Due Diligence Needed in Socially Responsible Investing

Published April, 2018, Investopedia

Environmental, social and governance exchange-traded funds (ETFs) are heavily marketed right now, and the idea that you could avoid profiting from corporate practices you consider unethical is appealing. The problem is many of these managed funds and ETFs marketed with socially-conscious monikers contain investments that might surprise you, while others include companies that have not been socially responsible in the past. An additional issue is creating enough diversification in your portfolio with such a limited number of options.

Screening Environmental, Social and Governance ETFs

Screening for stocks you don’t want to buy is called negative, or avoidance, screening. Common negative screens include tobacco, weapons production and firearms.

While negative screening indicates companies and industries you should avoid, positive or affirmative screening results in a portfolio that is more in line with your beliefs. You can select companies that are leaders in new product creation and design, engage in fair employment practices, have a diverse board of directors, are supportive of the environment and champion human rights.

Positive screens require more analysis into the issues of employment practices, corporate governance, polluters and diversity. Given the time necessary to properly analyze each holding, it is practical to combine a well-invested environmental, social and governance (ESG) fund with several individual, positive-screened companies.

Diversifying With ESGs Can Be Challenging

True diversification is difficult with this strategy because many ESG companies are smaller corporations, which limits your ability to diversify based on company size. If you decide to add larger companies, you run into the issue that large companies are more complex. Many have long histories that may include negative qualities, which you will need to decide if you want to take into consideration or ignore. Perhaps a company in the past was a big polluter but they have changed their corporate attitude towards a cleaner more sustainable future. Is it enough that they are moving towards a more positive future, or do you want all of your investment to be in companies that never polluted?

Take an Active Role

If you want to be a socially conscious investor, you have to take an active role in determining your investment portfolio. you should monitor corporate filings to make sure the companies’ policies are acceptable, and notify them if not. Screening has come a long way; the ability for an investor to develop a diversified portfolio of socially responsible investments has been aided by more sophisticated analysis and an awareness of what the socially conscious investor is looking for. Ask what investments are in the funds you own, have discussions around your screens and look for progress towards your goals for company ownership. Then engage in regular monitoring to ensure the investments you own are in line with your beliefs.

-Elyse Foster, CFP® 

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