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Socially Responsible Investing: What SRI Means and How It Works?

Socially responsible investing (SRI) is essentially the practice of investing in companies that have a net positive impact on society and the environment. This can include investments in companies with high social values, or investments in funds that invest in socially conscious stocks.

Socially responsible investors ensure that they do not make investments in so-called ‘sin companies’, businesses that sell potentially harmful products and services like alcohol, tobacco, and gambling. Instead, they focus on companies that bring about positive social change and help the communities they exist in. Thus, socially responsible investments have a dual aim of creating positive social impact and generating financial returns.

Why is SRI important?

Socially responsible investing fulfils the needs of socially conscious investors by maximising the welfare of people, society, and the environment. Equal or secondary to that is the need to get good returns on the investments. Ultimately, it is a vehicle through which socially conscious investors can put their money towards organisations whose morals align with theirs. 

Thus, SRI is important to some investors’ personal and financial well-being. Socially responsible investment funds work towards sustainability and social impact and, in many cases, generate returns equivalent to (or better than) traditional funds. While selecting companies with integrated ESG factors, SRI funds automatically select top-quality companies with sustainable businesses. As a result, their investments pool into companies generating high returns along with supporting social causes.

How does socially responsible investing work?

SRI is the combination of creating a positive social impact and earning financial returns on investment. However, it’s not as straightforward as it sounds. SRI integrates ESG criteria into the investment process for investors to decide which SRI funds to invest in. The construction of a socially responsible investment portfolio has multiple steps.

First, socially responsible investors must define the social principles and values they want to see reflected. Investors must be fully aware of the constraints inherent in investing in specific companies and businesses. For instance, some investors may be opposed to gambling and alcohol; others may be against firearms, while others could oppose all of these industries.

Once the constraints are defined, socially responsible investors can choose their investment approach. The approach can be inclusionary or exclusionary, wherein individual investors decide whether they will invest based on identifying positive attributes or by avoiding negative ones. Other approaches like advocacy and best practices work for bigger investors, like pension funds, that discuss their objections with the target company and dialogue it out.

The next step is to create a socially responsible investment portfolio that includes defined financial goals. Investors must ascertain what they want to achieve from their investment in terms of risk, return, and goals. Ultimately, investors can pick the most suitable SRI funds that fulfil both their social needs and financial wants.

Types of socially responsible investments

There are different types of SRI instruments to consider when it comes to sustainable investing.

  • Stocks and shares: Socially conscious investors can buy individual stocks and shares in companies with solid ESG policies, e.g. Wind Systems (VWDRY) and Nvidia (NVDA).
  • ETFs (exchange-traded funds) and mutual funds: Investors can choose from various funds that explicitly invest in companies that pursue socially responsible ventures or companies that prioritize ESG criteria in their business practices. Sustainable ETFs include VanEck Sustainable European Equal Weight UCITS ETF and iShares Edge MSCI Europe Minimum Volatility ESG UCITS ETF.
  • Community investments: Community investments allow investors to develop sustainable communities or invest in social issues like education, healthcare, housing, agriculture, environment or renewable energy. Socially conscious investors can contribute to their communities via CDFIs (community development financial institutions). 
  • Microfinance: One way people can make socially-sound investment decisions is by offering microloans or small loans to startups. They can also lookup companies in developing countries that offer financial aid.

Socially conscious investors can combine these types of SRI into an investment strategy that highlights their individual social responsibility values.

Is socially responsible investing different from ESG investing?

Both SRI and ESG investing are types of values-based investing. Both aim to create a positive social impact along with earning financial gains. While impact investing is also based on the same principles, it deals more with private funds, wherein socially responsible investing and ESG investing are both related to public assets and entities.

Despite the similarities in aims and outcomes, SRI and ESG investing follow different approaches. Socially responsible investments mostly follow exclusion principles to remove companies from the portfolio if they don’t match the investors’ values. On the other hand, ESG investing generally focuses on finding companies that create a positive social and environmental impact. 

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Environmental, social, and corporate governance criteria are integrated into the investment process to clearly define which businesses are adhering to them and to what extent. This makes it easier for investors to include only companies that meet the criteria, have a net positive impact on society, and endeavour to reduce their negative impacts.

Thus, ESG investing and SRI differ in their approach and methodology. They both, however, focus on the common goal of generating high financial returns for investors and making the world a better place at large.

Pros and cons of socially responsible investing

Socially responsible investment strategies work thematically for investors who want to eliminate certain industries from their investment portfolio and include only a select few. Investors can gain personal satisfaction and fulfilment from investing this way. However, they may need to compromise on investment returns at times. Thus, socially responsible investing has its own set of pros and cons.

Pros of SRI

Above all, socially responsible investments give investors a sense of satisfaction and peace of mind. They know they are doing good for society by not supporting unethical practices while still earning financial returns for themselves. It works best for individuals and businesses who value their social and environmental commitments and want to put their money where their heart is.

Overall, SRI allows investors to stick to their values and remain true to them. Investors get to take a stand against unethical processes and reward ethical ones. Socially responsible investors get to punish wrong practices and reward the companies for doing the right thing in a tangible way. In the process of doing so, the investors also feel better about themselves and how they are making money.

Cons of SRI

The biggest drawback of socially responsible investments is the occasional trade-off on returns. Socially responsible investors have restricted investment options by definition and may need to pay more to buy into socially responsible companies, thus reducing their returns. 

Another concern is about the ambiguity around being socially responsible. Even when the investors are ready to sacrifice a potential chunk of their returns for peace of mind, many companies may dupe them by claiming to be socially responsible when they are actually not. Thus, it is crucial to understand the ethics of companies in depth before accepting them as socially ethical.

How to build a socially responsible investment portfolio

Here are the steps to take towards a socially conscious portfolio.

  • Open an investment account: Open an account based on your needs. You can get a DIY account or use a robo-advisor to help maintain your account.
  • Decide what matters to you: Choose the criteria and values you will use to shun or screen companies. Do you want a weapons-free company or a company with female directors?
  • Research: Conduct comprehensive research on individual stocks of companies or funds with ESG integration. Also, check the ESG ratings of stocks, and track records of managed funds. With robo-advisors, check for socially responsible portfolios that align with your values and criteria.

Best SRI funds to invest in

What type of socially responsible fund should I invest in? A large number of index funds and ETFs focus exclusively on companies that are socially responsible and meet the ESG criteria. The top SRI funds include:

  • iShares Global Green Bond ETF (BGRN): BGRN focuses only on the bonds that meet the green principles. The bonds must be used to finance work related to water sustainability, energy conservation, pollution, climate change, and other projects for them to qualify to be a part of BGRN.
  • TIAA-CREF Social Choice Equity Fund (TICRX): The SRI fund boycotts companies involved in the production and sales of tobacco, alcohol, firearms, gambling, and nuclear power. It supports businesses that follow business ethics, corporate governance, climate change, and other ethical practices.
  • Portfolio 21 Global Equity Fund Class R (PORTX): PORTX is a socially responsible mutual fund that avoids companies dealing in weapons and fossil fuel exploration. It focuses on companies that meet the ESG criteria and work towards sustainability.

As a bottom line, socially responsible investing is an excellent way to follow your values. It allows you to comply with your value systems and principles while still generating financial returns on your socially responsible investments.

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