The Issues With Socially Responsible Investing

Posted in: Economics, General, Stock Market, Thought of the Week

In early May, Stanford University’s trustees made the decision to no longer invest in coal mining companies. They joined roughly a dozen other colleges that have made similar decisions in response to student protests. The new policy requires Stanford to redefine its proxy voting rules to back resolutions that direct companies to adopt sustainability principles, reduce greenhouse gas emissions, and increase the energy efficiency of their operations. This is an example of Socially Responsible Investing (SRI), where an investor will not consider owning the stock of a company that is in conflict with a personal belief. SRI is a concept that has grown quite dramatically over the last two decades, and several funds exist that offer investors an opportunity to invest only in equities deemed to be ethically sound.

Our Investment Committee recommends that investors leave emotion out of the investment process and avoid any implementation of SRI. The principle goal of investing is to achieve a desired rate of return using as little risk as possible. When investors utilize SRI strategies, they often do more harm than good to their portfolios for several key reasons:

  1. Diversification: The “Golden Rule” of investing is to maintain diversification at all times. Confining stock selection to only those that meet your personal beliefs can leave portfolio exposed to unanticipated risks.
  2. Higher Expected Returns: Since there are several fund mandates to avoid sin stocks, these equities are often cheaper on a valuation basis than other stocks that get crowded by the large fund managers that cannot own “sin” stocks.
  3. Effectiveness: Owning a stock of a company has little to no effect on its revenue generation, earnings, dividend safety, and/or compensation for management. A stock is nothing more than a claim on a percentage of the earnings for a company.
  4. Implementation is Nearly Impossible: Stanford may no longer own coal stocks but they likely still own stocks of companies that pay coal plants for power. Additionally, they almost certainly own stocks from companies that make products using coal based power. Simply put, Stanford cannot possibly remove all coal exposure from their portfolio.

Another common example of SRI is avoiding all tobacco stocks. Tobacco companies sell a highly addicting product that has been linked to thousands of deaths each year. The industry has caused pain and suffering to the world and cannot possibly be quantified. However, tobacco companies have delivered 5x the total return of the S&P 500 over the last ten years. The SRI funds that refuse to own tobacco stocks have done nothing more than limit their overall rate of return.

Our Investment Committee has suggested a far more effective way to support a cause. The first step is to avoid SRI strategies and instead keep strict focus on picking investments that can deliver attractive risk-adjusted returns and keep you diversified. Even if the thought of profiting from a business that you dislike makes you uneasy, the diversification benefit alone is a reason to at least consider these stocks. Then, if a gain is realized on an investment that conflicts with a belief, simply take those proceeds and donate them to a charity that you support. Not only will you be making a far more powerful impact, you will also likely qualify for a tax deduction.

Read this week’s Thought of the Week to learn more about Socially Responsible Investing.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.