Socially Responsible Investing – as seen from a fiduciarily responsible investment advisor


I’ve been taught that investing is something that is best done passively: buy a diversified portfolio that tries to maximize expected return (by asset class) while minimizing overall risk of the portfolio (by having non-correlated assets.) I’ve read books like “The Incredible Shrinking Alpha” and scholarly papers. Both explain that we aren’t going to come up with some bright idea that beats the market through our particular genius, other than by sheer chance. I’ve been taught to keep the fees low and keep transaction costs and the impact of taxation as low as possible. I’ve got the technical skills down.
But my clients walk in the door and say “I don’t want to invest in companies that don’t give benefits to same-sex couples” or “manufacture weapons” or grow GMO foods or sell tobacco or alcohol or hurt animals or are implicated in global warming or are banks that back gas pipelines or… It’s a really challenging conversation for me. I usually agree whole-heartedly with the values, but I also believe that it doesn’t work to very well to achieve your goals through your choice of investments.
So what do I do when they say, “I don’t want to own any fossil fuel stocks”?
The inconvenient truth is that divesting from stocks does not affect the company. When you buy a publicly traded stock the money goes to the last owner of the stock, not the company. . In the extreme situation where fewer buyers wanted to buy it and the price got driven down, the remaining owners would just find themselves with a fabulous dividend stream. In practice, divesting makes no difference to the company. Not buying the company’s products makes a big difference, though, and I encourage people to show their civic-mindedness by not burning fossil fuels, personally. It would be nice if there were an easier way, wouldn’t it? These funds appeal to people who don’t know how to invest, and as such they’re really expensive. Paying for an extra level of screening isn’t cheap, because it comes bundled with so much marketing expense. I know that clients get to spend their money where they want to; I’m okay with people buying funds that just make them feel virtuous. Feeling virtuous is a nice feeling and I’m all about helping my clients be happy. But I do feel like I ought to disclose that they’re paying for that feeling – and ONLY for that feeling
There’s some possible benefit to paying for “impact” investing, where you pay the mutual fund company for their advocacy and activism. Recently a shareholder proposal initiated by some of the more well-known socially responsible investing groups got passed when two massive investment companies, Blackrock (iShares) and Vanguard, joined in voting for it. There is no particular reason to think the company will change their behavior as a result, but it’s possible that it’s a battle of inches and this helps somewhat. More than divesting, anyway.
There’s also some possible downside risk mitigation by picking companies with good governance. The concept is that it’s one of the dimensions of value, basically. If you have a transparent executive suite and a good corporate culture, then it’s reasonable to believe you’d be less likely to discover fraud in a market downturn, or have employees abandon ship too quickly when the going got rough. You wouldn’t see these benefits when everything was going great, but perhaps in the next market crash companies with good governance will drop less? Maybe.
The hardest for me to write about has to do with “stranded assets”. I really really want this to be true, but I recognize a cognitive trap when I see one. This is really prone to emotional reasoning. I believe that carbon emissions are dangerous for humans continuing to exist on the planet under the same terms as we evolved. I also tend to believe that I’m very clever and can see things that other people can’t see. So when the idea was proposed that we shouldn’t invest in fossil fuel companies because a “Black Swan” event might come along and change them by surprise, stranding a lot of the company’s value in the ground, I really really like this argument. A “Black Swan”, in case you don’t know, is something you’ve never seen before and aren’t expecting. By definition, you don’t know they even exist. But when one shows up you have to change all your models because, duh, there it is. In terms of fossil fuels, a Black Swan event might be a hurricane wiping out New York City. It’s incredibly unlikely, but the nature of global climate change is to make the weather weird and violent. If you are so clever and so woke that you know this, wouldn’t it be nice to make money being better at valuing Exxon Mobil than everyone else? Except that the financial sciences actually answers this. Everyone actually already knows about climate change. They might argue about it on Facebook or whatever, but the science says that the wisdom of the crowds is smarter than any one of us. Essentially, the risk of having stranded assets is already baked into the Exxon stock price. I can’t prove it, and I don’t want to believe it, but I think it’s probably actually true.
My job is to advise my clients on how to achieve their financial goals. I’m really not sure that the next best place to put their “save the planet” dollars is into socially responsible investing. However, I did assemble a list of the best funds for each type that we can discuss in each case. My best guess is that ones that have good governance and maybe don’t have fossil fuels are going to do the best in a stock market downturn. I found a few new ESG index funds to try, with that in mind.