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SRI is the most commonly used acronym for “Socially Responsible Investing” or more recently “Sustainable and Responsible Investing."
SRI is an umbrella term to describe an investment strategy that allows investors to seek a financial return by investing in companies that align with their values and objectives. This is accomplished by directing investment toward companies that exhibit responsible corporate practices and/or avoiding companies that demonstrate unethical practices.
Some of the elements that SRI takes into consideration are: the nature of the business the company conducts, the products the company may sell, and the company’s demonstrated values. Historically the investment strategy was to exclude companies and industries on the basis of moral values (e.g., alcohol, firearms, tobacco, gambling, etc.). While this type of strategy still exists, it is important to note that SRI has evolved beyond emphasizing exclusionary screening based on a narrow range of criteria. Today greater emphasis is placed on which companies to include, rather than exclude, from a portfolio, giving rise to a range of complementary approaches that can be used to implement sustainable investment strategies.
ESG describes three specific segments through which a company may be analyzed and scored. Positive ESG criteria identifies the companies best positioned to deliver strong long-term financial performance.
The general belief is that companies with better performance on ESG issues, such as strong workplace practices, product safety, and environment protection, will have better financial performance.
Some investors and financial professionals are skeptical of sustainable investing because, intuitively, shrinking one’s investable universe could make outperforming the market more difficult. However, researchers from the University of Oxford and Arabesque Partners aggregated 200 studies globally and reports on the impact of sustainability on corporate performance and found the following:
One proxy commonly used to measure the performance of sustainable companies is the MSCI KLD 400 Social Index. This index is composed of firms in the U.S. with the highest ESG factor ratings relative to their industry peers, and it completely excludes companies in the alcohol, gambling, tobacco, weapons, and adult entertainment industries. Over the past 10 years, the MSCI KLD 400 Social Index has slightly outperformed the S&P 500 Index and has also done so with slightly lower volatility.
Source: LPL Research, FactSet 08/31/18Data are as of 8/31/18.
Essentially ESG is an added layer of scrutiny through which to analyze a company’s health and merit as an investable option.
According to industry experts at the CFA Institute, “systematically considering ESG issues will likely lead to more complete analyses and better-informed investment decisions.”1