Ethical Investing: SRI, ESG, and impact investing

The term ‘doing good’ is often associated with giving to charity. However, the greater good is more than just throwing money at a cause. The desire to make the world around us a better place drives how we provide for our family, raise our kids, and treat the people around us. We often even use how we spend our money to help improve the state of the world by making decisions like buying from small businesses, supporting the local arts, or buying fair-trade or ethically-sourced products. 

Ethical investing gives us yet another way to make the world a better place, allowing us to leverage our investment portfolios to support the businesses who operate with the greater good in mind.

For years, movies about Wall Street have painted investing in a bad light. And while there have been bad actors in the past, the truth is that investing is a tool. Your investing dollar supports the companies whose shares you own, providing the capital they need for growth in exchange for the opportunity to share in their success. 

Ethical investing is about being selective about who you support, making sure that you aren’t contributing to anything you find to be personally objectionable.

Ethical investing has been a concern for a long time, but it became far more prevalent around 2020, when more and more individual investors started to pick their own stocks instead of handing it to a mutual fund or financial advisor.

We’re going to cover the 3 main philosophies of ethical investing, according to their commonly-accepted definitions: Socially Responsible Investing (SRI), Environmental, Social, & Governance (ESG), and impact investing.

SRI is ethical investing in its broadest form. With SRI investing, you’re taking the nature of the business you’re supporting into account when you make investment decisions. 

Since the notion of ‘social good’ can be different depending on who you ask, there’s no objective way to tell if a security would count as SRI–it’s up to your own best judgment to determine what qualifies as social responsibility. SRI commonly excludes controversial industries such as tobacco, gambling, and weapons manufacturing, but could also exclude any other industries, businesses, or brands that you find personally objectionable.

There are 3 ways to apply SRI to your portfolio:

• Inclusive SRI, also known as “positive screening”,  means that you’re choosing companies based on social factors, in effect seeking out companies that you feel conform to your personal values to fill in your investment strategy.
• Exclusive SRI, also known as “negative screening”, means that you’re actively avoiding companies based on social factors, in effect screening out companies that you feel don’t conform to your personal values.
• Blended SRI means you’re using a bit of both: you’re showing a preference towards socially responsible companies, but you don’t necessarily let SRI guide all your investing decisions.

Most of the time, SRI is less of a definite strategy in a portfolio and more of a consideration that you apply to your main investing strategy.

How to find ESG ratings

There are many tools out there to do SRI and ESG research. MSI, Russell, and S&P all have their own tools, each of which uses their own scoring methods to assign ethical grades to securities. To get you started, S&P Global has a free ESG lookup tool that can give you basic ESG ratings for many listed companies.

There are also a number of funds that are built around SRI and ESG factors. SRI and ESG ETFs can be particularly appealing in Questrade accounts, where you can buy any ETFs commission-free. However, when considering SRI and ESG funds, keep in mind that there are many buzzwords that haven’t been formally defined (such as “Impact fund” or “Social fund”) which may be used to “Greenwash” a fund so that it sounds more SRI and ESG-friendly. If you’re going to go the ETF route, you may want to do a little research to make sure you align with the fund.

Finally, if you want peace of mind without the extra legwork, there are SRI and ESG robo-advisors which build a portfolio according to a set definition of ESG standards, and will often boast other features such as built-in diversification and real-time rebalancing. Questwealth Portfolios is one of these robo-advisors that offers several SRI portfolios.

Pros and cons of ESG

Using your investments to do good is a great sentiment to have, and ESG can be a handy way to gauge the positive impact that your investments make. However, it’s important to weigh the pros and cons when using ESG to influence your investment decisions:

Pros:

Simplifies extensive research 
ESG rankings boil many complicated factors down into a simple number, making it much easier to get a sense of the ethical impacts that publicly traded companies have on the world.

Relatively easy to look up
Thanks to widely-available research tools, ESG research is easily accessible online, both as free summaries and paid in-depth reports.

Tackles factors otherwise difficult to look up
Some ESG factors can be difficult to find through independent research, particularly when they deal with the inner workings of the company. ESG ratings look at such factors, such as how they treat their workers, the diversity of their internal leadership, and more.

