Does 'Feel-Good Investing' Come at a Low-Return Cost?

Socially Responsible Investing (SRI) – whereby people or institutions put their wealth in mutual funds, pensions, and companies that are environmentally “responsible”, socially “aware”, and have corporate governance policies that meet certain criteria–is the latest fad among the virtue-signaling crowd. Companies that produce carbon emitting products, firearms producers, and alcohol and tobacco companies are traditionally excluded from such funds.

But do these feel-good investments come at an economic cost? And if so, is it worth it? Some research strongly suggest that such investments could very well lessen one’s nest egg.

As a free-market capitalist, I am all for allowing people to (legally) spend their hard-earned money however they wish, even if the choice may seem to be economically questionable: For instance, playing roulette in Las Vegas offers gamblers mediocre odds compared to other games of chance, but I would never begrudge anyone who chose to play that instead of poker. People accept the worse odds because they may enjoy roulette more or like the chance of a bigger potential payoff.

But, as this example suggests, one should be aware that there are always financial consequences to one’s economic decisions.

If Vegas isn’t your thing, but being able to feel good about yourself and impress your politically correct friends and co-workers is, you should know there very well may be economic consequences to your investment choices as well.

To quote a popular axiom: Caveat Emptor.

Milton Friedman once opined that "There is one and only one social responsibility of business--to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

And yet many investment advisors are now counseling their customers to take “social” considerations into their investment decisions, and many pension fund and mutual fund managers are effectively taking political considerations into account in their portfolio management as well.

Robert Powell recently noted in USA Today that “Assets under management in portfolios that use various approaches to sustainable investing have grown to an estimated $23 trillion globally, an increase of more than 600% over the past decade.”

He attributes this growth, in part, to the fact that many investors are being advised that they can invest in SRI funds without any financial downside.

However, asserting that there is no cost to allowing politics to influence an investment strategy is facile at best.

For example, a recently-published study by Advisor Perspectives suggests that SRI/ESG investing results in lower than normal returns:

“New evidence from one of the world’s largest sovereign wealth funds shows that those investors are sacrificing significant performance…(w)hile SRI and ESG investing continue to grow in popularity, economic theory suggests that if a large enough proportion of investors choose to avoid “sin” businesses, their share prices will be depressed. They will have a higher cost of capital because they will trade at a lower P/E ratio, thus providing investors with higher returns (which some investors may view as compensation for the emotional “cost” of exposure to offensive companies).”

Furthermore, as a study by the Wharton School found that:

“There are far fewer socially responsible funds than ordinary funds. As an investor’s criteria for choosing funds get narrower, there is a growing chance that the best performance will be delivered by non-socially responsible funds. So the investor who puts great stock into the track records of active managers, and wants to focus on a narrow segment such as small-stock value funds, may sacrifice a lot of performance by limiting himself to socially responsible funds…It would be hard to believe that you would not pay a cost for severely reducing the acceptable fund choices…”

In fact, some have suggested that one can be more "socially responsible" by investing in better returning pension funds, mutual funds, and stocks and then using one’s greater returns to donate to charities that promote the social causes in which one believes strongly.

The bottom line is: 

If you believe carbon emissions are killing the planet: buy a bike;

If you believe guns are evil: don’t buy one;

If you believe smoking and drinking are socially unacceptable: don’t drink or smoke.

But if you want to ensure that you have sufficient assets to retire someday, don’t let politics affect your investment decisions.