Should I Align my Investments with my Values?
Casino Royale 1967 with Peter Sellers as James Bond, Ursula Andress and Orson Wells
SRI and ESG Investing
What does the movie Casino Royale have to do with SRI and ESG Investing?
SRI and ESG are not acronyms for medical diagnostics. SRI means Socially Responsible Investing. ESG means environmental, social and corporate governance. Both terms are used to describe categories and characteristics of publicly traded stocks and bonds.
The current momentum behind ESG investing is to align one’s personal values and beliefs with investment decisions.
I became familiar with SRI investing in 1992. It wasn’t new then. Institutional Investors, for the most part religious organizations, were looking for a specific bond fund or vehicle to invest in that would reflect their core beliefs and values.
The process for managing a fund that is “SRI” compliant is to eliminate specific industries or countries for investment.
Mutual funds were created with specific guidelines to eliminate investments in the following broad categories [1] :
- Alcohol
- Tobacco
- Military Equipment
- Gambling Casinos
- Pornographic Materials
- Healthcare Services
- Pharmaceuticals
- Issuers engaged in business activities in The Republic of Sudan
https://en.wikipedia.org/wiki/Second_Sudanese_Civil_War
The movie Casino Royale has at least 4 exclusions: alcohol, tobacco, casinos, and implied pornography (media companies that distribute would be excluded).
The dilemma institutional investors faced, after investing in a “sin-free” bond fund, was the performance return of the fund.
When a fund has restrictions on investable securities, opportunities for returns diminish. It’s like saying okay there are 50 companies I can invest in, but 20 of them are in my restricted list. So, my investable universe shrinks, giving up any performance the 20 restricted companies may have provided.
It becomes a self-imposed structural problem.
Over time, this is the problem institutional investors were faced with.
Investment committees have a clear fiduciary responsibility to provide the best possible returns for their employees and retirees. But if year after year the sin free fund performance is 1 % less than (actual performance data will vary from fund to fund. 1% is an example, not an exact data point) an unrestricted fund, well, that adds up to a lot.
It becomes a slippery slope to justify to your retirees . Give up performance to align investments with values? Is that in the best interest of your employees and retirees?
We think of values as personal. What happens when an institution imposes values or beliefs into an investment strategy?
The investment board decides that investing in certain sectors of the market is “sinful”.
Is the idea to impact the issuers of securities deemed “sinful”?
Eliminating pharmaceuticals because of drug addiction? What about the people who really need drugs?
So, the argument becomes philosophical. Or paternalistic. Is the purpose to change behavior or impact the market for certain securities?
Eventually some boards could not justify the continuing structural underperformance and decided against using “sin free” funds.
Today I have seen the same funds renamed and rebranded as ESG funds. The “sin free” restrictions remain in place. Additional guidelines have been added in the prospectus regarding investing in ESG companies, but the funds are further restricted by the number of companies who are ESG compliant. In other words, a smaller universe to choose from.
I have seen this information digging through the current prospectuses of funds I am familiar with.
The question you should ask yourself is: Am I willing to give up investment returns to align my investments with my values?
There is an excellent article on The Motley Fool website about ESG investing, published by Alyce Lomax and John Rotonti on September 18th, 2019.
I highly recommend reading this article.
What Is ESG Investing? | The Motley Fool
www.fool.com › investing › what-is-esg-investing
The article has detailed information about the differences between socially responsible investing and environmental, social and corporate governance investing.
If you still feel compelled to follow the ESG path, consider this alternative:
Invest to get the highest return possible, without restrictions, then donate some of your returns to charities that represent your values.
If you are investing in an SRI or ESG fund, make sure that the exclusion of different sectors or the inclusion of specific companies is what you are looking for.
More about how to use investments to match your values in my next investment article on Donor Advised Funds.
Language from the prospectus of a “sin free” fund.
[1] “The Fund will not invest in the securities of any issuer determined by (the investment manager) to be engaged principally in the manufacture of alcoholic beverages, tobacco products or military equipment, the operation of gambling casinos, the production of coal, or in the production or trade of pornographic materials. In addition, the Fund will not invest in the securities of any issuer determined by (the investment manager) to be engaged principally in the provision of healthcare services or the manufacture of pharmaceuticals, unless the issuer derives 100% of its gross revenues from products or services designed to protect and improve the quality of human life, as determined on the basis of information available to (the investment manager). To the extent possible on the basis of information available to (the investment manager), an issuer will be deemed to be principally engaged in an activity if it derives more than 10% of its gross revenues from such activities. In addition, the Fund will not invest directly in securities of issuers that are engaged in certain business activities in or with the Republic of the Sudan.
The Fund may invest in securities of issuers whose ESG practices are currently suboptimal, with the expectation that these practices may improve over time either as a result of (the investment managers) engagement efforts or through the company’s own initiatives. It may also exclude those issuers that are not receptive to (the investment managers) engagement efforts, as determined in (the investment managers) sole discretion.”
This website is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation for any security, nor does it constitute an offer to provide investment advisory or other services by The Modest Economist LLC.
