Joseph F Keefe, CEO and President of Pax World Funds
In the summer 2007 issue of this publication, I wrote an article ("From SRI to Sustainable Investing") arguing that sustainable investing is the next stage in the evolution of socially responsible investing (SRI)1. This shift from SRI to sustainable investing is not only taking shape in the real world, but the interest in and uptake in sustainability is accelerating. I think it's also true that whereas SRI has always been understood more as an "alternative" investment strategy, sustainable investing has the potential to be a transformative investment strategy2. Thus, the change is more than just semantics; it is fundamental, both stylistically and substantively.
From a stylistic or marketing point of view, the re-framing that sustainable investing represents addresses some of SRI's historical weaknesses:
SRI became associated in the popular mind with negative ("sin stock") screens whereas sustainable investing focuses on companies' positive Environmental, Social and Governance (ESG) characteristics3;
RI defined itself in terms of extra-financial "values" whereas sustainable investing makes a case for the financial materiality of ESG;
SRI could never articulate a clear investment rationale (indeed its performance message was counterintuitive because negative screens shrink the opportunity set); whereas sustainable investing makes intuitive sense: better ESG performance = better long-term financial performance.
SRI has been perceived as an alternative investment strategy for a narrow, niche market whereas sustainable investing has potentially broad, mainstream appeal.
From a substantive point of view, although SRI and sustainable investing are clearly related and share elements in common, they are not the same, nor is sustainable investing simply a subset of SRI. Sustainable investing is actually an emerging investment discipline, founded on the principle that the full integration of ESG factors into financial analysis and decision making is a strategy for identifying better long-term investments. It maintains that sustainability or ESG criteria have financial materiality, and that taking them into account – both through fundamental analysis and shareholder advocacy – is a smarter way to construct and manage investment portfolios over the long term. SRI was never willing to go this far, preferring instead the more modest claim that "you don't have to sacrifice performance”. In fact, SRI never represented a specific investment discipline per se so much as the marrying of various investment disciplines with various "values”, often through negative screens. Sustainable investing defines itself in terms of what it does invest in rather than what it doesn't invest in. It posits an alignment of financial outcomes with ESG outcomes – not with values, but with outcomes – insisting that corporations and markets behave differently because their long-term success will depend on meeting certain ESG benchmarks.
The response to my article has been generally positive, and has also stirred some debate. Some SRI practitioners argue that it doesn't matter what language we use – if we're all essentially doing the same thing we shouldn't get hung up on words. Others object to the turning away from "values" that they believe sustainable investing represents.
Regarding language, I agree: if people want to call it socially responsible investing, or sustainable investing, or mission-based investing, or anything else, it shouldn't really matter. Different language may work for different practitioners and different sub-sets of the market. My concern isn't about language so much as about definition. SRI can call itself what it wants; it's how it defines itself that will determine whether it continues to be a niche strategy or a mainstream strategy.
SRI's historic focus on negative screens was a niche or alternative mindset, whereas focusing on integrating positive ESG factors into the investment process – what I call sustainable investing – is a mainstream strategy for the broader market.
Regarding values, I always thought that defining SRI as "investing with values" was a mistake. It simply begs the question: what values are we talking about? One can get a sense of some of those values from the screens, shareholder activism and community investing strategies many SRI practitioners employ, but the industry itself has historically taken a neutral position with respect to values – leaving it to individual practitioners or investors to decide for themselves. Until quite recently, for example, the Social Investment Forum website defined SRI as "integrating personal values and societal concerns with investment decisions" – which, again, begs the question. This pluralism or agnosticism with respect to values doesn't really work because it ultimately fails to distinguish SRI from any other investment approach.
For example, some people believe that unregulated corporations and unfettered free markets combined with limited government and low marginal tax rates generate the optimal amount of wealth, freedom and equality. This is a moral philosophy (ie it's about values), and it is the edifice upon which conservative political economy is based. There are other people who think that homosexuality is morally wrong, and may therefore want to construct investment portfolios screening out companies that offer domestic partnership benefits to gay and lesbian employees. Still others, because they believe in creationism, or oppose contraception, or hold other religious beliefs, may decide to screen out firms involved in the biological sciences. These are all different sets of values, but are these the "values" that SRI is talking about?