Cons:

Extreme negatives can be hidden by extreme positives
Since ESGs are an aggregate rating, a company that has negatives which you might consider to be deal-breakers might be balanced out by positive performance elsewhere. For example, a company that sells dangerous products could have a positive ESG rating if they treat their workers well and have a small carbon footprint.

ESG adds another layer of research
An investing strategy will often involve a fair amount of research to begin with. While ESG does a great deal to simplify socially responsible investing, it’s worth noting that it does add an extra step to the selection process if you’re building your own portfolio.

ESG ratings are constantly changing
An ESG rating doesn’t last forever. Companies with poor ESG ratings could change leadership, address their issues, and clean up their act, while companies thought to be good can have scandals uncovered or decide to adopt poor business practices.

If ESG and SRI strategies are defensive plays that make sure that your money isn’t supporting companies that have a negative effect on the world, impact investing is the offensive play that makes sure that your money is actively contributing to the greater good.

Impact investing means investing in companies that you believe have an overall positive impact on the world. Some examples of companies that might be considered impact investing could include companies that research and generate sustainable energy, companies dedicated to servicing under-represented or struggling communities, or companies that focus on developing sustainable agriculture.

It’s important to note that impact investing, ESG, and SRI are not mutually exclusive. Impact investing is a pro-active style of ESG or SRI. In fact, impact investors might use ESG tools to vet their portfolio. After all, it’s possible for a company to use questionable means to achieve what seems like a noble goal.

Does impact investing mean sacrificing your financial wellbeing for the greater good?

While impact investing means finding companies that place overall social good over short-term profitability, that doesn’t necessarily mean that they’re not profitable investments. 

Of course it might mean that your impact investments see a lower return than more profit-minded competitors, but any publicly listed business, be they impact investments or otherwise, are still businesses. They still have their streams of income, they pay their employees, they’re overseen by corporate leadership, and they operate according to a long-term business plan.

If you’re incorporating impact investing into your strategy, it’s a good idea to do your research to make sure that you have an idea as to the sort of performance you can expect from the stocks and industry you’re focusing on, and adjust accordingly.

While ethical investing is a common practice, it’s not technically an investment strategy. Ethical investing doesn’t necessarily dictate things like portfolio diversification, asset allocation, or data analysis.

Ethical investing is more of a general consideration that you can apply to a strategy. Companies within each industry have their own set of principles and guidelines by which they do business, and so you could apply ethical investing considerations to virtually any investment strategy.

In other words, ethical investing isn’t a complete strategy on its own, but it does help you to guide your investment decisions to give you peace of mind with your portfolio.

While we often associate contributing to the greater good with personal sacrifice, it’s important to remember that socially conscious investments are not charitable donations. It’s just about making sure that you’re happy with who your portfolio is supporting. 

In fact, some aspects of socially responsible investing could actually be conducive to a generally healthy overall business. For example, corporate transparency could make it easier to catch red flags in leadership and business practices, sustainability could speak to the company’s long-term viability, and social responsibility could lead to a greater loyalty among the company’s community and workforce.

Conversely, negative ethical practices could potentially cause massive damage to a company’s long-term value, often in search of short-term profits.

Does that mean you get higher yields with socially responsible investing?

You can, but it’s not a guarantee. If you look at the Questwealth Portfolios’ standard and SRI portfolio performance, you can see that one does not consistently outperform the other: some years the standard portfolios outperform their equivalent SRI portfolios, other years the SRI portfolios outperform their standard equivalents.

There are countless variables to keep in mind when you’re talking about the performance of a stock. For example, a company could face social responsibility issues and ethics violations but still remain profitable for decades due to factors such as its size, its place in the market, or a lack of a viable alternative. Similarly, a company could be run with absolute transparency, operate with 100% sustainability, support its workers and community, and still fail because of unrelated issues such as supply chain issues or a lack of demand.

Ultimately, there are far too many other factors to predict a company’s performance based on their ethical responsibility.

At the end of the day, ethical investing boils down to how satisfied you are with the impact your money is having on the world.

Not sure where to start with SRI Investing? Our pre-built Questwealth Portfolios may be a great option.

Because we believe in full transparency, all of our Questwealth ETF portfolios are public and fully accessible on the web.

Check out what our Head of Portfolio Management - Ben Kim has to say about Questwealth's SRI portfolios and fees in the videos below.

Note: The information in this blog is for information purposes only and should not be used or construed as financial, investment, or tax advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.