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What You Should Know About Socially Responsible Investing

Hands are holding coins and a small tree, including an arrow symbol pointing up, demonstrating growth
Socially responsible investing refers to a class of investments that seeks to not only achieve positive returns but also contribute to a wider social good.

As concerns around issues such as climate change and social justice continue to gain prominence globally, many investors are increasingly paying attention to the social and environmental footprint of the companies they invest in.

Factors such as an investment’s long-term impact on humanity and the environment, along with associated financial risks, now have a role to play in an investor’s decision to invest or not.

In this article, we’ll look at the evolution of socially responsible investing and the steady rise of ESG integration. We will also explore the factors to consider when practicing socially responsible investing and some of the challenges associated with ESG investments.

Socially Responsible Investing Explained

Socially responsible investing (SRI) refers to a class of investments that seeks to not only achieve positive returns but also contribute to a wider social good. For example, investors may decide to invest in companies that treat their employees well or avoid businesses with a large carbon footprint. Evaluating the company performance against Environmental, Social, and Governance (ESG) criteria is one of the latest SRI strategies.

Socially responsible investing is often used interchangeably with ESG investing, green investing, ethical investing, sustainable investing, and impact investing; however, it is rather an umbrella term that embraces a variety of investment techniques and approaches, which we talk about below. While SRI has been around for decades, it has become a major topic of interest for many retail investors only in recent years.

How Socially Responsible Investing is Creating Change

The image shows a hand holding a coin, as well as three jars with coins and growing plants inside.

Choosing to invest money in a particular company or fund is a way to express your social and environmental values. Increased investment in socially responsible businesses can put pressure on companies that aren’t yet committed to embedding ESG values in their business operations.

As interest in ESG increases, so too are the kinds of investment products investors can buy. A growing number of institutional investors, such as pension funds and insurance companies, are proactively rethinking the investment solutions they can offer.

To keep up with the growing number of investors who want to understand how companies manage ESG-related risks, investment companies are engaging with corporate management teams to encourage improvements such as better transparency.

According to the Responsible Investment Association study, socially responsible investing is appealing to younger investors, such as Millennials, as they look to invest in companies and funds committed to social and political change, or environmental stewardship in addition to being profitable.

Socially responsible investing has come a long way and continues to transform the investment landscape in Canada and around the world.

What Makes a Responsible Investor?

Socially responsible investing takes on many forms. Investors can exercise their shareholder rights to advocate for changes in business philosophy, put money into companies that stand for environmental stewardship, or avoid companies that come with perceived ESG-related risks.

Here are some common SRI strategies that investors use:

  1. Negative screening: exclusion of certain industries, companies, or practices from a portfolio based on ethical criteria (e.g., alcohol, tobacco, weapons, gambling, fossil fuels).
  2. Positive screening: inclusion of certain companies in a portfolio based on their ESG performance (these are usually companies with a strong track record in sustainability).
  3. Thematic investing: investments in specific sustainability themes such as renewable energy, women-led businesses, ecosystems restoration initiatives.
  4. Impact investing: is very similar to thematic investing and includes investments in companies, organizations, or funds that can directly influence community development (e.g., housing, healthcare, education).
  5. Shareholder activism: using shareholder power to improve a company’s practices on the ESG front (e.g., attending and voting at annual meetings, inspecting corporate documents, engaging in dialogue with company management or board, submitting shareholder proposals).
  6. ESG integration: evaluating an investment’s financial potential through the lens of an environmental, social, and governance criteria framework.

A Closer Look at ESG Integration

The image is meant to demonstrate the concept of socially responsible investing: shows a coin lamp and a plant sitting on top of various financial documents.

ESG integration is a relatively new strategy that puts less emphasis on ethical concerns and is rather designed to maximize risk-adjusted returns. ESG builds on the ideas of socially responsible investing but relies more heavily on evaluating the financial relevance of non-financial factors.

In other words, a company that strives to achieve net-zero emissions and adheres to sustainable practices in its supply chains is likely to be a more favourable ESG investment than one that does not have the same objectives. ESG covers a variety of topics and industries which are applicable to all organizations in one way or another.

