Introduction
In recent years, the financial sustainability has become a more and more relevant aspect considered by all financial players when making investment decisions. The objective of generating financial returns is, today more than ever, often considered on par with the aim of minimising the impact that a business may have on the environment and the society in which it operates. That is because, today when making investment decisions and identifying businesses into which invest their money, investors consider not only factors such as diversification, dividends, rate of return, inflation, taxes, and risks, but also whether a particular activity positively impacts society. For this reason, Socially Responsible Investing have been created as a form of investment.
What is a Socially Responsible Investment?
Socially Responsible Investing (SRI), also known as sustainable, socially aware or ethical investing, is a medium-long term investment strategy that consists in investing in business and projects capable of both generating financial returns and having a positive impact on the society, as for example are engaged in social justice. Investors who engage in a Socially Responsible Investment consider not only the traditional financial metrics but also the now well-known ESG factors.
But it is important to keep in mind that there is a difference between ESG and SRI: ESG criteria are objective measures of an organization’s environmental, social, and governance behaviours, while SRI are subjective criterions used by investors to rate the social responsibility of an organization.
If you are interested in going deeper into ESG factor, you can read A look through Environmental, Social and Governance (ESG) metrics.
An historical overview of the development of SRI
Unlike what most people think, the concept of “responsible investment” have started a long time ago, initially closely related to religious traditions. Already in 1100s, the Catholic Church prohibited usury and the imposition of excessive interest rates on loans. In the 17th century, Quakers, a group of individuals who were part of the Religious Society of Friends, supported the abolition of slavery by refusing to profit from the trade of arms and slaves. The Society implemented a policy aligning its investment funds with core values, avoiding investments in weapons, alcohol, or tobacco, called “sin-stocks”. In 1928, the first investment fund, called “The Pioneer Fund”, was established in the US by Christian clerics, excluding securities associated with companies lacking ethical standards. Another supporter of the SRI strategy was John Wesley, a man of the cloth, who asked his faithful to avoid participating in gambling and supporting industries, which utilized toxic materials. Due to that, socially responsible investors avoided investing in the so-called “sin industries”. However, the investment trend evolved, especially since the 1960s, when people began investing in projects that fostered civil rights as well, as awareness that investments may impact on the world around and awareness over world’s main issues (such as global warming and climate change) increased.
While socially responsible investing started as a simple activity associated with religious societies, now it has become a mainstream practice, increasingly popular among both individuals and corporations, which embraces a wide range of investment interests based on investors’ beliefs.
As socially responsible investments tend to adapt to the political and social climate of the time, they have recently trended toward companies that positively impact the environment by reducing emissions or investing in sustainable or clean energy sources.
Which are the main strategies – Types of SRIs
Over the years, Socially Responsible Investing has grown, as lots of new strategies and investment vehicles available for investors have been created. Socially Responsible Investments are made into individual companies, that focus their attention on minimise their negative impact (or maximise the positive one) on the environment and the society in which they operate.
Now, socially responsible investors use the three ESG factors to assess the sustainability or social impact of an investment, usually through one of these approaches:
- Negative Screening – Screening a company’s practices and products and/or services, in order to discover possible unethical practices, before deciding to invest in it.
- Positive Investing – Investors choose to include in their portfolios companies whose values they share and of whose practices they approve, for instance recycling, purchasing energy-efficient equipment, enforcing eco-friendly work policies.
These types of investment are generally made through socially aware Mutual funds or ETFs, whichadhere to the ESG criteria and provide advantage to investors, who can gain exposure to multiple companies across many sectors with a single investment.
An example of SRI is investing in organizations that have a social responsibility, helping people who have been unable to raise funds from other sources such as banks and financial institutions, after pooling investor resources. The funds allow these organizations to provide services to their communities with the aim to improve their welfare, which in turn has a positive impact on the economy.
