What is socially responsible investing (SRI)?

Socially responsible investing is an ethical investing ethos that prioritises the social benefit a company delivers just as highly as its financial returns. If you want a guilt-free investment portfolio, then SRI might be for you.

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An introduction to socially responsible investing

Socially responsible investing (or 'SRI' for short) is an ethical approach to investing. Socially responsible investors choose to invest only in companies advancing specific causes, like social justice, the green energy transition, or other socially beneficial initiatives.

As we will explain later, SRI is closely related to environmental, social, and corporate governance (ESG) investing – some people even use the terms interchangeably. However, you should be aware of some subtle differences between the two.

ESG investors use the ESG framework to screen out companies with unsustainable business practices, whereas socially responsible investors seek out only those companies that are actively delivering a social benefit. In other words, ESG screens out harmful companies while SRI identifies those creating positive change.

Therefore, you can view SRI as a stricter application of ESG principles.

How has SRI come about?

Socially responsible investing has a much longer history than you might think. As far back as the 1700s, SRI proponents spoke out against socially damaging industries like the slave trade. Other early religiously motivated socially responsible investors urged people to avoid supporting and investing in industries perceived to be 'sinful', like gambling and alcohol.

However, modern SRI took off during the political upheaval of the 1960s and 1970s. Investors – including large institutions and pension funds – started to invest in companies and organisations advancing socially beneficial causes, like racial justice, housing projects, and healthcare

Additionally, boycotts, particularly of companies supporting the Vietnam war effort or South Africa under apartheid, saw more capital flow toward companies with socially-conscious business principles.

More recently, growing concern about issues such as climate change, business sustainability, and wealth disparity has increased the popularity of SRI even further. This is particularly true as a new generation of younger investors has entered the share market.

How is SRI gaining momentum in this changing world?

The COVID-19 pandemic, global supply chain issues, and climate change, among other recent and ongoing conflicts and crises, have put social and environmental concerns at the forefront of many investors' minds.

At the end of the day, investors don't like the idea that their money contributes to the social, geopolitical and climate problems they see all around them. And with the world seemingly lurching from one crisis to the next, young investors feel that industry-wide changes are needed urgently.

This has seen SRI and ESG investing strategies gain momentum in recent years. And companies are also taking note – most large corporations have now adopted detailed ESG and business sustainability frameworks. For example, Australia's major banks have all committed to achieving responsible lending targets to finance new green energy projects and other initiatives.

What are the main features of SRI?

There are at least four key features of SRI:

  1. It excludes some controversial industries completely. There are some industries – think fossil fuels, gambling, tobacco, and weapons manufacturing – that socially responsible investors will avoid entirely. This is because their products or business models are inherently misaligned with what most people consider socially responsible goals and principles. When entire industries or market sectors are screened out this way, it is usually referred to as 'negative screening'.
  1. It uses an ESG framework. The first step towards identifying a socially responsible investment is assessing the company's environmental, social, and corporate governance framework. Companies can improve their environmental rating by reducing their reliance on fossil fuels, improving energy efficiency, and reducing waste. They can also outperform their social score by supporting local communities through sponsorships, charities, and other initiatives, treating their employees fairly, and promoting gender equality in the workplace. Finally, companies can improve their governance through transparent and timely reporting, increasing shareholder rights, and electing an independent board.
  1. Socially responsible investors don't sacrifice financial returns. Although SRI investors want to invest ethically and support positive social causes, they are still profit-seeking. Generating positive (and hopefully high!) returns is still a big part of any responsible investment strategy.
  2. Socially responsible investing benefits everyone. SRI incentivises companies to build better ESG frameworks and can even force the overhaul of entire industries – all while still generating positive returns for shareholders. This means that in SRI, everyone wins!

What do socially responsible investors look for?

As mentioned, socially responsible investors will look for companies with solid ESG frameworks that advance specific positive social causes. They may still be large, mainstream or even blue-chip companies, but they actively engage in social, environmental, or other positive initiatives.

This often means finding companies that go above and beyond industry norms or government-imposed targets. And, as we've already discussed, it may mean excluding certain market sectors entirely based on their products or business activities.

The healthcare sector is an excellent place to start looking for socially responsible investments. Many companies in this industry positively impact society just by virtue of the beneficial products they create.

Companies like CSL Limited (ASX: CSL) benefit society by producing much-needed vaccines and other therapeutics. CSL has a robust ESG framework and is committed to reducing its carbon emissions and distributing its profits to employees and shareholders. It also employs a diverse workforce.

An example of an ethical investment from outside the healthcare sector is Suncorp Group Ltd (ASX: SUN). The Queensland-based insurer is an industry leader in sustainable business practices. It aims to source all of its energy from renewables by 2025 and has so far invested $378 million in low-carbon investments.

