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The previous post in this series discussed the nature of Socially Responsible Investing (SRI), otherwise known as ethical investing.

Prior to launching into detailed discussion or debate about SRI, I think it is important to step back and first consider the question of whether or not ethical investing is indeed desirable.

Should investors seek to invest their funds in a socially responsible manner? In my view – yes. Nevertheless, I feel that it is important to define and clarify the nature of the benefits of ethical investing, as well giving careful consideration to objections toward SRI.

The objective of today’s discussion is to define and clarify the nature of the benefits of ethical investing. Why should investors seek to be socially responsible? How does SRI help to achieve positive social outcomes?

A range of objections toward ethical investing will be discussed in the next few weeks.

 
Benefits of Socially Responsible Investing

Broadly speaking, there are two mechanisms by which proponents of Socially Responsible Investing argue that SRI helps to generate positive social outcomes. These are as follows:

 
• Allocation of capital resources.

SRI allocates financial resources toward companies and industries whose social, environmental and economic impact is considered to be positive and away from those whose impact is considered to be negative. 

By this mechanism, SRI supplies capital resources to socially benevolent industries, thus helping to stimulate growth, investment and expansion in such industries. This is predominately at the expense of industries whose impact upon society is considered to be particularly harmful.

For example, capital inflows from SRI funds typically help to stimulate growth in industries such as renewable energy and efficiency, healthcare and well-being, efficient transport, infrastructure and communications, waste management, financial services, and knowledge (education and media). These type of industries provide a valuable contribution toward the betterment of society.

On the other hand, capital inflow from SRI will typically be directed away from industries such as alcohol or tobacco manufacturing, adult entertainment, gambling or weapons manufacturing. Whilst such industries may provide some benefits to society, many would not consider growth in such industries to be desirable from a social viewpoint.

In addition, within individual industries, SRI allocates capital resources toward individual firms who adopt best practice in terms of ethical considerations within their industry, and away from firms who fail to adopt best practice.

Again, by this mechanism, SRI helps to stimulate growth of individual firms which adopt best practice at the expense firms which do not.

 
• Encouraging positive corporate behavior.

In addition to stimulating the growth of socially benevolent industries and individual firms, SRI also provides an incentive for industries and individual firms to improve their social and environmental practices.

From the viewpoint of industries and individual firms, there are considerable benefits of attracting the ethical investment dollar. Attracting SRI increases the ability of firms to raise capital and to do so on more favorable terms than would otherwise be possible. It also helps firms to maximize the share price, and in doing so maximize shareholder wealth, reduce the risk of takeover and positively impact the remuneration and continued employment prospects of senior management.

Moreover, given the magnitude of funds flowing into ethical investment, SRI funds now exert considerable influence. In America, SRI funds now account for approximately eleven percent of funds under management (refer PDF report). The equivalent figure for Europe is estimated at between ten and fifteen per cent.

Accordingly, there is now a significant incentive for firms to make efforts to attract the ethical investment dollar. This they can only do by adopting sound practices in terms of social, environmental and other ethical considerations. 

This is the first article in a series on Socially Responsible Investing (SRI).

Before we commence the series, I feel it’s important to step back and take a closer look at the nature of SRI and the type of activities it can involve.

 
What is Socially Responsible Investing?

Socially Responsible Investing (SRI), otherwise known as ethical investing, refers to the practice of taking social, environmental and ethical factors into account when making investment decisions.

Typically, those investors who endeavor to be socially responsible seek to invest their funds in a way that will have a positive impact on society as well as earning a competitive rate of return within an acceptable level of risk.

 
Common approaches to Socially Responsible Investing

In order to gain a broader grasp of the concept of SRI, I think it’s important to look at the range of different forms which Socially Responsible Investing can take.

Calvert.com provides a good summary of the different forms of SRI. Broadly speaking, there are six different forms (although Calvert lists only four):

 
• Investment screening.

