Broker Check

Socially Responsible Investing: No Urban Legend

by Darren L. Zagarola, CFP®, CPA, PFS

As seen and heard on News 12 NJ's It's Your Money & Money Radio 1510 AM, December 2011

Chupacabras, Bigfoot, and the perils of eating Pop Rocks while drinking soda at the same time. All of these urban legends are passed from person to person, leading some to believe the stories are true only because they have been heard many times from multiple sources. Well, I guess we can add Socially Responsible Investing (SRI) to this list because just like an urban legend, there are often preconceived notions about this type of personal investment philosophy. But, before we look at fact versus fiction, what is SRI?

SRI is the process of investing based on one's personal values and societal concerns. Investors, especially baby boomers, strive to incorporate their personal values into their investment decisions and SRI allows them to do so. Examples include environmental concerns (green investing, climate risk, organic foods); social concerns (faith based, community related, human rights); and corporate governance (executive compensation, fair labor practices). SRI considers the environmental and social consequences of investments, both positive and negative, within the context of rigorous financial analysis. The goal of SRI investments is the same as other investments - appreciation, capital gains, and preservation of capital. But this type of investing is not considered mainstream - therefore, there are several prevalent misconceptions surrounding SRI. And just as I did on television, I am setting out to bust the following myths:

Myth #1: SRI returns underperform the broader universe of funds. This is the Loch Ness monster of SRI myths. When SRI is mentioned to potential investors or discussed in public, I often hear the following: “It seems like a great idea, but I am just not willing to give up the returns to invest based on my personal values.” What if I told you that you don't have to give up any returns? The broader universe of large cap company stock is measured by the S&P 500 Index. The SRI universe is measured by the FTSE KLD 400 Index, which also mostly consists of large cap company stock. Over the 10-year period ending September 30, 2011 - and what a decade it was - the S&P 500 Index annual return was 2.8 percent. The FTSE KLD 400 Index annual return was very similar - 2.0 percent. In shorter periods, the FTSE KLD 400 Index actually outperformed the S&P 500 Index. As further support, The Forum for Sustainable and Responsible Investment's 2010 Annual Report on Socially Responsible Investing Trends in the United States found that during the most recent financial crisis, from the start of 2007 to the opening of 2010 (a three-year period when broad market indices such as the S&P 500 declined and the broader universe of professionally managed assets increased less than 1 percent), assets involved in sustainable and socially responsible investing increased more than 13 percent. Myth busted: You can choose to invest in SRI versus the broader universe and achieve similar returns.

Myth #2: There is a substantial premium tied to investing in SRI products. The cost a mutual fund or ETF charges the fund owner to operate that fund is called the expense ratio. The average expense ratio for an SRI product is only slightly higher than a broader universe large cap mutual fund. However, the expense ratio of an SRI product is similar to other investment vehicles such as small cap and international investments that offer a smaller pool of companies to select from and result in higher costs. The average expense ratio for SRI products based on independent analysis is between 0.5 percent and 1.5 percent. Myth busted: The premium is, at maximum, only slightly higher.

Myth #3: You cannot create a fully diversified portfolio with SRI products only. How many funds or investment products do you think it takes to create a well-balanced and diversified investment portfolio? I can tell you that any more than 15 to 20 individual holdings will not significantly lower the risk level of your portfolio. As indicated above, there are more than 490 investment products to choose from when developing a portfolio. They include the following asset classes: World Stock, Small Cap Value and Growth, Short-term Bond, Natural Resources, Large Cap Value/Growth/Blend, Intermediate Term Bonds, Multi-sector Bonds, and Balanced Funds. Do you get the point? Myth busted: A fully diversified SRI portfolio is definitely possible.

Myth #4: SRI is relatively new. The New York Stock Exchange dates back to the late 1700s – and the concept of SRI also dates back to that time. The first SRI mutual fund was opened in 1928. The most common index used for SRI funds is the FTSE KLD 400 Social Index, which was launched in May 1990. The proliferation of mutual funds and Exchange Traded Funds established in the last five years only makes it appear to be a new field of investing. Also noted in The Forum for Sustainable and Responsible Investment's 2010 Annual Report on Socially Responsible Investing Trends in the United States is that the number of SRI products has increased from 201 in 2005 to 493 in 2010. But for more perceptible examples, think back to the anti-Apartheid movement, or the Dow Chemical protests after the famous photograph of the Vietnamese girl who had been napalmed during the war. Personally, I stopped purchasing gas from Exxon after the Valdez oil spill. This is SRI. Myth busted: SRI is nothing new.

Myth #5: SRI is only for the wealthy. SRI investors comprise individuals, institutions (such as universities, hospitals, foundations, and pension funds), non-profit organizations, and religious institutions. As long as you have values that have significant meaning to you, you have the opportunity to benefit from SRI. Even better is that SRI is a great opportunity to teach your children and grandchildren how to invest according to their beliefs and values. Myth busted: Anyone can be a Socially Responsible Investor.

Myth #6: You need to have 100 percent of your portfolio in SRI to meet your personal goals. Nobody is perfect. If you strongly believe in something, you can create a well-diversified portfolio with similar returns to the broad universe at similar costs. If you would like to invest only a certain amount in SRI, it is your choice. Remember, these are your values. There is no rule that restricts you one way or another. Myth busted: The percentage of your portfolio that is SRI related is a direct reflection of what you're comfortable with. It's that simple.

My advice to you in my role as myth buster is this: Do not stand in front of a mirror and yell Bloody Mary three times – that is indeed an urban legend. Instead, start investing in accordance with your personal values. It will not negatively impact your portfolio and will personally impact you in a positive way.