The Shortcomings of “Socially Responsible” Investing

If there is anything the financial services industry is good at, it’s generating product that investors will buy.  Socially responsible investments play to many investors concerns about whether or not their portfolio is aligned with their values. Below is a rundown on why these products can be problematic for investors.

1) The first problem with “socially responsible” investing is that everyone has a different set of values. What one investor may deem to be irresponsible, another may call good policy.  Everyone has different values and certainly different priorities of those values. Do you value corporate governance? Or sustainability and environmental issues? What about issues relating to race, gender and sexuality? What about military contractors? Companies involved in the production of violent or sexualized materials? It is impossible for an investment manager to please everyone when it comes to social values.

2) The second problem is performance.  Like any other actively managed mutual fund, the socially responsible investment is more likely than not to underperform an appropriate market average, risk adjusted. While studies have been inconclusive about the relative performance of specific socially responsible investing strategies, it is reasonable to assume that these investments, on the whole, will underperform market averages by the magnitude of their total ongoing expenses, just as is true of all actively managed investments.

3) The final piece is a misunderstanding held by many investors. When an individual or mutual fund invests in a stock on the secondary market, the public company does not receive any proceeds of this transaction – the investor is simply buying a share in the company from another investor.  Only in Initial (or Secondary) Public Offerings (or IPOs) does the issuing company receive money from investors.  Otherwise investors are passive participants in the earnings of the company.

Ultimately we advise investors to maximize their potential investment returns by buying low-cost, broad based market indexes. Investors will then have the most opportunity to patronize businesses whose practices they agree with, or make charitable or other gifts to influence social and public policy according to their values.

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