Socially responsible investing (SRI) is a broad financial movement that incorporates a range of rationales and techniques. For those of you without a degree in economics, this post will start with a little background on what investing in a company really means.
For a public company [i], the stock price should be equal to the current value of the company, plus potential future profits, divided by the number of investors [ii]. Future earnings are, unfortunately for investors, reciprocally related to how much capital a company is able to raise, which is of course related to its stock price. Buying stock in a company not only indicates a vote of confidence in the company’s future earnings, but also directly impacts the company’s ability to raise capital and grow.
Socially Responsible Investing was originally focused on negative screens, particularly those related to investment in conflicts like the Vietnam war, or regions with human rights violations like South Africa under apartheid. Over time other negative screens became common, including those against companies involved in tobacco, gambling, weapons, or alcohol. Negative screens are the investment equivalent to consumer boycotts, where companies are punished for a perceived wrongdoing by investors withholding investment. Pension funds were some of the first investors to actively seek out investment in companies that were deemed to be doing “good” activities like producing environmentally responsible products, supporting community development, or providing above-standard working conditions for employees [iii]. Asset management firms followed suit and there are now over 200 SRI mutual funds available on the market [iv], plus a variety of other SRI mechanisms [v].
SRI funds have been painted as an altruistic investment for people who care more about morals than about financial return. There is, however, significant evidence that socially responsible companies provide tangible financial benefits over their business-as-usual counterparts, either through increased returns or decreased volatility [vi], [vii], [viii]. While the initial motivation was indeed a moral one, investing with an SRI fund is very different from donating to charity. SRI investments represent a 2.7 trillion dollar market in the US today (about 11% of all assets under management) [ix] and some level of corporate responsibility is an accepted necessity of doing business as a public company [x].
There are several reasons why socially responsible companies, and environmentally responsible ones in particular, are likely to provide the better than peer long-term returns found in SRI research. Social responsibility can be seen as both an asset in-and-of itself, and as an indicator of how the company is managed overall. The market for green products and services is increasing and in some cases is re-enforced by legal mandates, such as minimum fuel efficiency standards for cars or energy efficiency labeling requirements for appliances [xi]. Several studies have also shown that people are willing to pay a premium for goods and services that were produced responsibly [xii].
Another major reason why socially responsible companies are likely to produce good long-term results is their limited exposure to accidents (like the recent BP spill), lawsuits (like the type frequently brought by EDF and NRDC), labor disputes, and other more subtle shocks.
About this time, you might be asking yourself “this website is about energy, right?” When a company would like to become more socially responsible (or if you as an investor or consumer would like to evaluate a company’s social responsibility), energy use is one of the most logical places to start. A company with a low energy intensity compared to others in the same industry is not only reducing its environmental impact, but also reducing its costs. As discussed in our energy efficiency section, energy efficiency projects can be some of the best investments a company can make from a strictly fiscal perspective. Low energy use in comparison to peer companies provides both a direct measure of corporate efficiency, as well as a strong signal corporate management has investigated other inefficiencies as well. Management teams that have undertaken a full carbon footprint analysis generally have insight into a much wider range of their activities, including transportation, purchasing decisions, and waste management than their peer organizations. Evaluating exposure to climate risks, such as how a supply chain will be impacted by higher sea level or what a carbon tax might do to the bottom line provides companies with an extra level of preparedness. Lowering and diversifying energy use by using efficiency and onsite renewable generation also insulates a company from unexpected spikes in fuel and electricity prices.
Decades of experience by SRI fund managers has shown that, if done well, good environmental performance is good for corporate performance. When applying SRI principles to your company, it is important to think of using environmental and social performance as a tool rather than a Band-Aid. Donating to a deforestation prevention fund may be a good thing to do, but it will not help you run a better business. Alternatively, using a carbon footprint analysis to root out inefficiencies in your own operations can decrease costs and help your company manage risk better while also signaling to customers and investors you provide a sustainable product and a sustainable profit.
[i] This post will focus on public companies for simplicity, but socially responsible investing could be related to seed funding, securitized bonds, venture capital, micro-lending, or any number of other investment options.
[ii] This is based on the Efficient Market Hypothesis, which expects market participants to behave rationally. While this is not always true, it is a pretty good approximation where there is a developed market and sufficient liquidity.
[iii] For a more complete discussion, see Socially Responsible Investing, An Evolving Concept in a Changing World KLD Research & Analytics, 2009. http://www.kld.com/resources/papers/SRIEvolving070109.pdf
[iv] For a list, please see Social Investment Forum http://www.socialinvest.org/resources/mfpc/
[v] A third method of SRI, which will not be discussed in detail here, is shareholder activism where investors use their proxy votes as shareholders to demand better responsibility practices.
[vi] Statman, Meir and Glushkov, Denys. The Wages of Social Responsibility 11/25/08. http://www.scu.edu/business/finance/research/upload/Wages-112508.pdf
[vii] Leonardo Becchetti and Rocco Ciciretti, “Corporate Responsibility and Stock Market Performance,” Centre for International Studies on Economic Growth Research Paper Series, Working Paper No 79, March 2006. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=897499
[viii] Statman, Meir and Glushkov, Denys. The Wages of Social Responsibility 11/25/08. http://www.scu.edu/business/finance/research/upload/Wages-112508.pdf
[ix] Socially Responsible Investment Facts, Social Investment Forum http://www.socialinvest.org/resources/sriguide/srifacts.cfm
[x] Just Good Business. The Economist 1/17/08
[xi] For example, see the recent NY Times article Banks Grow Weary of Environmental Risks 8/30/10 http://www.nytimes.com/2010/08/31/business/energy-environment/31coal.html?ref=business
[xii] For one example, see the GfK Roper Yale Survey on Environmental Issus, Summer 2008: Consumer Attitudes Toward Environmentally-Friendly Products and Eco-labeling http://environment.research.yale.edu/documents/downloads/a-g/GfK-Roper-Yale-Survey.pdf