SRI and ESG Simplified

For some odd reason it occurred to me the other day that the movements in the title of this post have spanned a significant portion of my life and most of my career in the financial services business as a Registered Investment Advisor. 

The common acronym for socially responsible investing is SRI and the concept has been around for awhile.  SRI utilizes a screening process that excludes investments in industries or specific companies engaged in business or activities that an individual may consider undesirable.  Varying by individual investor, SRI popularly excluded companies engaged in the manufacturing or sale of alcohol, tobacco, firearms, gambling and the like.  

The movement has its roots in faith-based investing and the anti war movement during the Vietnam conflict.  In 1971 it led to the first ethical mutual fund - Pax Fund (renamed Impax Funds in 2022).  By the time I joined the fray in 1980 popular divestment campaigns in opposition to South African apartheid raised the profile of SRI and its potential for drawing attention to social change.  The movement achieved broader recognition with the adoption of the Domini Social Index in 1990 - recognizing the US Social Investment Forum and the growth of assets in this sector.

In 2004 the acronym ESG was coined. Named for a new emerging movement known as Environmental, Social and Governance; it introduced specific environmental, social and governance factors into traditional financial analysis to better assess a company's risks, opportunities and long term sustainability.  Financial considerations have continued to remain the primary focus of ESG.  In its nascent years ESG was a niche or boutique movement - a small frog in an enormous investment pond.  Notably, SRI didn't go away; as a matter of fact it persists to this day.   

By 2010, driven by global climate crises and events along with growing corporate support driven by evidence that sustainability improved returns; ESG entered the mainstream. 

ESG initiatives have boosted profitability by means of reducing waste and improving operating efficiencies.  They also enhance brand imaging which improves market position and attracts customers and talent. Stock prices benefit from enhanced stability as a consequence of managing risks associated with everything from labor issues, to brand loyalty to long term climate-smart resourcefulness.

For sure there are mixed results among specific industry sectors including emerging vs. mature markets; and there is not universal success in every single company. Nevertheless, there is strong evidence that ESG may provide a strategic advantage leading to long-term value creation over short-term gains.

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While the terms SRI and ESG are frequently used interchangeably there are nuanced differences.  SRI is values-driven (who you won't invest-in); while ESG is data-driven (evaluation of risks and opportunities).  

Why is this important?  When evaluating the application of the former vs. the latter in the drafting of an investment policy consider a very common misconception about the ownership of common stock.  Aside from an IPO (initial public offering) your purchase of a stock does not 'support' the company.  Nor does your divestment of a stock 'undermine' the company.  This is because it is not a transaction between you and the company; it is a transaction between you and the previous stock owner.

If you don't care to own shares of an armaments manufacturer because it is cross-ways with your value system that is perfectly OK.  The company will pay dividends to whomever owns the shares on the record date and it cares little for who that is unless you are amassing so much stock that you are approaching majority ownership. This is why companies are generally mum in response to divestment campaigns.  They're a welcome distraction from other, more potent, forms of activism such as a product boycotts.  A scenario altogether better managed by means of the latter vs. the former. 

Don't take my work for it, speak with your trusted financial advisor about how this may, or may not, impact you.

Cheers!  

*More background on the chart here:  https://www.bloomberg.com/professional/insights/sustainable-finance/are-esg-scores-relevant-for-portfolio-returns/