Peer under the hood of your mutual fund or portfolio of index investments. If you’re like most people, you’ll find that you own shares of at least a few companies that make you squeamish. Perhaps you no longer wish to make money when Equifax collects and sells your data, especially when it has proved that it can’t do so safely. Or perhaps you have soured on big banks that treat customers poorly.
And it should come as no surprise that in the wake of the deadly Florida school shooting, some people would want to use their largest pool of capital — their investment portfolios — to single out the gun industry.
For those so inclined, the good news is this: There are more opportunities than ever to invest with a conscience. One firm, Wealthfront, will even let you strip individual American companies that rub you the wrong way from one of the index-fund-like portfolios it creates for you.
But with all these choices comes a fair bit of confusion. To land the biggest blow with whatever investing dollars you have, you’ll first need to confront at least seven challenges.
DEFINITION While mutual funds that aim to change the world for the better have existed for over 45 years, it’s not clear even in 2018 what to call them. The term “socially responsible” seemed most apt for a while, then the awkward acronym E.S.G. came into vogue. It stands for environmental, social and governance.
The environmental part is easy enough to understand, and there are plenty of yes-no questions you can ask about how a company governs itself. But “social,” an echo of “socially responsible,” could mean nearly anything.
Jon Hale, who is the director of what the research firm Morningstar refers to as “sustainable investing,” suggests that people begin with two questions. First, do you want to align your investments with the transition to a low-carbon economy? Second, do you want to contribute to the development of a global economy that works for more people?
If you answer yes to either, you’re a candidate for sustainable investing. And you can move on to the next challenge.
MEASUREMENT What funds are worth considering and who evaluates them?
In a report in January, Morningstar published a list of 235 funds that you could use as a kind of menu. In 2016, the company also introduced a “sustainability rating” for more than 20,000 funds of all sorts. It describes the rating as a measure of how well funds handle environmental, social and governance issues compared with their peers.
There is no substitute, however, for examining the actual holdings of any fund. You never know, for instance, when a coal stock may somehow end up in your socially responsible fund. If that happens, it is worth figuring out why and determining whether it’s a deal killer for you.
EXCLUSIONS What do you not want in your portfolio and why?
In the first couple of decades of sustainable investing, the funds that aimed to invest on principle often avoided, say, oil stocks. Some of this still goes on today. One fund company called Inspire, according to one of its prospectuses, avoids companies that have “any degree of participation in activities that do not align with biblical values.” It includes among that list “the LGBT lifestyle,” without further elaboration.
Do you want gun stocks out of your portfolio? There may be mutual or exchange-traded funds that exclude them, but how far do you want to go? Publicly traded retailers like Walmart and Dick’s Sporting Goods sell guns, after all, even if they don’t make them. (This week, both companies announced new restrictions on gun sales.)
PERFORMANCE The knock on this group of funds has always been that they tend to underperform the closest comparable index fund. That notion, however, may prove to be outdated.
A 2015 study in the Journal of Sustainable Finance & Investment, which rounded up and examined about 2,200 pieces of research, found that about 90 percent of those studies showed no negative relationship between concern for social factors and corporate financial performance. A large majority, in fact, showed positive findings that were stable over time.
COST AND DIVERSIFICATION If you’re a committed index fund investor, seeking to own every stock or bond (or every sustainable one) in a particular market segment (say, small European companies), it may not be easy to do so cheaply if you can at all. And low costs, after all, are a primary attraction of index funds.
Betterment, one of the so-called roboadvisors that uses software to put people in inexpensive portfolios, introduced its socially responsible investing offering last year. The company announced it with an accompanying written lament about how it simply could not find low-cost ways to put customers in any comprehensive, socially responsible market-spanning funds except for ones that invest in large United States stocks.
“Currently, most accessible S.R.I. approaches make investors choose between a well diversified, low-cost portfolio and an inadequately diversified and/or higher-cost portfolio comprised of S.R.I. funds,” wrote Alex Benke, who is now company’s vice president of financial advice and planning.
ACCESS Many people make the majority of investments through workplace retirement plans, but so far most employers haven’t included these sorts of funds in the offerings for 401(k) and similar plans.
According to one industry study of 421 plans, just 14 percent offered at least one sustainable fund and only about 1 percent of assets ended up in the investments. Employers these days are reluctant to make their investment menus too long, so it is hard for any fund that is not plain vanilla to make the cut. Bloomberg is one exception; it guessed correctly that some employees would embrace the option.
CONTROL At first glance, Wealthfront’s approach to socially responsible investing is a sort of fantasy version of investing for control freaks. People who have more than $100,000 in a taxable account (which means individual retirement accounts are not eligible) can ask the company, which is a roboadvisor, to strip individual companies out of their stocks holdings.
Angry at Wells Fargo? Kick it out of this part of the portfolio. Dive into the details and other restrictions, however, and it becomes clear that you still may end up with exposure to many of the companies that you deselect in other parts of your Wealthfront stock and bond portfolio.
Still, the concept is tantalizing. If every investment adviser could invest directly in thousands of stocks and bonds for each customer (and didn’t simply buy inflexible mutual funds or exchange-traded funds), we all could apply our own social screens and excise any company that did not meet our own idiosyncratic standards. (At Wealthfront, some investors seem fond of dropping the big banks that nearly destroyed the economy in 2008.)
So is this the future for fans of sustainable stock and bond screening? Divesting in this fashion is one form of protest. But staying in a stock and confronting the company is another.
At Betterment, Boris Khentov, vice president of operations and the company’s legal counsel, imagines a time not too long from now when index-fund investors, who lack actual shareholder voting privileges at individual companies, can use self-organized social media campaigns to pummel the management and board members of misbehaving companies.
That sounds almost as much fun as knocking a company out of your portfolio. Is he building such a social campaign system? “It’s not on the immediate road map,” he said. “But we’re dreamers.”