What is socially responsible investing? Broadly, it means incorporating ESG (environmental, social, and governance) criteria into your investment decision making. That could mean investing specifically in companies with positive social missions (like those that hire formerly incarcerated individuals or ensure that their whole supply chain is well paid), or it could mean divesting from companies who are hurting the environment (like the companies building the Dakota Access Pipeline or failing to clean up their pollution.) It could also mean proactively investing in smaller or local businesses that bring important goods or services to their communities.
These ESG criteria aren’t inherently financial, so some people question whether it makes sense to apply them when making financial decisions. This debate goes back decades, but the good news is that experts and researchers have asked that question thousands of times to find out whether responsible investing will hurt your returns as compared to standard investment strategies.
In 2015, Deutsche Asset & Wealth Management conducted an analysis that aggregated evidence from more than 2000 empirical studies on ESG variables and financial performance. They found no negative correlation between high ESG ratings and overall company financial performance in the vast majority (90%) of cases.1
Similarly, an analysis by Arabesque Partners found that companies with strong ESG practices have historically performed better than companies who haven’t prioritized ESG, on a variety of criteria like higher stock prices, operating income and productivity. 2
You can even look for yourself by comparing the historic returns of one ESG fund to the returns of the market at large. The oldest US stock index using ESG metrics – the Domini Social Index (DSI)/MSCI KLD Social 400 Index – has actually outperformed both the S&P 500 and the Russell 3000 for 25 years.*
There’s a certain logic to investing in a company that supports its employees, considers long-term opportunities and doesn’t risk lawsuits, boycotts or public outcry.
Anecdotally, companies who don’t prioritize ESG practices can show the reverse: companies who rate low on ESG criteria could be considered riskier investments. An MSCI study found that companies with the lowest ESG ratings realized greater losses over time than companies with the highest ratings.3 As a recent example, one fund creator explained that companies that rated low on data security, like Facebook and Equifax, saw painful performance drops after their respective data breach crises. 4 But it’s important to remember that those are just some examples, and not the results of a rigorous study.
What about diversification? Passive, long-term investing means trying to track the market, not beat it, so it’s important to diversify by holding a variety of companies and assets. Some critics argue that ESG investing limits your ability to spread risk and create a fully diversified portfolio, and it’s true that classic divestment methodology can constrain your portfolio. Fortunately, new strategies enabled by more thorough collection of ESG data, better financial modeling, and more advanced computing techniques have allowed responsible investors to make the most of their investments.
For example, OpenInvest’s investment approach still gives you exposure to most industries and sectors, while ensuring that the quality of the investment universe is up to par. Unlike other robo advisors, we create fully customized portfolios for every customer using individual securities, ensuring that financial and social goals are at the heart of your investment decisions.
Here’s the gist of it. Research shows that historically, socially responsible investments have done just about as well as other investments (or better). It’s important to remember that historic performance is no guarantee of future returns. OpenInvest won’t promise you any kind of returns, and nor should anyone else! We only hope you remember that socially responsible investing is just like any other passive investment strategy when you’re deciding what you want your money to support.
1. ESG and Financial Performance: Aggregated Evidence
2. From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance
3. Foundations of ESG Investing
4. How socially responsible investing can help you avoid catastrophic drops within your portfolio
*Disclaimers: Direct comparisons between indices are not without limitations. Indices may track different market segments and include a number of different securities, including options, derivative instruments, and fixed income investments. Additionally, different market conditions may have material impacts on index performance where indices track different market segments. Indices may be unmanaged and unweighted and may not include the deduction of advisory fees or expenses. Historical performance is no guarantee of future returns. Any investment strategy carries with it a risk of partial or total loss of the capital deployed.