Socially Responsible Investing: The Pitfalls of Socially Responsible Investing

siri1By Siri Yellamraju, Spring 2016 Student Intern

In theory, the goal of Socially Responsible Investing (SRI) is noble and practical. Who wouldn’t want to pioneer a movement towards investing in only the “good companies” and help the world? Unfortunately, many of the best companies that have generated the best returns and bolstered our economy are also some of the worst culprits in violating human rights laws, environmental regulations and general corporate governance rules.

As stated in this article from the Atlantic, at some level, our economic system is socially problematic. It’s hard to balance the goals of making money and benefiting the world at the same time. Investing in a free, capitalistic market comes with certain caveats and challenges. No matter how much you pay attention to where the materials are sourced from and the labor practices of the corporation, at the end of the day investors get a pay out when the company performs as well as possible. Corporations do not provide the requisite transparency needed in order to determine whether or not they are “clean handed” and socially responsible.

Over the past five and ten years, 65% of socially screened funds have performed below the average returns of other comparable funds. Many of the corporations self-report their performance, especially in regard to their compliance with environmental regulations (carbon footprint for example). If people are investing in a fund based on a number that can easily be skewed from being self-reported, directors and executives have more of an incentive to skew numbers. A firm’s ethical practices rarely affect the shareholder price and may actually end up being a loss to the investor. Intangible assets like employee satisfaction or customer perception of brand do not show up on balance sheets and income statements, and are not a part of the equation when determining stock price.

SRIs are also prone to being used as pawns in scams. It’s easy to market the benefits of an SRI when the factors that make the fund socially conscious do not show up on the balance sheet and are intangible. These factors can’t be measured, but can be observed or “felt” by the community. For example, the SEC charged an investment adviser who defrauded clients of $8.7 million. He promised to use their funds to invest in socially responsible companies but used it instead to pay other investors and fund his business.

By doing extensive research, enlisting the help of a reputable broker, investors can still invest money in funds that are socially responsible, but give a healthy return. After all, you can’t put a price on doing the right thing.