For mutual fund investors, taxes are inevitable. Even if you’re a long-term buy...
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In fairness, it is a reasonable argument for two reasons. The first is that assuming the return streams are better if tobacco companies are included, then the ability of the investor to create impact through charity is in fact greater. Especially when you consider that $1 invested in the tobacco sector in 1900 would have yielded $6,280,237 by 2015, making tobacco the single highest performing part of the economy to invest in over that 115-year history.1
The second reason advisors tend to dissuade clients from socially responsible investing is a bit subtler. If our hypothetical investor concerned about lung cancer decides to divest from a tobacco stock, another investor will come in and buy the stock. So the tobacco company isn’t punished. And if the investor underperforms as a result, the big loser is the charity as there is less money available to distribute to them.
For these reasons, the socially responsible investing movement (which got going in the 1970’s in response to apartheid) never really went mainstream. There will always be investors that want negative exclusions of an industry or two from their portfolios, but advisors advocating that such an approach is a bad idea have outnumbered their investors. And advisors jobs were made easier because SRI strategies tended to underperform their benchmarks.
This said, SRI gave way to ESG in 2013 or so, and the easiest way to explain the difference is that SRI was about negative exclusions (tobacco, weapons, coal, etc.), whereas ESG looks at the economy as a whole and excludes companies from each sector that are poor stewards of the environment, badly governed, and detached from social justice issues. Because ESG is less about exclusion and more about inclusion of well-run companies, underperformance is no longer a major issue. Indeed, it is now possible to outperform conventional investment approaches, including index funds through ESG investing. As a result, assets are starting to flow into ESG strategies, as well as other values-based investment strategies; and portfolio management firms are rushing to bring new ESG product into the marketplace.
Don’t get too hung up on the math as I believe there is some double counting going on here, but according to US SIF 2016 annual report, of the $40 trillion of investment assets under professional management in the U.S., $8.72 trillion of these assets have incorporated ESG/SRI/values-based themes. Responsible investing is growing at 33% per year in the U.S. To be clear this isn’t all retail money.2 Far from it as the number includes assets from public pensions, endowments, and faith-based organizations. In recent report from McKinsey & Company called, ‘From why to why not: Sustainable investing as the new normal’ the authors state “More than one-quarter of assets under management globally are now being invested according to the premise that environmental, social, and governance (ESG) factors can materially affect a company’s performance and market value.3
One way big institutional investors protect their investments is by working with corporations to ensure that management teams get focused on ESG factors that represent material risk. These factors will vary by industry and some are common across all industries, such as pension fund status, management and board diversity, and executive compensation. We’d all agree that water usage isn’t a big thing, for say, a bank. But it is a big thing in a beverage company, or a utility. Not only do they use a lot of water, their businesses depend on water. Investors want them to mitigate this risk by being thoughtful stewards of water as an asset.
This emerging ecosystem has built-in feedback mechanisms. Investors push for progress and if they don’t get it they vote their shares against the board and management. Public companies increasingly disclose annual corporate social responsibility reports, which then allow investors to compare and contrast multiple companies in the same industry groups in order to decide which are best managing ESG risks. This process applies to both equity and corporate bonds. The data is increasingly transparent, and all stakeholders in the ecosystem have access to it. Millennials are already stakeholders as well in that they are signaling the social behaviors they expect in return for their consumer loyalty.
There is one broken link in the ecosystem, however, and that is the financial advisor community. According to Cerulli Associates, as of the beginning of 2017, there were 310,504 financial advisors in the U.S., half of which plan to retire in the next ten years.4 In general, these advisors formed the opinion many years ago that SRI = underperformance, and many haven’t grasped the shift underway in which investors are increasingly looking to align capital with values and now have the tools to do so without sacrificing performance. Financial advisors need to get caught up, as most don’t understand the difference between SRI and ESG, let alone more nuanced values sets, and are dismissive of the effort. But clients of all generations are starting to understand and ask for more sustainable investment options, and this is before Millennials enter the investment picture and change everything.
1 Dimson, Elroy, et al. “Credit Suisse Global Investment Returns Yearbook 2015.” Credit Suisse, 1 Feb. 2015.
2 Vorhees, Meg, and Farzana Hoque. “2016 Annual Report: US SIF and US SIF Foundation.”US SIF.
3 Bernow, Sara, et al. “From ‘Why’ to ‘Why Not’: Sustainable Investing as the New Normal.” www.mckinsey.com.
4 “Number of U.S. Financial Advisers Fell for Fifth Straight Year -Report.” Reuters, Thomson Reuters, 11 Feb. 2015.