Investing for Good
As we come to the end of a genuinely exhausting and bizarre year, I wanted to shift the conversation away from the many unknowns and general weariness and highlight an area of the market that's received a lot of recent interest. In recent articles, we've discussed the unique sell-off that tore through the markets in March and recovered at a record pace over the summer. During that same time, socially responsible funds saw record inflows and strong returns, a phenomenon that's generated a lot of talk amongst fund managers in recent months. As consumers express greater interest in these funds and their assets grow, it's worthwhile to understand where this "fad" came from, how it's defined, and whether it's here to stay.
While investing for good is still in its early stages, the idea of business for good has been around for a while. Particularly for consumers in the U.S., significant economic growth in the last century has resulted in an abundance of products and services from which to choose. In such a space, companies find themselves pressed to differentiate themselves to win over buyers. No longer can a company present a good product because there are already a dozen other similarly good options. Instead, companies now find themselves faced with a need to identify their customers' values and respond in kind. The result is the rise of companies like Toms Shoes, whose one for one model gives away a pair of shoes for every pair purchased. This practice encourages customers to buy their shoes not merely for their style and comfort but also the altruistic feeling a consumer gets from the purchase.
Similarly, the outdoor gear company, Patagonia, has a 1% for the Planet pledge to give 1% of sales to the restoration and preservation of the environment. Not only are these pledges potentially beneficial to society and the environment, but they're a differentiating aspect of each brand and one that attracts consumers with similarly held values. As our choices continue to grow, various brands' ability to connect with consumers' values will likely be an essential aspect of their growth.
Shifting back to the idea of investing for good, we see a similar pattern. Fund managers have keyed onto this idea that business for good is not only attractive to consumers and investors alike but can also be exceptionally profitable. Consider, for example, a company with poor governance policies. Identifying such a company and potentially decreasing an allocation to it's stock or eliminate it all together may allow investors to avoid losses should that company find itself in trouble. Alternatively, many funds are popping up with a focus on environmental responsibility. These funds hope to attract climate concerned investors who want to express their values with how they invest. Furthermore, these funds hope to generate superior returns by opportunistically exploiting an emerging market for renewables that could become a crucial part of the energy sector as governments consider cleaner policies.
At present, socially responsible funds remain loosely defined and understood. One of the more common definitions is the ESG approach referring to Environmental, Social, and Governance. To be categorized as such, investments must pursue some positive business elements either in being environmentally friendly, socially responsible in terms of fair labor practices, or having favorable governance policies in place such as pay and decision-making accountability. Presently, funds are considered either exclusive or inclusive in nature. Exclusive funds exclude businesses deemed harmful such as tobacco makers, whereas inclusive funds seek to positively identify companies seeking to do good.
Finally, as with any other decision within the financial markets, it's essential to do our due diligence and consider any investment product's shortfalls. Socially responsible funds are no different. When it comes to evaluating them, it's essential to also consider the costs and tradeoffs. Are these funds more expensive than their non-socially responsible peers, and are they able to match or exceed benchmark returns? As time goes on and more of these funds pop up, having a more extensive data set will go a long way in answering these questions.
Furthermore, it takes time to know whether a strategy is indeed a strategy or merely a fad. What may seem like a smart investment may turn out to be one primarily driven by investor sentiment with little merit on its own when the interest dies down. Or, there may be a sustainable element to the idea that investing for good really can enhance returns. Only time will tell. In the meantime, it will be interesting to continue to watch this new and quickly evolving area of the financial markets and learn what we can from their insurgence.
To learn more about this topic, check out this recorded webinar on the subject.
Lovely Abundance is presented in conjunction with Sherwood Financial Partners. The publication of this article should not be construed by any consumer or prospective client as Sherwood's solicitation or attempt to effect transactions in securities, or the rendering of personalized investment advice over the Internet. Past performance does not guarantee future results. The information in this article should not be construed as the provision of personalized individual advice from Sherwood.