Investing has traditionally been a bottom line driven activity with investors focused on the financial rewards they receive for the investments they make. Over the past few decades, many investors have become increasingly aware that they may be investing in companies whose business practices are inconsistent with their personal values. The disconnect between their individual choices and the companies they invest in was disconcerting. Responding to these concerns, some investment firms have started to incorporate non-financial criteria into their investment process.
Broadly characterized as "socially responsible investing," these investment management firms have developed investment processes that factor in environmental, social, and governance (ESG) objectives alongside traditional investment methodologies. Socially responsible investing (SRI) is a broad sub-group within the investment management industry and the ESG objectives of a portfolio manager or mutual fund can vary widely depending on their preferences. Historically, the ESG criteria might have focused on excluding investments in companies in the gaming, alcohol, tobacco, defense, or weapons industries. More recently, a greater interest in environmental and sustainability issues has generated new funds designed to meet those objectives. Another common set of ESG criteria are those that align with the practices and teachings of certain religious denominations.
For investors that are interested in incorporating socially responsible investing concepts into their portfolio, it is important to do your research and understand that more effort is going to be required. First, an investor should read a fund's prospectus to understand the investment philosophy and the specific ESG criteria that the portfolio manager will use. Since each mutual fund may have a different set of ESG screening criteria, it is important to understand the specific criteria that will be used for the fund you invest in to ensure that it is consistent with your personal priorities. Along with the fund's prospectus, the investment firm's website is a good source of information about a manager's investment process.
Once you are comfortable with a fund's investment philosophy and social criteria, it is important to understand how the fund may fit within your total portfolio. One of the challenges that SRI may present is that, depending on the screening criteria of the manager, it may eliminate or exclude certain industries or sectors from the portfolio. In many instances, SRI portfolios tend to have a growth investment style bias because they exclude or underweight industries such as energy and manufacturing, etc. In these instances you will either need to complement your SRI investment with other non-SRI options or accept the portfolio biases that might result from SRI investing. In either case, it is important that you do your research in advance so that you better understand the trade-offs that you are making in your portfolio.
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