either. There is a one way cause and effect in the market when it comes to stock price. If the managers run a company poorly, losing revenue and earning, and generally doing things that harm the company, then eventually the stock price drops.

A group of investors banding together to only buy companies that hold a certain ideal or promote a certain social good could artificially lift a stock up. The market is so vast though that it will only be short lived. Others (quants, traders, computer algorithms) will sell a company they think is overvalued because a group of people artificially bid it up higher due to its social responsibility characteristics. The “profiteers” only take into account its business practices and valuation. They’ll swoop in and sell shares, bringing the stock back to its fair market value.

Let’s look at some SRI funds

SSGA Gender Diversity Index ETF (Ticker SHE) — This is a new fund that seeks to invest in companies that advance women through gender diversity in the leadership roles at the board and executive level. Who doesn’t want to see women have as much of an opportunity to lead our great companies into the future? This seems like a great idea on the surface.

Now lets look at the top 5 holdings. They are Pfizer, Pepsi, 3M, Amgen and Mastercard.

What if women’s equality and the advancement of women in leadership is important to you, but on the other hand you also disagree with promoting sugary drinks to children (Pepsi)? You also think drug companies promote unnecessary drugs to people that could benefit from other treatments (Pfizer, Amgen), and you worry about the debt crisis and think credit card companies (Mastercard) promote bad behavior. How do you reconcile those beliefs?

These are just some examples that could make it difficult for people to invest in funds that capture all their values. Don’t forget the underlying fundamentals of the fund itself too. In this case, the expense ratio is only 0.2%, one of the lower ones in the category, but that is still 4-5 times higher than a total stock market ETF.

Lets look at the return over the last year:

SSGA Gender Diversity Index ETF (Ticker SHE)

As you can see, the fund is too young for us to see a true track record. It underperformed the total stock market by over 5% last year.

iShares MSCI KLD 400 Social ETF – Now let’s look at another ETF, the iShares MSCI KLD 400 Social ETF (Ticker DSI). This EFT holds companies such as McDonald’s, Walt Disney, Time Warner, and Coca-Cola.

What if you are very committed to minimalism? You also think society, in general, is wasteful and over indulgent? Can you own Disney or Coca Cola even though the fund promotes other aspects of social responsibility?

This fund started in 2006, and its expense ratio is 0.5% – about ten times greater than a total stock market fund. Here are its returns:

iShares MSCI KLD 400 Social ETF

This fund has underperformed a bit more than the difference in its expense ratio. Keep in mind, these funds are actively managed.

Social Index Fund — Even Vanguard has the Social Index Fund (Ticker VFTSX). These managers examine companies for certain social and environmental criteria.  They also exclude companies involved with weapons, tobacco, gambling, alcohol, adult entertainment, and nuclear power. Its expense ratio is 0.22%, another one of the better values.

Here are their returns:

social index fund VFTSX

As you can see, the long-term returns are inferior. The fund has a higher expense ratio than the Total Stock market ETF.

Are there alternatives to SRI?

Yes, you could create your own socially responsible fund! However unfortunately, going back to the previous ideas, you don’t really contribute to the profits of the company. You do have a vested interest with the companies you select though, but buying and selling of the stock won’t contribute a dime to the company’s bottom line.

Is index investing social responsible?

The answer to this question is, it depends on your definition of social responsibility. When you buy a total stock market index fund, you have a vested interest in all that participate in that market doing well. You don’t contribute a dime to any of the companies the index fund holds, but you do want each person in the workforce to show up and do the best job they can to make profit and return value for their services.

Another perspective is that by being a shareholder of what you consider a socially irresponsible company, you can vote for the board to change practices with which you disagree. You could probably do more good as an owner of an ethically disagreeable company, than someone who boycotts its stock.

What about the fund doing the investing?

As for the fund itself, you do choose whether you will support or not support that company. I think as far as financial companies go, those that keep costs low and maximize investor returns are a pretty good choice.

Companies like Vanguard fit the bill. They’ve had a commitment to help investors keep more of their money longer than any other broker. Other companies that concentrate on high value and low costs are also looking out for their investors. The research shows that keeping costs low helps investors generate higher returns.

Then the investor can do things like donate to charities or set up a donor advised fund. These brokers and their diversified low-cost funds give investors opportunity to work less time in a high stress, less healthy job. They can then retire earlier to a life of more relaxing life and concentrating on benefiting their fellow man. We can use our profits to affect real change around us and make a personal difference in the lives of the people we love.

It might even help the investor live longer so she can dole out even more kindness, and spend more energy seeing the beauty of the world and sharing it with others.

I love the idea of socially responsible investing, just like I love the idea of active fund managers returning more profits than an index. The way the system is set up, however, it just doesn’t happen.

If we put our hard earned dollars towards the fund companies that have our best interest at heart, we can put our earnings toward the best interests of our planet and our fellow citizens.

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Tom is a doctor, husband, and father of five with a passion for parenting and finance. He started HighIncomeParents.com, a parenting and personal finance blog that helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self-sufficient. When he isn’t hiking, skateboarding, riding BMX, or jumping on the trampoline with his wife and kids, he is reading and writing about personal finance.