Private Vista & Socially Conscious Investing

By Private Vista on September 4, 2019

The Vocabulary of Socially Conscious Investing

By Joe Feldmann, CPA, CFP®


The socially conscious investing movement we see today seems to have evolved as a response to the nature of the corporate entity to operate in its own self-interest, with a time frame that is generally short.  This short time frame is generally in step with quarterly earnings periods that can dramatically affect the stock price of the corporation.  Socially conscious investing has been around for a long time, but had not really taken off until recently.   The younger generation of investors as well as some baby boomers seem to have dropped the old “greed is good” mentality and instead are trying to make a positive change in the world.

Along with this change in attitude, new approaches are being tried, and old ones are being dusted off.  The earliest approaches were “Socially Responsible Investing (SRI)” and “Impact” investing, as they were easiest to implement.   ESG (Environmental, Social and Governance) investing is more recent. The definition of the word “Sustainability” (defined below) has evolved to describe an objective that really was not widely understood or embraced, until “global warming” became a more well-known issue.

This new attitude toward socially conscious investing has also brought about an increase in the number of investment products.  The increased number of products provide investors with a wide breadth of tools that were never available before.  It is now possible to construct a complete portfolio with these products.

To understand this socially conscious movement, investors and their advisors first need to learn the meanings of the new terminology and their abbreviations.  Luckily, they are easy to define and understand if kept simple.


The following are simple definitions of the basic terminology used by those in the socially conscious investing movement:


SRI (Socially Responsible Investing) is exclusionary investing.  For example, companies involved with certain products, such as guns or alcohol, may be excluded from a portfolio.


Impact investing is inclusionary investing.  For example, companies involved with wind farming or clean water may be intentionally purchased.


ESG (Environmental, Social and Governance) investing is not solely exclusionary or inclusionary.  It attempts to engage with management to improve corporate behavior with regard to favored Environmental, Social or Governance issues.  It is a form of shareholder activism.

For example, a large shareholder may engage with management to try to inhibit a company from spilling waste into a nearby river.  Or it may engage with management with regard to the compensation of executives or gender representation on the board of directors.  Often it involves proxy voting towards certain favored issues.

ESG is aligned with the motivations of active money managers, as negative issues have long been considered “risky” by analysts and portfolio managers, while the resolution of these issues is perceived as removing some level of investment risk.  Many active money managers have said that they have considered ESG issues within their stock-picking process for decades.  These practices have only recently been defined as “ESG”.   Engaging with management is what most differentiates ESG from the strategies of SRI and Impact, which are mostly stock screening processes.  However, some investment managers use ESG factors only for screening purposes, and do not attempt to engage with management.


Sustainability is more of a concept than a specific way of managing a portfolio.  In general, it refers to meeting current needs without compromising the needs of future generations.  More specifically, it also refers to the avoidance of the depletion of natural resources in order to maintain an ecological balance.  For example, climate change may be thought of as a Sustainability issue.  Sustainability issues may be imbedded within SRI, Impact and ESG investing approaches.



Now that the key terminology has been defined, the effectiveness of these approaches can be debated.  The following discussion represents the writer’s views on the subject matter, and not necessarily the views of every advisor at Private Vista, LLC, and it also does not represent any policy of Private Vista LLC.  This discussion does not represent an endorsement of any specific investment product or strategy.

A natural question comes to mind, which is “Can I be a socially conscious investor without sacrificing return?”  Unfortunately, there is not a perfect answer to this question which will satisfy everybody.  Certainly, there are studies that “prove” socially conscious investing improves returns.  There are also studies that “prove” it impairs returns.  A lot depends on the time frames and the methodology.  It is important to consider if a particular study is being sponsored by a financially interested party.

Earlier back in time, in the 1980’s and early 1990’s, it was considered common knowledge within the financial community that socially conscious investing harms investor returns.  A lot of that view was due to the outperformance of certain so-called “sin” stocks, such as Phillip Morris, at the time.  Recent studies covering more recent time periods seem to indicate a benefit to socially conscious investing.

However, there are some things that can be said to be certainly true.  Impact (inclusionary) investing is generally not a diversified approach suitable for an entire portfolio.  SRI (exclusionary) investing can cause wider dispersion of returns from the market as a whole, due to its exclusion of certain stocks or sectors.  ESG (engaging with management) investing should be able to reduce some of the investment risks due to ESG factors.  Further discussion of each of these three approaches are as follows:

SRI (exclusionary)

The exclusion or underweighting of certain stock or bond investments based on SRI will affect performance and reduce investor diversification.  Relative performance may tend to lag if the excluded investments outperform the applicable benchmark indices, as was the case with Phillip Morris in the distant past.  Conversely, if the excluded stocks underperform the market indices, the SRI strategy may tend to outperform.  It is not possible to know with certainty whether excluded investments will outperform or underperform in the future, regardless of the outcome of various studies and research trying to answer that question.

