Common Ground: What Is Socially Responsible Investing?

December 2004

What Is Socially Responsible Investing?

A Response to Paul Hawken

By Joe Keefe

During a period of seemingly unending corporate scandals, and with growing numbers of citizens concerned about the environment, globalization, and other social issues, the investment approach known as socially responsible investing (SRI) is on the rise.

The SRI industry now totals some $2 trillion in assets under management, accounting for nearly $1 in every $9 invested in U.S. markets, according to the Social Investment Forum. A Harris Interactive Investor Confidence Survey commissioned by the Calvert Group in November, 2003, found that:

• 93 percent of investors believed that their financial advisor should investigate the ethical as well as financial performance of investments before making investment recommendations.
• 84 percent were more likely to invest in a mutual fund emphasizing companies that engage in ethical business practices.
• 71 percent believe that companies operating with higher levels of integrity carry lower investment risk, while 68 percent believe they deliver higher investment returns.

Clearly, investors have come to understand that there is often a clear connection between ethical performance and financial performance, and that their investment decisions have real social consequences.

Despite its growing popularity, socially responsible investing remains unfamiliar to many Americans, is often misunderstood, and, of course, has its detractors. Critics from the right question the efficacy of including any social or ethical criteria in investment decisions; critics from the left occasionally complain that the social and ethical criteria aren’t strict enough, allowing too many irresponsible companies into “socially responsible” portfolios. Paul Hawken is the latest entrant in this latter group, issuing a report critical of SRI that was discussed in the October issue of this magazine.

Hawken has nice things to say about my company, Calvert, listing us with a handful of “leaders” who have made “real contributions to corporate reform and accountability.” At the same time, I think his report is unfair to some of our colleagues in the SRI industry, leaving the false impression that most SRI portfolios hold large numbers of socially irresponsible companies. I don’t think that is true, and I believe this line of criticism obscures rather than illuminates the larger point Hawken wants to make.

The term, “socially responsible investing,” refers to a range of investment strategies that include: (1) screening investments based on certain standards of corporate social responsibility; (2) exercising one’s rights and responsibilities as a shareholder to hold corporations more accountable (so-called “shareholder activism"); and (3) allocating a portion of one’s investment assets to sustainable economic development — either through community investing or socially conscious venture capital. What these strategies have in common is the intent — and hope — on the part of socially responsible investors and practitioners that their investments over time will have a positive impact on corporate behavior, on financial markets, and on society itself.

Critics like Hawken focus on the first strategy listed above — portfolio screening — arguing that too many polluters and other problematic companies find their way into “socially responsible” portfolios. The problem with this criticism, however, is that SRI funds do not purport to separate all the “responsible” companies from all the “irresponsible” ones. Instead, funds using social and environmental screens try to invest in companies that meet certain standards of corporate social responsibility. Those standards may differ from fund to fund, and it is true that there is no agreed-upon industry standard, no bright line where all “socially responsible” companies fall above the line and all “socially irresponsible” companies fall below the line. But that is not the point.

The point is that individual and institutional investors can deploy a host of strategies — including social and environmental screening — to promote corporate social responsibility and more enlightened financial markets through their investment decisions. The process doesn’t create perfect companies any more than voting creates perfect candidates or charitable giving creates perfect non-profits. But it is still worth doing. Over time, it can have a positive impact on companies, markets, and society as a whole.

Hawken contends that “over 90 percent of Fortune 500 companies are included in SRI portfolios,” and his report includes a chart, “SRI Holdings as of December 2003,” listing 11 problematic companies (including Wal-Mart and Halliburton) held by SRI firms. In fact, none of the 11 companies pass Calvert’s social criteria, and if some of them are held in some SRI portfolios, I suspect this is the exception rather than the rule. And if it is the exception rather than the rule, then SRI funds deserve credit for excluding most problematic companies rather than blame for investing in some.

It would be impractical, and self-defeating, for SRI firms to exclude all or even most Fortune 500 companies from their portfolios, let alone adopt the more rigorous test proposed by Hawken: “The most important criteria to determine a company’s social responsibility is whether it should exist at all,” he writes. “In other words, is the company helpful to the world and its people?"

