Socially Responsible Investing
This year I’ve had the opportunity to learn about CSR from multiple perspectives. Initially somewhat skeptic of the level of impact in this field, I decided to join a Fund that manages investments following Socially Responsible Investing (SRI) criteria. This field of investing is relatively new in several aspects: A) there are relatively few metrics developed to measure success, B) there is limited data showing the historical performance of these funds, and C) there are few industry standards to guide investors to a more educated selection of investments.
To begin, I had preconceived notions about the sort of companies that could be considered ‘responsible’. But it quickly became apparent that shallow considerations of companies that simply state ‘green’ initiatives would not suffice to justify purchasing the stock. The Fund considers that in order for any initiative to be considered relevant, it has to contribute directly to a more robust business. Or in the words of a traditional investor, these changes should “reduce risks for a given level of return”. Our role is to understand how these changes enhance the fundamentals of a business. Exposure to industry professionals allowed me to learn from their best practices as they pitched companies that by hearsay would not immediately stick out as favorable options. Following a more careful due diligence of their business enabled me to understand how they were better positioned than some of their competitors that perhaps spent more marketing resources persuading the public of rather meaningless short-term campaigns.
So far, SRI funds have moved from the passive investing philosophy of negative screening, which focused on excluding companies that engage in businesses related to alcohol, tobacco or weapons. The approach soon became focused on positive selection of companies that displayed positive initiatives that enhance the governance, labor practices, community engagement and environmental sustainability practices of their business. Over time, this approach evolved into more rigorous criteria and currently it has moved towards picking those companies that clearly articulate a strategic and comprehensive “best-in-class” CSR strategy. These businesses are considered to be advancing the entire industry towards better standards.
This last approach has enabled two improvements. First, it allows investors to compare direct competitors, which might eventually become an incentive for companies to develop positive changes as a competitive advantage. Second, from a diversification point of view, the approach is helpful as it enables investors to choose companies in industries that may not at first sight be considered ‘responsible’. The “best-in-class” approach enables investors to go beyond industries like alternative energy, into areas more difficult to assess such as chemicals, entertainment or financial services.
To date, our understanding of this space has improved as we keep raising the criteria requirements before including a stock in our portfolio. However we still struggle to determine the term under which we are willing to hold the investment and how this decision is aligned with the overall sustainability of the business. We strive to find the most accurate information publicly available and benchmark investments against relevant indexes. However, there are some areas where the decisions are less clear. For instance, with the duty to deliver returns to the Fund, let’s take a scenario where there are two comparable companies with similar sustainability practices. One is successful communicating its initiatives to the public, whereas the other one still remains relatively undiscovered. Should you invest in the company that is already well known and that will likely be fairly priced already reflecting these benefits? Or should you invest in the relatively undiscovered one because there is room for upside (“alpha”) when the market finally recognizes these initiatives? Furthermore, in the presence of a steep and unexplained stock price decline, how should long-term-minded investors respond? Over time, we hope that with increased transparency and more integrated reporting, financial markets will be able to reward businesses following a better informed decision-making process.