A SRI portfolio approach can produce a nicely diversified portfolio, or one that is not diversified enough.  If entire sectors, such as the energy sector, are excluded, diversification is clearly reduced.  On the other hand, excluding controversial investments or investments with negative issues could have the positive effect of reducing some individual security risk within a portfolio.

It has been argued that excluding a company’s bonds or stocks from a portfolio can increase the capital cost to the company by reducing demand for the company’s securities.  This can hurt the company’s competitive position, or cause it to raise prices, possibly reducing consumer bad behavior.     However, it is also true that a decline in the price of those securities can attract value investors who are not constrained from holding those securities.  In those cases, the securities may simply change hands and may eventually return to their equilibrium price.  The company management may not even be aware that certain investors are avoiding their securities, or why.

Historically, Socially Responsible Investing (exclusionary) alone has not been enough to successfully eradicate certain behaviors or products from society.  We still have guns and alcohol and cigarettes, despite decades of SRI investing.

But it is certainly true that investors who wish to underweight or exclude certain issues from their portfolio may feel better about their portfolio due to the underweighting of those individual securities.

Impact (inclusionary)

Impact investing has the potential to increase risk by decreasing diversification.  If the result is a portfolio that eliminates or greatly reduces an allocation to an entire sector or sectors, diversification is clearly reduced.   Sector weightings could also potentially become so misaligned that performance risk becomes a factor (the portfolio could substantially underperform its peers or the market as a whole).

There may also be a tendency for some SRI and Impact strategies to have more focused portfolios (holding fewer stocks than other less constrained portfolios).  It is easier for a portfolio manager to closely follow the internal practices of a smaller number of companies than to closely follow the internal practices of a larger number of companies.  To the extent this is the case, more single stock risk may be inherent in these portfolios.

Good themes do not always make for good investments.  For example, solar power is great for society and it is great that people invest in those companies, but it does not necessarily mean those companies will make money for their investors.  Companies that depend on government subsidies, in particular, add additional political risk to portfolios.  However, things change and technology improves over time, costs come down, and companies that may not be doing well now may perform extremely well in the future.

Investors that overweight certain bonds and stocks through Impact investing may be reducing the cost of capital for those businesses, helping them survive.  To the extent that those businesses provide an outsized positive impact to society, that is a good thing.

It is true that Impact investors who wish to overweight certain issues in their portfolio probably feel better about their portfolio due to the overweighting of those individual securities, and even more so if those positions happen to outperform.

ESG (engaging with management)

Investors that truly want to make a difference, who want to leave the world in better shape due to their own existence, can actually do so through ESG investing.  Anecdotal evidence suggests that that ESG investing does make a difference by influencing corporate behavior, particularly when investment managers, analysts and large investors engage with company management on ESG issues.

Corporate upper management will listen to the views of major shareholders who can vote them out of their boardroom.  An individual mutual fund or mutual fund family does have the ear of upper management.  Analysts and portfolio managers do meet with upper management regularly.  The ones that incorporate ESG into their analysis do bring up these issues regularly at those meetings. If executives continually hear of the same ESG issues from many analysts and portfolio managers, it is possible that their behavior can be nudged in the desired direction.

From the viewpoint of the investor, ESG investing does not necessarily disrupt the investor’s portfolio.  A nicely diversified portfolio can be achieved because securities are not necessarily avoided.  Sometimes it is important that the portfolio actually holds the questionable security so that analysts and portfolio managers can raise the ESG issues to management.  Management is more likely to listen to investors that are shareholders, rather than investors that are not shareholders, as is the case with SRI.

ESG Investing might help reduce individual security risk for the investor.  It does this by reducing controversial issues that can cause stock volatility if not addressed.  The removal of risk issues can also improve a stock or bond’s short-term performance by triggering a revaluation of that security.   So there is a case to be made that ESG investing can possibly improve performance and reduce risk.


The New Opportunity

Socially conscious investing practices began decades ago, starting with SRI and Impact investing.  Those investing practices may have had some effects over time.  Unfortunately, those practices also can potentially have negative effects with regards to an investor’s portfolio diversification.

Today’s ESG investing is an advance in socially conscious investing that holds the promise of generating real change without too much sacrifice in portfolio construction.

In the past, investors that wanted to implement SRI, Impact and/or ESG practices into their portfolio added perhaps one or two funds to their portfolio, or were forced to utilize separate account management.  There was not really enough breadth of products to construct a complete portfolio.

Today, new attitudes of investors have caused a proliferation in the number of investment products now available that utilize ESG, Impact and/or SRI investing.  Entire portfolios can now be created that utilize a combination of those investing practices.  By combining ESG strategies with SRI and Impact strategies, investors can now build a more diversified portfolio, than through SRI or Impact strategies alone.

Not too long ago, ESG investors did not command much attention from the upper management of companies because they were fewer in number. Today’s increased investor interest and the growing amount of assets within these strategies forces more attention.  As a result, it is possible that socially conscious investing may be more effective going forward than it has been in the past.  In fact, there may have never been a better time than there is now, to build a diversified socially conscious portfolio and also achieve real societal change.


Questions about Socially Conscious Investing? Contact Private Vista today!



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