This involves a process whereby potential investments in a portfolio are subject to a screening process to determine their suitability for inclusion in the portfolio from an ethical standpoint.

Some investors apply negative screens, under which investment in certain assets or companies is specifically excluded on ethical grounds. Other investors apply positive screens, under which they specifically seek out investments in certain sectors or firms which demonstrate specific forms of positive ethical behavior.

 
• Divestment.

As the name implies, this refers to the practice of divestment of shares or other assets based on ethical grounds.

This can be thought of as ‘selling in disgust’ or selling as a form of protest, and is often done in response to particular actions of the company.

 
• Shareholder advocacy.

Shareholder advocacy refers to the practice of shareholders using their position as owners of the company in an effort to influence corporate behavior and apply pressure upon their company to act in a socially responsible manner.

This can take many forms, and can include simple actions such as letters or phone calls, or more substantial actions such as resolutions at shareholder meetings, which are designed to mandate that the company act in a certain manner in relation to a particular issue.

 
• Community Investing.

Community investing involves channeling funds toward community projects, typically directed toward communities whose credit needs are not met by the traditional credit system.

Typically channeled through a Community Investment Institution, these investments provide funding for essential community services or infrastructure, as well as seed capital for promising local enterprises.

 
• Social Venture Capital.

Social venture capitalists provide early-stage funding in enterprises which are pursuing profitable ways to meet social needs.

Traditional venture capitalists provide early stage or seed funding to new or start up companies, often enterprises which are developing a form of new technology or business methodology. This funding provides the necessary capital for the enterprises to develop ideas into successful businesses or enterprises.

Social venture capitalism operates on a similar concept, but differs in two ways. First, social venture capitalists seek positive social outcomes from their investments, usually in addition to a competitive financial return. Second, social venture capitalists typically restrict their investments to fields which have a particular benefit to society, such as renewable energy, waste management, education or health and well-being.

Social venture capital involves a high level of risk, and should only be considered by investors with considerable financial resources as well as experience in project risk management.

 
• Social Entrepreneurialism.

This involves using traditional entrepreneurial skills to organize and manage business-like ventures to achieve a desired social outcome.

This differs from social venture capitalism. Social venture capitalists provide financial resources for the projects which aim to produce desirable social outcomes. Social entrepreneurs, on the other hand, initiate, organize and manage such projects.

The social entrepreneur may invest his or her own financial resources. But often financial resources are provided by external parties, such as lenders or social venture capitalists. More often than not, the principal ‘investment’ made by social entrepreneurs is the personal effort required to manage their venture to achieve the desired outcomes.

Conclusion

As we can see, SRI can take a wide variety of forms, and there are a range of options available for those wishing to invest their money in a socially responsible fashion. 

Dear readers,

Many people wish to invest their money in a way that will have a positive impact on society as well as maximizing their return on investment.

Accordingly, in tomorrow’s post, I wish to commence a series of discussions based around the topic of Socially Responsible Investing (SRI), otherwise known a ethical investing, a concept whereby investors take social or environmental factors into account when making investment decisions.

At this point, the precise number of posts and range of topics which will be included in this series has not been finalized, and as valued readers, please feel free to advise me about any specific issues which you would like to see covered in this series.

As a guide, this series will deal with the following issues:

(1) How to define ethical investing or SRI;

(2) Different types of ethical investing and different approaches toward SRI;

(3) Whether or not investors should indeed take ethical considerations into account when making investment decisions;

(4) The effect of Socially Responsible Investing upon corporate behavior;

(5)  How ethical investments fare against regular investments in terms of financial returns; and

(6) How to go become a socially responsible investor.

For the purpose of this series, SRI will be referred to interchangeably as Socially Responsible Investing, SRI or ethical investing.

 
Disclaimer

This series of articles is provided for general discussion purposes only.

I am not a financial planner and cannot provide any form of financial advice. All readers are encouraged to consult a qualified financial planner before acting upon any information contained within this series of articles, or elsewhere on this blog.