Origins of SRI
Let’s start by considering SRI’s roots: socially responsible investment (SRI) is a descendant of consumer activism. Both responsible consumption and responsible investment appeal to consumers as actors in changing companies’ behavior; both use this appeal to shift demand such that companies are economically motivated to change behavior; and both movements use a combination of proscriptive (e.g. boycotts, exclusionary portfolios) and prescriptive (e.g. buying organic or fair trade, investing in “best in class” companies) approaches. Both cover a wide variety of social and environmental causes, some of which directly benefit the consumer and others of which appeal to altruism; and not all participants in the movements share the same opinions as relate to this slate causes. Both responsible consumption and responsible investment involve trade offs, not just between individual causes but also between causes and functionality: sometimes shoe style trumps concerns for labor, other times concerns for labor trumps concerns for the environment. These are complex decisions. [See The Myth of the Ethical Consumer (2010) for more on this theme.]
But the method of making these complex decisions differs significantly between consumption and investment. With consumption, individual consumers make decisions with relatively little foresight, no accountability for decisions once made (except occasional social pressure), and in a context which varies considerably by product and purchase environment. On the other hand, investment decisions are made by professionals who must be able to defend both their process and their results to the individual and organizational investors in their funds. These professionals also represent a more concentrated market than consumers. The professionals may or may not derive non-monetary benefits from the investment transaction.
Getting to the point
The point of a consumer activist campaign is more or less clear: make company X stop (or start) doing something, after which the campaign is over. What is the point of SRI? I see several options:
- Motivate better behavior by companies
- Clear one’s conscience by not being “part of the problem”
- Profit (or reduce losses) if and when externalities are internalized by companies
Motivating better corporate behavior
The first option comprises some practices that may on first glance confuse socially concerned investors: to motivate companies to improve, one may include a limited set of poor performing companies in the portfolio (to allow engagement with management) and maintain a relatively lower bar generally (to make inclusion an attainable goal for companies on the margin). So an oil company is fine (a) if it’s one of the better oil companies, for instance, having a better safety record, investing in renewable energy, and having robust protocols for environmental protection or (b) if it’s horrible and the manager thinks he can convince it to improve. A big box retailer is fine if it is one of the better retailers in terms of, say, providing employee benefits, selling organic and fair trade products, and (not) demanding tax breaks; or if it isn’t (but could be).
How the class for this “best in class” approach is defined can get sticky — e.g. is a Chinese company compared against other Chinese companies or against all companies in its industry? — and weights must be decided between the various social and environmental issues, but generally this is a straightforward approach to building an SRI portfolio. [There are a number of ways that a portfolio manager could implement a best-in-class approach, which we’ll make the topic of another post. We’ll also have a separate post to talk about how civil regulation in general could be more effective. And I should note that a portfolio of nothing but poor performers with an intention to engage and improve them could be a perfectly valid response to this first goal.]
Clearing consciences
Pursuing a goal of a clear conscience is actually — somewhat surprisingly — much harder. Most large companies have some skeletons in their closets. How does the investment screening process handle, say, a discrimination class-action suit that was filed 10 years ago but remains ongoing and undecided? Or a chemical plant accident, after which the company has completely revamped its safety procedures (or not)? Or an NGO campaign against a company with a “responsible” brand or an HQ in the EU, due to the leverage that gives the NGO, even if the company isn’t necessarily the worst in its industry? Are entire industries, such as oil, excluded, and if so does it matter that all the other companies in the portfolio are responsible for creating demand for oil? I suspect that this conundrum is part of the reason that the vast majority of “social investment” in the US is social only in that the portfolios exclude investment in tobacco companies. [See reports from the Social Investment Forum for the figures.]
An alternative to SRI for this purpose (or, depending on how you look at it, a subset of SRI) would be impact investing — actively screening in companies who are making positive social contributions, such as good job creation, or solving environmental and social problems with their products.
Profiting on foresight
A more values-agnostic approach gives rise to a third, more focused style of SRI (if we can still call it SRI). Potential financial impacts of a limited number of environmental and social issues can be estimated as the basis for reducing risk in investment portfolios. Investors can (to some extent) anticipate the costs of climate change (both complying with regulation and adapting to changing weather), regulation of toxic chemicals, etc., as well as revenue boosts from sales of organic or clean tech products, and include adjustments for these factors into their financial models. This is the world of “doing well by doing good.” [A troublesome slogan that’ll be the subject of another post.] But as Robert Reich points out, if there’s an economic benefit, then it’s not social responsibility we’re talking about. Which is fine, particularly if and when these focused portfolios meet goals of clear conscience and motivating better company behavior besides. [Though keep in mind that a values-agnostic portfolio could also invest in a company that isn’t the best in terms of greenhouse gas emissions or liability for pollution, but the portfolio manager thinks the market has overreacted to news of the company’s liabilities.]
But let’s not sell this approach short: far too many large financial companies don’t know how their portfolio of bonds and other assets will be affected under climate change, or even simple things like earthquakes in California or along the New Madrid fault. These events could strike financial companies doubly, both in investment losses and in losses to mortgage and insurance portfolios. All investors should pay attention to environmental and social risks, for reasons completely separate from social responsibility.
Checking the foundation
Assuming you’re reading this because you do care about social responsibility, however, consider the starting (and startling) point of both responsible consumption and responsible investment: the assumption that we will consume or invest. If I don’t buy fast food, then I can’t expect McDonald’s to really care what I think as a consumer. If I don’t invest in large, publicly traded corporations, then I will have to figure out another way to sway their managers than SRI (e.g. be an active citizen?). So for these tactics to be successful, their adherents must consume and hold out the carrot of consuming more. This assumption definitely holds in the aggregate — a helluva lot of people consume and invest. And there are a number of institutions that consume and invest on our behalves (e.g. school cafeterias, the person that buys office supplies, my bank and insurance company and 401(k) manager).
But still. Consumption is assumed — and required, as far as these “socially responsible” tactics are concerned. And yet, NOT consuming (or consuming less) would be the single most effective thing we could do, at least for biodiversity and climate change and pollution and competition over limited resources. The most socially responsible investment portfolio, then, would perhaps be one that invests in companies who commit to not pursue revenue growth beyond population growth. [There are, of course, those who have been long arguing that financial interest is inherently destructive to society.] Of course, there are ways to increase revenue without additional environmental impacts. And reducing consumption always runs into the criticism that it destroys jobs (and we’d have to figure out another way to fund retirements), but that’s a question for another post.
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