If you're curious about socially responsible investing, you may have encountered all kinds of phrases about this phenomenon, including socially responsible investing (SRI), mission-related investing, sustainable investment, ethical investment, socially conscious investment, impact investing, and investing based on environmental, social and governance (ESG) principles.
At their core, all these phrases refer to investment strategies that take into account both financial gain and social principles, but in practice, each of these phrases has a slightly different meaning.
Two of the most commonly referred to investment strategies include SRI and ESG, and as you explore different investment strategies, you may want to understand some of the nuances between these concepts.
What Is Socially Responsible Investing?
SRI is driven by the investor's ethical principles, and this investment strategy can be extremely personal as it's tied to the investor's religious, social, environmental, and other ethical frameworks. For instance, one investor may want to avoid investing in companies that do fetal tissue research, while another investor may want to avoid putting money into fossil fuel companies.
Often, SRI focuses on divestment from certain types of investments, rather than on actively seeking out socially responsible investments. Financial professionals refer to this as negative screening. In other words, the investor identifies the industries, types of investments, business practices, or even specific companies they want to avoid.
What Is Investment Based on ESG Principles?
While SRI relies on negative screens to shape an investor's portfolio, investing based on ESG principles takes a more proactive approach. With this investment strategy, financial professionals assign ESG ratings to investment options, and when investors look at prospective investments, they take these ratings as well as financial elements into account.
This investment strategy considers the effect ESG elements have on the investment's projected performance. Looking at ESG factors can help investors identify potential risks and evaluate the company in a way that brings in greater detail than a technical evaluation on its own.
ESG factors don't just reflect a company's ethical framework. They can also indicate how likely the company is to survive in certain situations. To explain, imagine an investor is committed to working with companies with strong safety practices and environmental stewardship, and they find a natural resources company focused on these principles. That company meets the investor's ethical concerns, but perhaps more importantly, those practices help put that company in a better position to survive catastrophic events.
To give you another example, say an investor wants to put their funds into companies with strong shareholder rights, positive governance policies, and a commitment to transparency. A company that meets these ethical considerations may also be poised to succeed in a world that places increasing importance on these elements. As a result, the investor gets to put their funds into a company that has both financial strengths and ethical business practices.
Keep in mind that neither SRI or ESG are proprietary terms, and they are both relatively new concepts. As a result, some investment professionals or companies may use these concepts slightly differently than explained above. To learn more, consider reaching out to a financial professional to talk about your ethical investment goals.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Socially Responsible Investing (SRI) / Environmental Social Governance (ESG) investing has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
This article was prepared by WriterAccess.
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