Evolution of SRI Leads Investors to a Sustainable Future
It’s no secret that positive screening as an investment strategy is becoming increasingly popular as advisors seek ways to identify substantive investment opportunities. The practice focuses investors on the elements of a company that can make a positive impact both on the bottom line and on society, pointing to socially progressive companies that generate returns.
Positive screening derives from the traditional roots of Socially Responsible Investing (SRI), and was ironically born out of the polar opposite approach: negative screening. In the early days of SRI, religious communities avoided “sinful” industries such as tobacco and military manufacturing, and anti-war activists supported that outlook as part of the protest against U.S. involvement in Vietnam.
The 1980s provided a new dimension and increased following as anti-apartheid sentiment led to divestment from South Africa. A youth movement, legislative action, and the staggering amount of money at stake brought into focus the power of avoiding certain industries.
Investment firms took their cue to capitalize on the momentum. The potential of attracting socially conscious capital spurred on by divestment validated the idea that a service could be established to cater specifically to these clients.
The foothold gained during this time period grew beyond any one social issue. According to a 1995 Dow Jones article, “Despite predictions that the end of apartheid in South Africa would lead to the demise of socially responsible investing, three out of four U.S. money managers who handled investments for clients opposing apartheid continue to manage responsibly invested portfolios.” i
The seeds of modern SRI were further nurtured by a team of accidental participants focused on employee advocacy. In 1984, Milton Moskowitz and Robert Levering published their first analysis of The 100 Best Companies to Work for in America to highlight ethical management best practices. The list was compiled without regard to strong financial performance, but
a 2009 study determined that the companies on that list from 1984-2005 “outperformed industry- and characteristics-matched benchmarks, and…the Best Companies also exhibited significantly more positive earnings surprises and stronger earnings announcement returns.” ii
This close correlation between performance and ethics issued a powerful message that SRI should require only eliminating the questionable industries. The idea began to form that companies that behave ethically can be profitable, flipping the approach to SRI on its head. By identifying the elements of a strong company and sustainable performance, the practice moved away from simple avoidance and towards productive investing.
For investors looking to gain traction through both financial and social impact, the challenge of positive screening is ensuring that one is not lost in favor of the other. Portfolio strength is developed on themes, opportunities in the marketplace, and underlying quality, and it is (and always has been) critical to have a full understanding of the composition of and rationale behind each investment. Such due diligence requires investigating elements such as:
•Disruption opportunities. Economies are made up of shifting plates of industry, and those who identify undervalued areas poised for significant momentum – and individual companies that are positioned to benefit – will see enduring upside that thrives when the general investing population weakens.
•Quality of Demand. Stability and sustainability of demand are critical factors that drive opportunities. Investors must also understand the value of functional demand as it relates to supply. In the last decade, for example, the demand for commodities as investment products brought many outside buyers into the commodities markets, driving prices well above the rational price suggested by the functional supply and demand fundamentals in the global economy. This mispricing left investors vulnerable.
•Debt/asset ratios. A low debt/asset ratio is a fundamental sign of a strong balance sheet, and in a deleveraging environment it is a critical component to sustainability. There is a true competitive advantage to having actual liquidity at hand; it provides management with the flexibility to keep their options open, to pursue opportunities that may benefit shareholders, and to grow market share when overleveraged competitors are weakened by a lack of accessible capital.
•Dividend growth. Management that gives back to its investors with consistent increases in dividend returns demonstrates a long-term commitment to the enterprise, and invites shareholders to remain dedicated.
•Social positioning. Companies that lead with ethical business practice set a standard that captures competitive advantage. Fair treatment of employees, the environment, suppliers, customers, and shareholders is rewarded by the market and influences vendors and partners. Just as important, those that provide solutions to environmental or social concerns are tying their business to market needs that have the potential to spike as the global picture changes.
Socially responsible investors must also acknowledge that trends are long-term, and the right strategy can lead to strong returns over time. This opens the door for the benefits of compounding returns, further amplifying results.
SRI has for decades remained on the fringe of strategic money management, routinely battling the perception that prioritizing an ethical or social focus requires sacrificing significant returns. Market conditions, however, now highlight the correlation between company performance, integrity and transparency – an interdependence that makes smart SRI nearly indistinguishable from smart mainstream investing.
While 40 years ago, the nascent industry was content to label investments in black and white via negative screening, the current environment makes clear that SRI is a complex web of research and individual preferences. Global issues such as corporate fraud, opacity in the financial sector and delays in addressing climate change spotlight the importance of sound, forward-looking business practices. Simply put, good management with a moral compass and a long-term view reduces investor liability – and in our ever-progressing world, opportunities abound to grow capital while promoting positive social change.
Endnotes:
Study: Socially Responsible Investing Growing In The U.S., Lynnette Khalfani, Dow Jones, September 26 1995, i Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices, Alex Edmans, Wharton School, University of Pennsylvania, August 12, 2009, ii