The problem with values is that they are subjective, having their origins in religion, culture or personal experience. There are moral and ethical values, religious values, aesthetic values, and countless examples of individual values: compassion, non-violence, equality, honesty, generosity, humility, courage, loyalty, tenacity, self-reliance, equanimity, right livelihood…. To speak of "values" in the abstract doesn't mean very much because values are specific and subjective. To define an investment approach as "investing with values" is therefore not particularly helpful.
The notion that you can invest with values is self-evident. Of course you can. Your ability to do so with any degree of success may depend on the number and variety of investment options out there – ie whether you can find someone to manage a portfolio tailored to your particular values – but there is nothing in principle to prevent you from doing so. Moreover, it's worth remembering that any investment style is based on some values, even if it's simply the conservative nostrum that unfettered free markets are the best arbiters of the good. So if you want to invest with values – whatever those values may be – go for it. It's a free country. But an investment discipline this does not make.
The truth of the matter is that SRI was never really about "investing with values" per se, but about investing with certain values to the exclusion of others. It seems to me, therefore, that SRI has a choice: it can either (A) define the values it is talking about with more specificity; or (B) leave "values" behind as a defining concept and embrace a different approach. The SRI industry has never been willing to make this choice, preferring instead to stick with "values" in the abstract. This is not sufficient. Values in the abstract are simply not an adequate basis for defining an investment approach with any intellectual rigor or precision, nor are they an effective way to communicate with the public and attract investors.
Not only is it virtually impossible to justify in financial terms an exclusionary screen based solely on a value judgment, but some of SRI's traditional negative screens are problematic even on their own terms. For example, the SRI industry has proceeded for years on the assumption that excluding alcohol is somehow essential to its mission, and that investors care. (Based on research I have seen, most investors don't care at all.) Unlike the weapons and tobacco screens, which at least have clear social rationales (not profiting from war; inherently harmful product), the alcohol screen arguably has none. Social investors surely aren't yearning for a world where there is no beer or wine (although they likely do favour one where there is no war or cigarette smoking). Moreover, since many SRI practitioners take a drink, alcohol use per se is apparently not the "sin" this screen was meant to address.
Alcohol abuse and attendant social problems, like addiction, drunk driving and domestic violence, is clearly the concern; but then one must ask whether the screen does anything at all to address this problem4. It seems pretty clear that it does not – that divestment from alcohol manufacturers has absolutely no impact on their business. The SRI industry nevertheless continues to embrace the screen as received wisdom5.
If the SRI community really wants to do something about the social costs of alcohol abuse, a positive or best-of-class approach would be far superior to a zero-tolerance screen. Such an approach would 1) allow the screening process to analyse company advertising practices, efforts to combat underage drinking, support for alcohol treatment centres, domestic violence programs, etc; and 2) allow shareholder activism strategies to engage the liquor industry (or at least the better companies in the industry) regarding those same issues. Such a positive approach would mark a departure from the old world of SRI by focusing on the sustainability of company business practices rather than a values-based condemnation (and exclusion) of the entire industry6.
Values-based exclusionary screens will always be viewed by a large section of the investing public as extra-financial and irrelevant, if not compromising when it comes to performance. They are no way to define an investment approach, and not a very good way to attract investors either. This is not to say that exclusionary screens can't continue to play a role in a sustainable investing approach. At Pax World, for example, our funds exclude weapons and tobacco, and other firms may apply different exclusions based on differing value judgments. What is clear, however, is that the industry as a whole can better accelerate its growth and impact by adopting an ESG or sustainability focus, and that values-based exclusions should be understood as additive or collateral to the primary financial focus, which should be on sustainability. And that's the key. Sustainable investing as I am using the term is a financial concept. It is an emerging investment discipline that has its origins in SRI (and other places) but also represents a refinement of and a departure from traditional SRI – or at least SRI as it has been traditionally understood.