How to build an SRI portfolio

There are many approaches you can take to building an SRI portfolio — some of which may be unique to your personal financial situation and risk appetite.

However, here are four basic steps that can help just about anyone to get started:

1. Go with your heart

It might sound a little corny, but SRI is a strategy that allows you to put much of yourself into your investments. With SRI, you can tailor your investment portfolio to your personal values and beliefs.

Therefore, before you start, think about what causes you care most about. Maybe it's climate change, gender equality, education, or a different set of causes altogether (or a combination of causes!).

It's best to define your personal goals first, so you can start focusing only on those investments that closely align with your values.

2. Look at SRI and ESG exchange-traded funds (ETFs)

Many ETFs on the ASX claim to invest only in ethical companies. If you need investment ideas, find a mutual fund or an ETF that follows an ethical investing strategy and see which companies that fund manager has chosen to invest in.

This can be a great way to get started, as these funds have already screened out companies based on ESG criteria. You can also look at the methodology behind each fund's negative screens for ideas on assessing other investments you are interested in.

Ethical ETFs are also a worthy investment option in their own right. They reduce the time you have to devote to stock-picking and provide instant diversification benefits. Just be mindful of their fees, and make sure their holdings align with your causes and beliefs.

3. Check third-party ESG ratings

Most large companies now produce ESG reports at least annually. These are great resources for socially responsible investors who want to assess a company's ESG performance.

However, it can be difficult to tell from these reports how companies perform relative to their peers and the industry average. This is where third-party ESG ratings providers like MSCI can be helpful.

The ratings agency provides rankings of companies based on their ESG performance. They have searchable databases, which include many major ASX companies, and allow you to see how they stack up against others in their industry.

4. Remember other asset classes

In addition to equities, you can also add bonds, property, and other asset classes to your portfolio. This provides diversification benefits and can reduce the overall volatility of your investments. The BetaShares Sustainability Leaders Diversified Bond ETF – Currency Hedged (ASX: GBND) screens out companies that are heavily exposed to fossil fuels or other unsustainable industries.

Points to remember

Always do plenty of research before committing to an investment. Companies that appear to be performing well based on their ESG metrics may, in fact, be less socially impactful than their industry peers.

Also, look beyond a company's main business activities to see how its ESG initiatives might impact its entire industry.

For example, at face value, an ASX company like Brambles Limited (ASX: BXB), which supplies pallets, crates, and containers, might not be your first choice for a sustainable investment. However, pallets are vital to the transport and logistics industries, and Brambles is a carbon-neutral company that has recently launched a pallet made of 100% recycled plastic.

These initiatives can cause a real step-change in industry and are worth supporting if you are a socially responsible investor.

SRI versus impact investing versus ESG investing

As we discussed earlier, ESG and SRI investing are closely related. However, SRI can be viewed as a stricter approach because it actively seeks out those companies delivering a social benefit rather than just screening out those companies that are harmful.

A subcategory of SRI investing, impact investing aims to make a clear and observable social impact. While impact investors still seek a return on their investment, the priority is more heavily weighted towards the social benefit their money will deliver.

Most impact investing is conducted through private equity investments or other targeted methods. These investments seek to deliver a tangible and usually short-term benefit, such as an affordable housing project, a waste repurposing and recycling initiative, or education outreach (among many others).

Benefits of SRI

The obvious benefit of pursuing an SRI strategy is that you can be confident your investment portfolio aligns with your own personal values and beliefs. This is very important to many investors, particularly younger people, who feel unsustainable business practices have historically damaged society and the environment.

With an SRI strategy, you can feel good about your money's impact on society and the planet. And – most importantly – you can enjoy guilt-free returns on your investments!

And the disadvantages

Although socially responsible investors still want to generate positive returns, there is always the chance that they might miss out on more profitable investments because they screened them out. Limiting your investment choices places some limitations on the returns you earn as well.

However, most socially responsible investors are happy to make that small trade-off for the peace of mind that comes from knowing their money is ethically invested.

Should I buy into socially responsible investments?

It is crucial for everyone to carefully consider the impact their investments are having on people and the world around them. ESG and SRI have had real effects on business and society by advancing gender and racial equality, creating safer and more inclusive workplaces, and achieving green energy targets.

As an individual investor, you will have your own unique set of values and beliefs. You will also have your investment objectives, return aspirations, and risk appetite. And at the end of the day, all of these different factors will influence your investment decisions.

However, it is still essential to ensure you invest your money into companies and assets you feel comfortable supporting. And SRI is one way to ensure you are always doing that. So, embrace SRI, and start enjoying guilt-free investment returns!

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

Motley Fool contributor Rhys Brock has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended CSL. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.