Considerations for Socially Responsible Investing

— 8 min read

As consumers, we are aware of how we can be making socially responsible choices, whether that be through buying organic items, or leaving a smaller carbon footprint.

Through a superannuation fund or investment portfolio, one can also make a social impact by choosing a socially responsible fund that invests money aligned with your values.

What Funds are available?

Assuming you don’t have time to research the internal policies and financial statements of companies, a managed fund will choose a selection of companies based on certain criteria. Socially responsible funds use two primary techniques for selecting equities. They can either begin with a pool of investments and filter out certain industries altogether, say tobacco and alcohol for example. Or they can look to focus investments in companies on how they manage their environmental, social and governance (ESG) risks.

What is Environmental, Social and Governance (ESG) and why is it important?

Companies can be ranked based on their ESG factors.  An environmental metric might track clean technologies and water and waste management.  The upside for investors is that these companies minimise environmental liabilities, increase efficiency, and reduce regulatory, litigation and reputation risk.

Social measurements capture human rights, labour management relations, and health and safety records.  The positive outcome is that productivity, morale and brand loyalty increase. Governance data is analysed for how companies are run, capturing diversity, corporate risk management, board accountability, shareholder rights and information disclosure. Strong figures for governance indicate that shareholders and management are aligned which reduces financial surprises.

Risks and considerations

Ultimately investing is about growing your wealth to help you reach your goals. One accepts a certain degree of calculated risk in hopes of earning a return.

Historically there have been concerns that companies seeking to do the right thing may not maximise returns. However, research has shown that companies that have long term goals in mind perform better.  For example, companies focusing on low carbon technology will most likely be more competitive in the future and companies that treat employees fairly have less turnover which in turn leads to more consistent cashflow.

There is still the risk that strong performers are missed when companies such as Amazon or Apple  are either reduced or excluded from an ESG fund due to their business practices. For example Amazon has been reduced or excluded from certain funds for labour-management practices while Apple’s ESG score has dropped because of labour-management and supply chain issues.

Funds that have high investment fees will erode the benefit of investment returns. This rule also applies to socially responsible investing. A fund with a highly specific mandate will require more research and management, boosting costs. Also, if a fund is too specialised there could be a smaller base of investors, making it more expensive to run, as well as less liquid.

Diversification is key to reducing risk in a portfolio. A concentrated fund may provide insufficient diversification.

Selecting a Fund

The rules for selecting a socially responsible fund are based on choosing any investment.

Always start with considering your goals and objectives when you are investing, e.g., buying a home, building long-term wealth, saving for education fees. Consider your time horizon and your risk appetite. Then narrow your selection of funds available to  the asset allocation you are seeking to capture.

The fund you choose should match your personal circumstances by understanding the investment criteria for the fund, how it complements your overall portfolio and the mandate-specific risks.  Alternatively, speak with a financial adviser about appropriate funds to include in your portfolio.

 

Disclaimer: * The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.

Authors

Tao Hsu

Consultant
Melbourne

Tao has completed her Advanced Diploma in Financial Planning and is currently pursuing her CFP qualifications. Tao commenced her career in research and strategy for multinational companies, and adopts this rigour and experience when developing strategies for individuals seeking financial independence and security. Tao is passionate about empowering her clients to make informed financial decisions and working with them to develop strategic long-term wealth management plans.