By Steven Dudash and Alex Papadopoulos
Both of us began our careers in financial services working at firms not far from the Northwestern University campus in Evanston, Ill. From time to time, a graduate student or professor would wander into our offices and inquire about socially responsible investments.
At the time, these vehicles were in their infancy. Few people outside of investment circles knew much about them, and not only were the options limited but as with most new ideas they were nebulous and somewhat difficult to define. Invariably, little, if anything, came of these conversations.
Fast forward 15 years, and the landscape has changed dramatically. Socially responsible investing, no longer a passing interest among a small slice of the public, has hit the mainstream. Today, we both meet an increasing number of clients who ask us how they can better align their investment portfolios with their core beliefs.
But for advisors, this is where things can get interesting: Even as this approach has become more fashionable, it’s not any easier to define, since clients often think about socially responsible investing in much different ways. For some investors, it means steering clear of certain companies, businesses or industries that conflict with their values – which could include anything from casinos to defense contractors.
For others, it’s not enough to simply avoid particular areas. It’s about investing in companies or organizations that actively promote various social issues – including poverty, hunger, crime prevention or climate change – and have strong corporate governance policies in place to protect workers. This latter view has even given rise to a new term in recent years, impact investing.
It’s up to advisors, therefore, to figure out what their clients really want. Or perhaps more precisely, what they want to be: merely a socially responsible investor or a more focused impact investor? Either way, here are some things to think about when discussing this topic with clients:
- What about the returns?: At one time, socially responsible investment options were limited, and the ones that did exist typically underperformed the broader market by a wide margin. It was almost like investors were making a sacrifice, choosing to feel good about where they had their money over the chance to earn higher returns with a more conventional approach. In essence, they were making a donation to a good cause rather than an investment (This was especially the case with impact investing). This is no longer happening. Socially responsible funds and companies are more than holding their own. Over the last five years, the KLD 400 social index has gained more than 60 percent, beating the Dow’s performance over the same time period by about 8 percent. Even more impressive, according to Market Watch, the fund’s average return has outpaced the S&P 500 on an annual basis since 1990.
- Maintaining diversity: Though socially responsible and impact investment vehicles have become more competitive – and in many instances, as demonstrated above, outperformed broad market indexes – it’s never a good idea to have an entire portfolio concentrated in one area. Advisors must help clients interested in this approach understand that any shift in focus has to happen within the context of well-built financial plan. Given how passionate many investors can get about this topic, this may be easier said than done. For the sake of diversity, the best approach is to either use new funds or to convert a small percentage of their current holdings to create a new portfolio. Otherwise, their core holdings, which are typically invested more broadly, should stay the same. More wholesale changes could not only put the client a greater risk but introduce new tax liabilities.
- Surviving downturns: The rise of many socially responsible and impact investment funds have coincided with a bull market of more than six years. That has led some to say that this investment approach may not be able to weather rockier times. That’s misguided. Many of the companies within these funds are now profitable, and the ones that aren’t receive significant government support, including a high number of wind and solar power firms. In fact, you could even make the case that, if anything, some of these funds may actually prove more resilient in down times. In this country, there still some debate about the impact of fossil fuels. Much of the rest of the world is not having that debate. They are convinced: Fossil fuel emissions must come down, and foreign funds that include companies working to produce wind, solar and electric alternatives could benefit in any market environment.
Clearly, not all your clients will express an interest in socially responsible or impact investing philosophies. But with more than 400 funds comprising more than 18 percent of all managed assets at the start of last year, according to Morningstar, socially responsible investments need to become a part of nearly every practice’s core capabilities.
Steven Dudash and Alex Papadopoulos serve as President and Senior Vice President, respectively, at IHT Wealth Management (www.ihtwealthmanagement.com), a Chicago-based firm with approximately $650 million is assets under management.