Socially Responsible Investing: why it fails and how to fix it.

The future of Socially Responsible
Investing (that is investments made to serve a social purpose instead
of a purely financial one) faces a long difficult battle against its
inherent contradictions. If SRI strategies are disappointing it's
because their proponents have thrown out financial planning basics
and lack the creativity necessary to compensate. Most SRI options
take the form of mutual funds which are popular investing products
because their diversity, flexibility, and professional management
shelter them from violent swings in the market. But SRI philosophy is
all about screening, an action that whittles down the list of
potential stocks and bonds under the fund considerably. This limits
diversity and ties up the discretion of the fund manager in
sustainability reports and corporate responsibility ratings.

SRI converts are quick to point out
that despite the higher costs of these mutual funds, despite the
restrictions on what companies and industries can be invested in, SRI
funds do produce returns for the investor. Modest returns, sure, but
returns nevertheless. A quick look at major holdings reveals why this
is and brings up another reason why SRI doesn't work. SRI funds are
bursting with blue chip stocks: Walmart, AT&T, Apple, Dell....
This may be fine and good, but how socially responsible is Starbucks
really? Sure they buy Fair Trade coffee and probably aren't dumping
toxic waste into the ocean, but will their business practices produce
a better world or just change the troubles in the background?

Perhaps the biggest indictment of SRIs
is that they are sold as proactive investments when at best they're
more like the financial equivalent of carbon neutral. The companies
in their folds aren't necessarily improving society, they're just
progressive enough to cancel out whatever other damage they might be
causing. Since there is no way to objectively measure social benefit,
there's no definitive way to say SRIs don't improve society at large.
It comes down to common sense: would you live in a world that Xerox,
McDonalds, Microsoft and WholeFoods built? What would that world even
look like?

The SRI theory excuses owning shares
of such companies by claiming that by being stock holders, the fund
has voting influence over the corporation and can guide it to better
business practices. But in reality we run into another contradiction
between form and function: mutual funds are supposed to spread assets
over as many different companies as possible, in order to have enough
of a voting share to really make a difference one way or the other in
a company the fund would have to have an insane amount of capital.
For example, PAX World's Women's Equity Fund owns 12,500 shares of
Johnson & Johnson (roughly 2.5% of the total portfolio) valued at
about $840,000 currently. 12,000 shares seems like a nice piece of
action unless you consider that Johnson & Johnson has over 2
billion shares in play. If we assume that 50 million shares might
give you enough influence to really change corporate policy, PAX
would have to invest roughly $3 billion. In order to keep its
portfolio appropriately diverse its holdings would have to be within
the trillions.

Building Better Social Responses

I may not see the point in trying to
completely nullify my carbon footprint, but I accept that working to
offset our damage is a positive step that needs to be embraced. So it
is also with SRI, it's a step in the right direction that shouldn't
be thrown away.

Can SRI actually improve our world and
our pocket books? Yes. The key is creativity, the willingness and
ability to stretch out beyond the small safe pool of blue chips. In
fact, there are five steps that the SRI community can take right now
to bring the industry closer to its goals. Some are already being
done a little bit here and there and all of them are well within the
grasp of industry leaders.

Step 1: Have a Vision

The problem with most SRI options is
that they are too general. They don't produce any social benefits
because they don't have any specific social goals. There's no such
thing as a perfectly responsible company and there never will be, so
SRIs need to stop screening and start prioritizing. Already on the
market there are “Green Funds” that are specialized around
improving the environment, but there needs to be more movement
towards specialization. Without it, SRI funds end up holding
investments that often seem to cancel each other out in social
benefit, like Corning and Coca-Cola.

Step 2: Go Global ... No REALLY Global

Why don't more SRI funds invest in
foreign markets? When the dollar began to sink, my European ETF's
were strong performers. Still, despite the dippiness of the US market
over the last ten years (first the dot com bubble burst then subprime
tanked...) the closest most SRI funds get to global are American
conglomerates. While some SRI groups have special international
funds, these too stay with blue chip stocks in major exchanges.
Emerging markets may be a huge risk for a fund, but companies trading
on the smaller exchanges are often dealing more directly with the
issues SRI supporters want to get behind: human rights, development,
poverty, health. Cellphones and solar power, for example, are huge
thriving industries in developing parts of Africa and Asia because
they allow businesses to sidestep the massive infrastructure
investments that would otherwise have to be made by their governments
to get telephone and power service across the country. Companies
dealing in this are listed on smaller exchanges across the globe and
our doing more for poor countries than billions in foreign aid have
done.

Step 3: Embrace Social Enterprise

A few funds talk a bit about investing
in smaller more innovative private companies, but in practice this is
translating to a few scrappy alternative energy investments. A sad
state of affairs indeed because the possibilities for this kind of
investing are plentiful. Little private companies aren't just
building better fuel technology, they're also running Fair Trade
factories, building energy efficient houses, rehabilitating street
youth ... the list is endless.

Step 4: Amp Up Community Investing

Most of the major SRI funds claim to do
Community Investing (putting money into credit unions, rural banks
and microfinance institutions) as part of their commitment to social
responsibility, but in fact even Calvert Funds, which runs its own
bond program specifically for this type of investing (Google Calvert
Foundation Community Investment Notes), only puts 1%-3% of the assets
of SOME of their funds towards it. With the impressive repayment
rates of microfinance loans, Community Investing risks are relatively
low. The only reason not to put more into it is that such investments
have no hope of covering the overwhelming expenses of SRI funds.

Step 5: Get into Real Estate

Until recently economic development and
environmental protection did not go nicely together, but the age of
the global citizen has given birth to many new trends where we can
have our cake and eat it too. If only there were some Real Estate
Investment Trusts around to nurture growing industries like
ecotourism and agritourism! Ecotourism alone is the fastest growing
sector of the world's largest service industry. Tourists come in to
see the untouched beauty of the planet, resorts that offer low key
sustainable accommodations, and a slice of local life. It's a
win-win-win situation: the environment gets protected, the economy
gets stimulated, new jobs get created while local traditions are
preserved. Although not without potential flaws, ecotourism has been
successful in Costa Rica, in West Africa, even underwater.

SRI strategies do not fail because
it's a bad idea to blend capitalism with causes. They fail because
instead of trying to create truly new investment products, they
create old investment products with trendy marketing and little
substance. If an investment company is going to employ a full
research department to screen companies for SRI criteria, there's no
reason why they should be so myopic in where they find their
investment opportunities. Discretion and good judgment are
essential-- blowing your money on a shady cotton company or a failing
biofuel producer doesn't really help anybody-- but “safe”
investments should be there to balance out a few “risky” picks
that are carefully selected because of the social impact they can
make.