Some SRI practitioners worry that a sustainability or ESG focus reduces every value to financial materiality – if ESG issues are only relevant to the degree they can produce financial results then, it is argued, sustainable investing unwittingly reinforces the conservative paradigm that the corporation's only duty is to make a profit. I don't think this is true. While it is certainly essential for any investment approach to make a financial case for market or above-market returns – and sustainable investing, unlike SRI, is able to do this – sustainable investing is actually much richer than this. It holds that the best companies (and the best investments) are those that act in the public interest; that serve all their stakeholders, not just shareholders; that do not externalise their costs onto society; and that pursue wealth creation strategies focused on the long term. Moreover, government (ie the public) has a positive role to play in regulating corporations and markets to redress social imbalances and optimise social outcomes. Far from suggesting that ESG criteria are only relevant to the degree they produce financial results, sustainable investing posits that long-term financial health is only possible to the degree that it respects and integrates ESG imperatives. In other words, corporations and markets must behave differently. Their wealth-creation strategies must become sustainable – we can no longer tolerate poverty and injustice and environmental degradation as the necessary by-products of market capitalism.
Sustainable investing, like any investment approach, is informed by certain values. The fundamental one is that properly functioning corporations and markets that internalise certain normative standards with respect to how they interact with workers, customers, communities and the environment will be more durable and valuable in the long run. There will therefore always be certain normative standards embedded in the ESG criteria that sustainable investing deploys. The desire to preserve and protect the planet, or promote diversity, or respect the human rights of workers, are all derived from values – just as all human activity is a reflection of underlying values. But "values" per se is not an investment concept and is of little use in defining an investment philosophy. In this regard, I think sustainable investing is a better formulation, and a better way forward for our industry. It is the best strategy for broadening our market, attracting investors and maximising our social and environmental impact.
This report appeared in GreenMoney Journal in its Spring 2008 issue. Article reprinted with permission from the GreenMoney Journal, a socially responsible investing newsletter publishing since 1992. For more information, visit GreenMoney Journal online at www.greenmoney.com.
1 I am defining sustainable investing as "the full integration of environmental, social and governance (ESG) analysis into investment analysis and decision making”, and distinguishing it from SRI, which has often been defined as "integrating personal and societal values with investment decisions."
2 Although neither my earlier article nor this one focus on shareholder activism or community investing, I do strongly believe that shareholder activism and community investing are core strategies at the heart of sustainable investing. With respect to community investing, it is by definition a form of sustainable investing as it is essentially investing directly in sustainable economic development. As for shareholder engagement, the notion of sustainable corporations (or sustainable markets) is literally impossible to imagine without presupposing active, engaged, empowered shareholders, ie shareholder democracy. I have chosen to focus on screening because, historically, SRI has been understood or perceived by the public largely on the basis of its (mostly negative) stock screens, and I believe this is a problematic positioning for the industry.
3 I did not contend in my article that SRI consists solely of negative screening, or that SRI firms don't employ positive ESG analysis. My only point was that, historically, SRI has been largely defined or understood in terms of its negative screens, and that this positioning is problematic – it tends to repel rather than attract investors, and retard rather than accelerate the industry's growth.
4 Interestingly, many if not most SRI firms that exclude alcohol don't really discuss the issue in their literature, so if SRI is trying to make a statement – it is one I suspect nobody really hears. Moreover, singling out alcohol for exclusion because it can easily be abused begs the question: why not exclude other things that are subject to abuse? Pharmaceuticals (oxycontin addiction), banks (how many Americans are in foreclosure or bankruptcy because they couldn't control their spending?), food (just one word: obesity), and many other products are equally subject to abuse.
5 There are several zero-tolerance screens in this received wisdom category – gambling, US Treasuries, nuclear power. Arguably, SRI firms impose these exclusions upon investors who often wouldn't choose them on their own, and such screens probably warrant greater scrutiny and intellectual rigor if they are going to remain part of the SRI armature.
6 Pax World Funds eliminated its alcohol screen in 2006. Since that time, Pax World Management Corp, investment adviser to the Funds, has become more involved in supporting the work of Odyssey House, a non-profit focused on programs for at-risk-youths struggling with substance abuse. We are currently helping Odyssey House build a recovery school for high school-age students dealing with substance abuse issues. We genuinely believe Pax World's support for Odyssey House over the past few years has already had a greater impact than did our alcohol screen over the entire 35 years of its existence.