In addition to these funds, there are other 2 types of SRI:
Community investments – An investor can also put their money directly into projects that benefit communities, such as contribute to Community Development Financial Institutions (CDFIs).
Microfinance – Individuals seeking socially responsible investments can support startups by providing microloans or small loans. There may be opportunities especially in developing countries, where businesses offer financial assistance.
Opportunities and challenges
Socially Responsible Investing is a strategy that offer investors many advantages. They can support initiatives that share their own ethical and moral values and contribute to positive social and environmental outcomes by directing capital toward socially responsible and sustainable businesses. Companies with strong ESG practices demonstrate higher standards of corporate governance and greater resilience over the time, offering investors long-term stability and competitive potential financial returns.
As we live in a rapidly changing society where people pay a greater attention to the environmental protection, investing in socially responsible companies seems to be profitable as they are more likely to comply with emerging regulations related to environmental and social issues.
Moreover, this type of investment often prioritises innovation and allows investors to access to growing markets, thanks to an increasing number of investment options and vehicles.
Despite the several benefits, as socially responsible investments tend to adapt to the political and social climate of the time, investors have to better understand the potential risks they may have to face. Subjectivity, lack of transparency and of standardised criteria for measuring socially responsible factors are factors that can lead to subjectivity in the evaluation of business performances, making it challenging to compare different SRI’s options.
A focus on ESG factors and the exclusion of some sectors may lead to investment decisions only based on values rather than financial metrics, potentially resulting in lower returns.
The Greenwashing is another risk, to which investors has to pay attention. It is when a company presents itself as an environmentally friendly activity, but actually it does not incorporate sustainability into their core operations. In addition, the ever-changing regulations related to ESG criteria and changes in government policies may impact the performance of SRI portfolios and their profitability, resulting in market volatility. And lastly, public perception and sentiment can influence the success of SRI strategies, too.
Despite the challenges listed before, many investors believe that the potential benefits outweigh potential risks of this type of investment. Anyway, it’s essential for investors to weigh their risk tolerance and investment goals before incorporating a Socially Responsible Investment strategy into their portfolios.
Recent years’ global trends of SRIs
Interest in SRI has risen in recent years, especially since the COVID-19 pandemic, as more investors prioritise the impact of how their money is invested. As a result, there has been a steady increase in sustainable investment net inflows over the years.
2021 saw $649 billion of sustainable investments, more than twice the amount invested in 2020, according to Bloomberg. At the end of 2022, Global ESG fund assets reached about $2.5 trillion. The growth has been mainly driven by Europe, accounting for 84% of global sustainable fund assets and seeing positive inflows of $40 billion during the Q4 2022. In contrast, the US, which accounts for 11% of global sustainable fund assets, saw outflows of $6.2 billion during the same period.
Despite the rebound experienced in 2022, shown also by positive performances of SRI indices, in the Global Sustainable Fund Flows report, Morningstar reported that global sustainable inflows dropped to $18bn in Q2 2023, lower than the $31bn in Q1, citing increasing inflation, rising interest rates and recession fears as reasons for why investors are pulling their cash from funds. In fact, in the second half of 2023, global sustainable funds (in Europe as well as in the US and emerging markets) experienced outflows, with $37bn exiting registered despite the improvement of sustainable fund performances in Q3.
However, it is estimated that sustainable assets could reach $50 trillion by 2025 and that the number of sustainable funds is expected to increase, as 77% of sustainable funds and only 46% of traditional funds, over a span of 10 years, is expected to remain active.
Conclusion
In conclusion, due to the increasing importance of a more sustainable global economy, thanks to the advantages that it offers and the positive forecast for its future performance, over the years, the Socially Responsible Investing will attract more and more investors aiming to obtain high financial returns but also to positively contribute to the social development.
While this investment strategy continues to mature, political efforts will be necessary to set standard metrics in order to make responsible investing safer and their effect measurable, and to promote an active collaboration between financial institutions and the global community with the aim to make our future more sustainable.
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