There's a smart way and a not-so-smart way to try and make the world a better place with your investments.
Because of one of the sandboxes I play in (younger professionals looking to grow their wealth), I expect to encounter frequent questions about socially responsible investing (SRI).
This is the concept whereby an investor screens out a number of companies from his/her portfolio based on personal (usually ethical) opposition to some of the business practices of that company. Favorites for this type of treatment are fossil fuel companies, big pharmaceutical firms, cosmetics companies, casinos, weapons manufacturers and alcohol or tobacco producers. But it can be anything.
Interestingly, I must say anecdotally that I have encountered a lot less of this than I initially expected to from this demographic, but there are clearly still many people who would like to at least explore the means of implementing a SRI strategy.
Wall Street, never one to miss a trick when it comes to manufacturing a product that it can sell to a particular demographic, has created SRI funds which it dangles in front of investors, promising no ownership of, say, gun manufacturers within the holdings of the fund.
Some funds also add what they call a "positive screen", so not just keeping the “bad” companies out of the portfolio, but overweighting companies that they consider to be “good” from a SRI standpoint.
Some funds are available that take out whole sectors from an investment. An example of this may be a fund that invests in the whole market, except for all the companies in the financial services sector.
There are three main problems with these funds.
They are very expensive. Someone, somewhere has to take the time and make the effort to conduct the initial pre-screen for these funds and then monitor them to ensure that they do what it says on the label. Guess who pays for that? That’s right, the investor who buys the fund.
Annual expense ratios for SRI funds can be many hundreds of percent more expensive than broad, unfiltered index funds. For example, the Calvert World Values International Equity C fund (CWVCX) carries an annual expense ratio of 2.15%. This compares to the Schwab Broad Market ETF (SCHB) which costs 0.03% per year. This SRI fund costs you over 70 times as much to own as the broad market fund, every single year. Do the compounding math on that one and you will see what enormous damage you can cause to your wealth by owning such an investment.
They can often underperform, sometimes very significantly. Right away, by paying the exorbitantly more expensive fees associated with these SRI funds, your odds of underperforming the broad market shoot right up (probably to the 95-99% range over longer periods of time in the case of funds that charge more than 2%, like the example above). But it can get worse. Depending what you are screening out of (and into) your portfolio, the returns on these funds can lag the broad market, even before the ridiculously higher fees are taken into account.
An example may be in the fossil fuels corner of a portfolio where a SRI strategy might lead the investor to not own firms like Exxon, Chevron or Royal Dutch Shell. If/when the oil price recovers or economic policy moves in a way that would benefit these companies, this investor will miss out on all the growth and dividends that that generates.
Of course, it can be argued that it works the other way, too, that investors in such a fund may have been shielded from the recent fall in the price of oil, but that is attributing a selective investment strategy of market timing (proven not to work in the long run, by the way) to what was actually an ethical decision that had nothing to do with an anticipation of the gyrations of the commodity markets.
The investor is taking a higher degree of concentration risk in the portfolio as it becomes less diversified, not just because of the exclusion of a number of stocks, but sometimes virtually or completely an entire sector.
The fund provider decides what is “bad”, not you. The criteria for what exactly constitutes SRI is intensely personal. SRI funds come “pre-packaged”, in other words, you do not get to choose exactly what is excluded or over-weighted in the holdings of these funds. They come with sweeping, broad names like “World Values” and “New Vision” and may well be excluding or including the stock of companies that do not conform to your perception of what should be included or excluded. Maybe they are excluding retailers whose stores sell tobacco products, yet including pharmaceutical firms that conduct animal experiments. Maybe they are excluding firms that produce weapons, but including firms that buy those weapons.
The point is that it is virtually impossible to find a fund that conforms exactly to your vision of precisely what should or should not be excluded or included in a portfolio.
And there’s another very important thing to understand when it comes to SRI, that arises from a misconception of what buying a stock actually means. By making the decision to buy or not buy a company’s stock, you are having zero effect on the company’s worth. In other words, if your goal is to “send a message” to a firm by not buying their stock, it is a message that will never be heard. Equally, if you do buy their stock, you are not giving the firm anything.
Here’s what I mean ..
If you buy 100 shares of, for example, Exxon Mobil (XOM) at, say, $85.00 per share, you are not giving Exxon $8500 when you pay for those shares. Exxon is not $8500 better off as a result of you doing that. This is what is very often misunderstood.
Those shares currently belong to someone else. You are not buying them from Exxon, you are buying them from another investor. You are giving your $8500 to that other investor, not to Exxon. All that happens when you buy them is that the record of ownership of 100 shares is electronically transferred from the previous owner to you. Exxon does not benefit from the transaction in any way. All that has happened as far as they are concerned is that the record of the list of their shareholders has been ever so slightly and temporarily amended, as it is millions of times every single trading day as their shares change hands.
