WHAT ARE ESG AND SRI FUNDS?
Every generation has their different stereotypes informed by their attitudes and behaviors. This is caused by many different factors: the economic, political and social environment when they were growing up; changes in the media, communications, and travel options that occur over time; different education, family and lifestyle priorities.
Digging into exactly why different generations prioritize different things isn’t the point of this post. We know the great depression or the baby boom era shaped those generations just as those of us today have been influenced by the great financial crisis and other recent events.
What I find interesting are the ways in which these generational attitudes change and how the companies that want to receive their purchasing and investing dollars change to accommodate them.
Younger Generational Values
Taking a look at the younger generations: Millennials, the tail end of Gen X, upcoming Xennials, you hear some common themes that have shifted compared to past generations. They tend to value experiences over things, they are more concerned about the environment, they want to know the companies they purchase from and work for are good actors in the world.
Corporations as Do-Gooders
Companies have embraced some of these themes and have tried to earn their customers trust in different ways. Some by focusing on what they call their triple bottom line: social, environmental, and financial impact; rather than only worrying about their profits. Other companies can now be classified as B Corporations, which means they must balance their decisions between purpose and profit. And some companies, such as Patagonia, tout the work they do organizing and working to impact climate change.
Individuals are interested in this not only from a consumer standpoint, but from an investing standpoint as well. Investors want to invest with companies they believe are operating in accordance with their values. This can be because investors believe it is the right thing to do, and also because they believe that companies that care about the same things they do – the environment, social issues, their community – will prosper and do better as a result.
Similar to the early days of investing to track an index, investing in socially responsible or environmentally responsible companies in the past has been challenging. But as with most other things in capitalism, where there is a demand, a product will be created to meet it. Enter the SRI and ESG funds into the mutual fund and ETF landscape.
People tend to use the two terms interchangeably but there is a big difference. Using the term ESG, means in addition to traditional valuation metrics like sales, cashflow, and debt; you are also considering the environmental, social, and governance practices when evaluating a company.
ESG – Environmental, Social, Governance
Environmental: Climate Change, Pollution, Renewable Energy Use, Protection of Natural Resources
Social: Human Rights, Community Engagement, Employee Relations, Health and Safety, Child and Forced Labor
Governance: Transparency, Quality of Governance, Conflicts of Interest, Independent of the Board of Directors, Ethical Conduct, Executive Compensation
SRI – Socially Responsible Investments
SRI goes a step further, when you use a set of values to screen companies based on their ESG metrics.
- Investing in companies that increase transparency in their supply chain and manufacturing methods to improve worker health, safety and working conditions.
- Not investing in companies that contribute to climate change, or ignore their effects on natural resources.
- Investing in companies that support the use of renewable energy.
- Not investing in firearms manufacturers.
Due to the growing interest in investing in these types of companies, index companies have built SRI and ESG indices and funds to track them. Most of these funds are designed starting with an index like the S&P 500 and then removing or reducing the amount of companies with lower ESG scores.
But rather than tracking an objective metric like company size or location, evaluating and scoring companies based on their SRI and ESG metrics is a subjective measure. Fund and index companies will weight things differently and you must do your due diligence when purchasing these funds to understand which companies are included.
As this story from marketwatch illustrates depending on your views and what you deem to be socially responsible you might be surprised to learn that your SRI fund owns sugary soda companies or chemical manufacturers.
The Future for SRI Funds
As the younger generations move into their prime working and investing years I wouldn’t be surprised to see the demand for these types of funds increase. Since the Forum for Sustainable and Responsible Investment first began tracking them in 1995 the amount of assets invested in these funds has grown from $639 Billion to over $11 Trillion.
If you are interested in aligning your investments with your values make sure you do your homework on the companies involved. If you have questions it would be a good idea to talk to a financial advisor, who could help you understand the differences and risks involved with different funds.