Welcome to my first column for The Daily Fray on socially responsible investing. So that we all are on the same page, let us start by defining what we will be talking about as we go forward.

Socially responsible investing, or SRI, is an investment philosophy that has gained acceptance as a way of targeting investment dollars that focus on companies with stated dedication to what has now become environmental, social, and governance, or ESG, investment and accounting practices.

In many ways, ESG investing is an outgrowth of SRI, which eschews any investment believed to have a net negative impact on humanity. A simplified example is an abstention from investments oriented toward the sale of alcohol, tobacco, or firearms.

ESG takes SRI one step further as it considers the impact on both the environment and society as well as the governance of the company. ESG investing utilizes strategies focused on a disciplined evaluation of one or more of those three major considerations:

These considerations would include environmental themes, such as responding to consumer demand for sustainable practices; social themes, such as investing in companies committed to a diverse and inclusive workplace; and/or governance themes that are committed to diverse board composition, strong oversight, and shareholder friendly policies.

ESG appears to have reached a critical mass among investors. Large brokerages have ESG-only mutual funds aimed at matching the more socially minded investor with firms that meet their mindset.

Viewed as voting with dollars, ESG-oriented investors are trying to better the world by prompting companies to adopt ESG-positive policies so as to attract those investment dollars.

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"The Department of Labor has issued a clear shot 
across the bow of ESG-minded fiduciaries."

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Unfortunately, not everyone views the world with an ESG outlook. The U.S Department of Labor released a new regulation in late October 2020 that may limit or eliminate socially responsible investing in retirement plans.

While the rule was revised to remove explicit references to environmental, social, and governance (ESG) factors, it mandates that fiduciaries of retirement plans choose investment strategies based entirely on how those strategies affect financial performance.

How could this rule impact ESG investing?

Consider that 54% of the $5.6 trillion invested in ESG funds would potentially be forced to reallocate to non-ESG funds. This would benefit energy names and hurt technology stocks that are often ESG favorites. 

The Department of Labor has issued a clear shot across the bow of ESG-minded fiduciaries. They can invest with that mindset themselves, but when managing the assets of others, they must put aside their environmental views.

To point out the importance and popularity of SRI and ESG investing, just shy of $44.3 billion was directed towards SRI- and ESG-focused mutual funds and ETFs during the fourth quarter of 2020, bringing the 2020 net inflows total to $94.1 billion.

Utilizing a social and ethical conscience is comparatively new to Wall Street. Broadly defined, a company's profit potential would now be analyzed alongside the social impact and ethical implications of their products and business operations. 

While earning a return on capital is arguably the primary objective of capital investment, there are two critical, inherent goals of socially responsible investing: social impact and financial gain.

And there could be a conflict between the two.

An investment that advertises itself as socially responsible does not always translate to a good return. And the promise of a good return is far from an assurance that the nature of the company involved is socially conscious.

Socially responsible investing has become a more politically polarizing topic because of climate change – a cause that is viewed quite separately by different political factions.

Socially responsible investments tend to mimic the political and social climate of the time. That is an important risk for investors to understand because, if an investment is based on a social value, then the investment may suffer if that social value falls out of favor among investors. 

For this reason, socially responsible investing is viewed through the lens of ESG. This approach focuses on the company's management practices and whether they tend towards sustainability and community improvement.

There is evidence that placing a spotlight on this approach can improve returns, whereas there is no evidence of investment success when encompassing social values alone.

There has been an increasing awareness regarding global warming and climate change. As a result, SRI has trended toward companies that positively impact the environment through reduced emissions and investment in sustainable or clean energy sources.

» Lauren Rudd is managing director at Rudd International of Raymond James-Sarasota. You can write to Lauren.Rudd@RuddInternational.com or call 941-706-3449. "Green Wise" will appear monthly in The Daily Fray. His "StreetWise" column appears regularly in the Sarasota Herald-Tribune, a USA Today Network newspaper. For his back columns, go to RuddInternational.com.

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