Let’s take a closer look at the ESG acronym to highlight the components investors pay attention to when considering ESG investing:

Environmental: Factors that consider a company’s impact on the environment, in both positive and negative ways. Environmental aspects of a company to research and analyze include:

  • Greenhouse gas emissions and carbon footprint
  • Environmental risks posed by business activities such as pollution, deforestation, destruction of ecosystems
  • Use of natural resources: air, water, land
  • Waste management practices
  • Usage of renewable/non-renewable energy
  • Sustainability policies, strategies, and disclosures
  • Compliance with government regulations
  • Commitment to R&D (Research and Development)

Social: Criteria that reflect a company’s culture and how it treats its employees, customers, suppliers, and local communities. Social aspects of a company to research and analyze include:

  • Fair and equal employment standards as it relates to wages, social benefits, opportunities for growth
  • Employee safety policies, including those related to sexual harassment prevention
  • Gender, diversity, and inclusion policies
  • Sustainable supply chains, including relationships with both natural and human resources
  • Public stance on social justice issues

Governance: Factors that encompass corporate policies and how a company is governed. Governance aspects of a company to research and analyze include:

  • Executive compensation, bonuses, and perks
  • Incidents of corruption and bribery
  • Diversity within the board of directors and the management team
  • Level of corporate transparency in communicating with its shareholders and stakeholders
  • Commitments to allocating capital effectively for the benefit of shareholders

How to Get Started with Socially Responsible Investing

An image of an arrow-shaped tree pointing upwards and sitting on a beige background. Symbolizes the concept of ESG investing

If you are new to socially responsible investing, a good idea is to work with a registered investment advisor with expertise in SRI and ESG screening who can help you build an SRI portfolio that is in line with your values and financial goals. Alternatively, you may consider using a robo-advisor, or do-it-yourself through self-directed investing. Several brokerage firms, mutual fund companies, and robo-advisors now offer SRI portfolios.

Regardless of how you decide to manage your investments, conducting research will better equip you to make the right decision or assess your advisor’s recommendation. Consider these steps when researching a company:

  • Examine corporate websites and search for sustainability strategies, annual reports, or stand-alone sustainability reports using global sustainability standards.
  • Look for concrete numbers and metrics that demonstrate real progress towards sustainable transformation.
  • Monitor media coverage and use independent sources to double-check everything you hear or know about the company.
  • Keep up with the latest ranked lists from respected business sources.
  • Read employee reviews on popular employee ranking websites or job boards.

As with any other investments in your portfolio, it is important to regularly revisit your holdings to make sure they still align with your financial goals and risk profile.

Challenges Associated with ESG Investing

Canadian securities regulators, such as the BC Securities Commission, are paying close attention to investor protection in the growing SRI and ESG markets. Improving transparency and ensuring that companies provide investors with accurate information have always been a priority.

Data collection is the trickiest part of ESG investing as there is no standardization for how organizations report ESG information, and much of it is self-reported. Under Canadian securities law, there are several guidelines and corporate governance-related disclosure requirements (typically provided in a company’s management information circular); however, requirements mandating environmental and social-related disclosures are currently limited. Sustainability disclosures are often provided on a voluntary basis. Traditionally, these are policies, targets and outcomes, focus areas, and specific initiatives.

Since there are currently limited ESG reporting requirements, and no standardized terminology, investors should be cautious when reviewing company disclosures and investing in ESG assets.

How to Protect Yourself

Like any other type of emerging investing trend, sustainable investing has become increasingly susceptible to marketing hype. Unfortunately, many companies today are advertising themselves as environmentally sound, when in fact they may not be making any meaningful commitment to green initiatives. Such strategies are known as greenwashing and may provide misleading information about a company’s environmental practices to drive profits rather than meet investors’ needs.

Play it safe when it comes to a company’s adherence to ESG commitments. Here are some tips that can help prevent you from falling for misleading marketing slogans:

  1. Conduct thorough research to avoid falling into the ESG marketing trap: Read about the company philosophy, sustainability goals, and achievements to date.
  2. Define your values: Be clear on what matters to you and what you want to achieve with your socially responsible investing strategy.
  3. Be sure to understand what you are investing in: Seek independent, professional advice to learn about the associated costs, risks, and opportunities from sustainability trends.
  4. Do not let anyone pressure you into an investment opportunity: Watch our videos to understand the fraud warning signs and learn how to protect yourself from investment fraud.
  5. Do not invest more than you can afford to lose: Be sure to prioritize and set boundaries, as well as know your financial goals, and risk tolerance. Remember, regardless of how new and appealing the investment trend is, investing always comes with risk.
  6. Consult with a registered investment advisor: Seeking a professional’s help can give you better insights into emerging trends such as ESG investing.
  7. Demand greater corporate transparency: Push for more openness, better communication, and stronger accountability from companies you invest in.
  8. Check with your local securities regulator: If you are concerned about an investment or individual selling an investment, contact the BCSC.

Report a Concern

If you have any concerns about a person or company offering an investment opportunity, please contact BCSC Contact Centre at 604-899-6854 or 1-800-373-6393, or through e-mail at [email protected]. You can also file a complaint or submit a tip anonymously using BCSC’s online complaint form.

InvestRight.org is the BC Securities Commission’s investor education website. Subscribe to receive email updates from BCSC InvestRight.

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