Equally, the action by which you do not buy the shares has no effect on Exxon at all either. Someone (an individual, an investment bank, a day trader etc.) already owns those shares. Exxon doesn’t. The company couldn’t care less who owns the shares, you or someone else. By you simply choosing to not buy them from that current owner, you are not sending any kind of message to the board and you are not negatively impacting Exxon’s bottom line in any way.
The company has no idea that you chose not to buy their shares and will feel no pressure to change any of its practices as the result of an action (or inaction) that it does not even know about. That current owner of the shares will simply continue to hold on to them until someone else comes in and buys them from him and a microscopic change is then made to the shareholder roster for a few nano-seconds until the next trade happens.
You are not achieving anything, you are just standing aside and watching others play the game.
USING SRI FUNDS .. AT A MUCH HIGHER COST AND INCREASED RISK TO YOU, YOU HAVE HAD ZERO NEGATIVE IMPACT ON THE FINANCES OF THE TARGET COMPANIES AND ZERO POSITIVE IMPACT ON OPPOSITION TO THOSE POLICIES.
So if you do want to send a message to a company and not go broke by always overpaying for often underperforming SRI funds that don’t even do exactly what you want them to do or to exactly whom you want them to do it, what is a better option?
Here’s a suggestion, taken from a service that Anglia Advisors offers to its clients ..
First, identify an organization that is active and effective in opposing the policies of the exact subset of companies with which you have a problem. These may be large organizations like Greenpeace, UNHCR, Planned Parenthood or the World Wildlife Fund or may be smaller, more micro-issue-focused organizations. The size and nature of the organization is not important, all that matters is that you are convinced that a) it focuses and advocates on precisely the issue you care about and, b) it is effective in doing so.
Next, work with your CERTIFIED FINANCIAL PLANNER™ (CFP®) professional on a diversified exchange traded fund-based asset allocation for your investments that is completely agnostic when it comes to particular company holdings and whose composition is driven exclusively by your personal needs, goals, objectives, risk tolerance and time horizons and is as optimized as possible from both a cost and tax perspective.
At the end of the year, talk to your CFP® professional about which companies you have a problem with. Provide him/her with a list of those companies and ask that they go into your account and calculate exactly to the penny how much, if anything, your investments in these companies have generated to you over the course of that year.
Say for example, you provide your CFP® professional with a list of eight companies whose business practices you object to. The CFP® professional will then go into your account, figure out the total profit (if any) that you made over the course of that year due to ownership of those firms and report back to you with a dollar number of, say, $1,537.28. You are that amount richer because you owned the stock of those eight companies over the course of that year (depending if you still own the shares or sold them during the year, the government may take a slice of that money in capital gains taxes). Meantime, you remain invested in an unfiltered manner.
You then turn around and make a (possibly tax deductible as a charitable donation) contribution of $1,537.28 to the organization that you have identified earlier as the most optimal and effective for opposing to the target companies' practices. After that, you can genuinely say that you have not personally profited at all from your ownership stake in those particular companies.
USING ANGLIA ADVISORS'S SRI OPTION .. AT A MUCH LOWER COST AND DECREASED RISK TO YOU, YOU HAVE HAD ZERO POSITIVE IMPACT ON THE FINANCES OF THE TARGET COMPANIES, BUT A TANGIBLE POSITIVE IMPACT ON OPPOSITION TO THE FIRM'S POLICIES (AND POSSIBLY A TAX DEDUCTION THROWN IN AS WELL!).
Why is this strategy so much more effective than investing in SRI funds?
As explained earlier, you have not benefitted the target company at all by owning their stock over the course of the year, yet you have potentially contributed to actually damaging them by means of your donation.
Your donation, and the calculated amount of it, is specific to exactly which companies you want to target, not to some selection of companies determined by a Wall Street investment committee.
You have not uselessly poured enormous fees into the coffers of a Wall Street SRI fund provider, money that can be otherwise used by you to help the cause that you feel passionately about.
You will not put your retirement fund or the funding of any other objective at risk by pointlessly and dangerously diluting the all-important diversification of your portfolio and instead investing in always overpriced, often underperforming SRI funds that don’t send out a your message anyhow to the target companies.
You can be comfortable that you did not personally profit from the fractional ownership of these companies (since you gave it all away).
You might even get a tax deduction on your donation if the organization that you are giving to is appropriately qualified. Speak to your tax preparer about this.
If your financial advisor is unwilling to offer this service to a client that feels passionate about certain issues, then perhaps you may want to consider switching to one who is. This SRI service is available at no cost to all Anglia Advisors clients.