This standard is more utopian than realistic. Where it is realistic — i.e., where entire industries can be excluded because they are deemed particularly harmful — many, perhaps most, SRI firms apply such exclusions. Examples are the tobacco industry, weapons manufacturers and nuclear power. Otherwise, investors simply don’t have the luxury of making this sort of grandiose philosophical determination each time they invest. Moreover, to apply such exacting standards would reduce the universe of potential investments to an impossibly small number of companies, thereby undermining portfolio diversification, exaggerating risk and penalizing financial performance. SRI funds would be unable to attain market returns, and hence unable to attract investors.

This is an important point: SRI is an investment strategy; SRI funds need to sell their shares to investors. For investors, the alternative to SRI isn’t perfection — it is funds with no social or environmental agenda, no shareholder engagement strategies, and no commitment to devoting a portion of their assets to sustainable economic development. Certainly, there are other ways to effect social change (political engagement, charitable giving, green shopping, etc.), just as there are other ways to invest, but the last time I checked, SRI was the only way — imperfect as it is — to pursue social change as an investor. For socially responsible investing to be an effective social change strategy, it must also be an effective financial strategy.

Hawken counters that, “striving for the highest rate of return is a cause of social injustice and environmental degradation worldwide,” and he and his colleague, Hilary Mandel, report that, “in our informal discussions with many investors, we’ve gathered that they would accept a lower rate of return if they received a greater amount of information and rationale for portfolio selection.” This is a false dichotomy. The choice needn’t be between the “highest rate of return” and “lower” (i.e., below market) returns.

Indeed, social investors generally reject the “highest rate of return” approach because, as the recent corporate scandals remind us, it creates a short-term earnings bias that disfigures financial statements together with ethical and social values. Social investors equally reject the “below-market returns” approach proffered by Hawken, as there is simply no reason to assume that a financial penalty must accompany honest, ethical and socially responsible business practices. To the contrary, growing numbers of social investors believe that companies embracing high standards of corporate social responsibility ultimately carry lower risk and are better positioned for long-term performance than their less-enlightened peers.

Today, there are few if any publicly traded companies that have achieved sustainability in the true sense of the term — zero emissions, zero waste, etc. — and therefore few opportunities to invest in such companies. Where such opportunities exist, or where companies are introducing new, green technologies or business models, SRI funds frequently pursue such investments.

Calvert, for example, has a “special equities” program that proactively seeks out such companies. In the meantime, we have no alternative but to choose from the existing universe of publicly traded companies for the lion’s share of our portfolio investments. The key not only for Calvert, but also for many other SRI funds is that we approach such investments differently:

• Through rigorous social, environmental and corporate governance research, we try to invest only in those companies that meet certain, basic standards of corporate social responsibility.
• Through shareholder activism, we try to persuade companies to embrace higher standards of corporate responsibility — from disclosing their environmental liabilities, to adding women and minorities to their boards, to adopting non-discrimination policies for gay and lesbian employees.
• Through alternative, sustainable investment strategies, we invest in “green” start-ups and devote a certain portion of our assets to community economic development.

These investment strategies will not change the world overnight — but they do offer a way for investors to promote increased corporate accountability, more enlightened financial markets and more sustainable socio-economic structures over time. That, ultimately, is what socially responsible investing is all about.

The SRI industry is still young. Hawken is right to argue for better definition, clearer standards, and more disclosure — for the SRI industry to “reassess [its] terms and descriptors.” The term, “socially responsible investing,” itself may be inadequate, and certainly there are ways that the SRI industry can better articulate its underlying goals, strategies, and standards. These are important questions, and they deserve to be addressed in a collegial and constructive dialogue.

In the meantime, socially responsible investing will continue to grow despite its critics because it is the best means, and indeed the only means, for investors to integrate their financial goals with the long-term health of society and the planet.

Joe Keefe is Senior Advisor for Strategic Social Policy at the Calvert Group (www.calvert.com), and a member of the Board of Directors of the Social Investment Forum (www.socialinvest.com).

Read other responses in this debate about socially responsible investing on our parent company website.

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