Many of my clients are interested in SRI. They would like to express their values through their investment strategy and are interested in an advisor who can assist them with developing a strategy based on their values.
If only it were that simple! There are several levels of understanding involved with SRI:
Level 1 Advisor to Client
The first is from the advisor to the client. Are the advisor’s method of compensation and responsibility to the client in alignment with the clients’ ethics? Most clients prefer to work with a client who does not receive commissions or other third party payments That way the advisor’s compensation is not influenced by the investment recommendations he or she makes. This model of compensation is called Fee-Only. Unfortunately the vast majority of advisors do not operate this way. They receive commissions and most clients do not fully realize how their advisor is compensated. Even fee-based advisors receive commissions. In order to advise a client on SRI the advisor’s business practices should also be ethical.
Level 2 Not all SRI Funds are the Same
Once the advisor is treating the client ethically, the next level involves the client’s values. There are two major types of SRI funds: Boycotters: those that do not invest in X-type of company and Influencers: those that do invest in X-type of company but try and influence its behavior through its ownership in the company. The client needs to decide what causes they believe in, and which SRI philosophy they believe in, Boycotter or Influencer.
Level 3 Understanding the Costs/Effects of SRI Investing
This is an area that is not discussed often. Like actively managed funds most SRI funds charge substantially higher fees than index funds (an exception is the Vanguard FTSE Social Choice Index), and may reduce diversification somewhat because many of them do not invest in certain sectors of the economy. The fee differential is about 1% per year. For example if you invested $500,000 in SRI funds you would pay mutual fund fees of $6,250/year assuming an annual expense ratio of 1.25%. If you invested in low cost mutual funds you would pay $1,250/year assuming an expense ratio of 0.25%
Often people also misunderstand the way the SRI funds influence company behavior. The common misperception is that by not purchasing a company’s stock you have a direct effect on the company’s bottom line.(they strategy of Boycotters). That is not correct in most cases. Once a company has issued stock they have their money. Any subsequent stock trades have no direct effect on the company’s finances. Investors are actually purchasing shares from each other, not the company.
There may be a secondary effect if (a big if) SRI fund actions can suppress the stock price since that will put pressure on the company’s management. This is the strategy that Influencer SRI funds use. Although they almost never control enough shares to dictate company policy they can shame or embarrass a company’s management by sponsoring resolutions. These campaigns can be effective on an issue like Darfur.
Level 4 Are there Alternatives to SRI Funds?
I love for my clients to make their own decisions and not to accept anything uncritically even if it agrees with their overall world view. With that in mind, I have proposed to clients an alternative approach: Invest in low-cost mutual funds and use the difference to directly fund causes that are important to you. Although I have no evidence, my belief is that this approach may be more effective in causing the change the client wants to see, especially if desired change is on a local level.
Much of the high fees of SRI funds go to analyzing which companies meet the investment criteria of the fund. I see this expense as a dead weight loss. By having the client invest that dead weight loss directly into causes they believe in the money is used directly on the change they wish to see.
Although, only a very few clients have taken this approach, I put it out there as an alternative to think about for people that are interested in SRI.
PS. If you really want to affect a company’s bottom line DON’T PURCHASE THEIR PRODUCTS or use less of them if the product is a necessity. This is much more inconvenient, but if enough people do it, so much more effective than not purchasing that company’s stock.
Often the most worthwhile things we do require some sacrifice.