WealthyStreet Academy
WealthyStreet Academy

Doing Well by Doing Gooder

Michael Reid, CFA
Aug 31, 2021

Socially Responsible Investing

In the universe of money management, environmental, social, and governance (ESG) and socially responsible investing (SRI) has become big business. Huge business in fact. Maybe not to the scale that index investing now occupies, but the “hockey stick” shaped upward sloping growth trajectory among ESG & SRI related funds has certainly captured the attention of Wall Street’s well-oiled marketing machine. Let’s be honest, it’s not that Wall Street’s manufacturing process has suddenly become woke to sustainability as a core organizing principle, it’s much more likely the $2 trillion torrent of ESG & SRI inflows has triggered a Pavlovian response to the irresistible draw of profits. Perhaps I’m overly cynical, but then again, perhaps not.

First the Bad News: Some Assembly Required

For investors seeking to integrate ESG/SRI criteria in funds set aside for retirement, education, and legacy giving, there is no “easy” button. Don’t be fooled by the palette of green hues or colorful rainbow displays adorning pine scented brochures, when it comes to ESG/SRI, one size does not fit all. The road forward is fraught with false promises, hidden risk, conflicting values, and yes, the inevitability of at least mild compromise. For the truly committed, the ESG/SRI road can be a solitary and somewhat lonely path. After all, discernment of values, the order in which they are prioritized, and exactly where to draw lines in the sand will never be perfectly mirrored when authored by committee. In just about every case we’ve encountered, where real human beings struggle to consistently apply their closely held beliefs, the commitment is going to get personal. Deeply personal. It’s also going to take time and perseverance. Lots of it.

Now the Good News: You Have Choices

In 2017, Swiss Sustainable Finance, the CFA Institute Research Foundation, and the CFA Society of Switzerland published the Handbook on Sustainable Investments: Background Information and Practical Examples for Institutional Asset Owners. While the publication contains a wealth of detail and case studies involving billion-dollar plus asset pools, many of investment vehicles discussed are well out of reach for all but the wealthiest qualified purchasers. Still, there are some valuable nuggets of practical advice for the rest of us. Here’s what you need to know.

Shun the Wicked. A targeted “hit list” of industries, companies, or specific business activities to divest from or exclude from investment consideration is frequently the reflexive first step. And why not? When a company engages in a commercial enterprise or activity some consider morally or socially reprehensible, the first reaction is to vote with your feet (and secretly hope the shares retreat to zero just before the company goes out of business in spectacular fashion). Negative screening means you’ll never again grant the offending company access to your capital or any capital where you exercise discretionary authority over how investment decisions are made.

An exclusion strategy works best when there’s clear alignment with a singular and universal organizing principle. For example, a pulmonary oncologist may specifically want to exclude tobacco companies or firms engaged in the manufacture of products containing asbestos from investment consideration. Similarly, a union pension fund may want to exclude companies whose labor practices have been uniformly hostile towards efforts to organize collective bargaining units. A word of caution: When the list of exclusions starts to bloat and subsequently excludes multiple industry groups and scores of companies, cost may outweigh reward. In those instances, there is real risk of sacrificing the benefits of diversification and experiencing investment returns that fall short of the general market. While performance shortfalls may be perfectly acceptable when the funds in question are yours and yours alone, that’s not always going to be the case. It’s when you are tasked with making investment decisions that directly impact funds owned by or shared with others (whose views may or may not perfectly align with your own), that the fiduciary calculus can quickly become treacherous.

Elevate the Saints. ESG/SRI motivated investors who find themselves troubled by the rigid pass/fail limitations exclusion strategies tend to impose, typically gravitate toward policies and practices designed to identify, motivate, and reward companies willing to promote positive change. It’s the proverbial carrot vs. the stick. Promotion of best practices (or “impact investing”) begins with understanding and acceptance that all corporate saints have a past and all corporate sinners have a future. The devil, of course, is in the details. Viewed from this perspective, the most important consideration is the incremental progress companies achieve.

On a macro scale, some industries are clearly better positioned to tackle existential challenges to humanity like climate change or infectious disease mitigation while nearly all companies are equally positioned to address micro challenges like board diversity or compensation practices that dictate terms of the wage gap between senior management and the rank and file. Unlike negative screening that often feels like a “set it and forget it” exercise, impact investing can be more subjective and require significant commitment to monitoring and analysis. As I overheard one industry rep quip at a conference, “we don’t demand perfection right out of the gate, we just want objective evidence our companies are getting a little gooder every day.”

Unfortunately, analysis and monitoring of these criteria also requires additional time and expense. This means a fund sponsor’s financial incentives to cut corners can add up quickly. Increasingly, the U.S. Securities and Exchange Commission’s Office of Compliance, Inspections, and Examinations is turning a punishing eye towards any firm that can’t back up claims of the “rigorous” criteria they claim to use when selecting investments. From a regulatory enforcement perspective, exaggerated claims or any claim that can’t be substantiated is a form of consumer fraud. Even if you, as an individual investor, have no financial incentive to cut corners, the amount of time and expense to invest intentionally should not be underestimated. And the reward for this effort? At least anecdotally we’ve found many clients who head down this path are not only more engaged, they also report a higher degree of satisfaction with the investment process in general.

Stuff the Ballot Box. For those willing to eschew mutual funds, exchange traded funds (ETFs), and index funds of altogether, there is a third less obvious path: Buy shares in individual companies and exercise your voting rights on all matters that properly come before shareholders. In contrast to other options, voting proxies can stand all on its own or simultaneously paired with either of the first two strategies.

Want to take your game to a whole new level? Don’t simply vote by proxy, show up in person and make a scene. You don’t have to wear a chicken suit or make a grand entrance like Lady Gaga dressed in a floor length meat jacket. Sometimes understatement can go a long way. Imagine an entire row of Dominican nuns dressed in their formal habits quietly lined up at the microphone to voice support or opposition to a shareholder proposal. Years ago, these folks were derisively referred to as corporate gadflies. Today we call those people influencers. Start a social media campaign that highlights your principled issues. Seek out members of the press there to cover the event and tell them how you are voting...and why. Enlist their support. Borrow their megaphone. Become that influencer. With any luck, you’ll join forces with thousands of other likeminded people, project a disproportionate volume level in the conversation, and collectively start to turn hearts and minds. To the gooder.

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Michael Reid, CFA is a Managing Director and Partner at Exchange Capital Management, a fee-only, fiduciary financial planning firm. The opinions expressed in this article are his own.