The first obvious question when investigating this type of investment approach is to consider which investments and companies fit the criteria of being "socially responsible". The criteria many SRI investors look at first are whether a company operates in a sustainable, ethical field.
Companies that are involved in industries such as arms manufacturing, tobacco, gambling and alcohol may be crossed off the list of potential investments. Companies that are involved in less harmful areas of business but are excessive polluters (some manufacturers or mining companies) may be excluded.
Any companies with poor labour practices or those that engage in any cruelty to animals (such as cosmetics testing) would also be excluded. This process of eliminating companies is called negative screening.
Some ethical investors will also exclude investing in certain countries based on political policies. For example, they may rule out countries that engage in whaling or those that do not respect human rights to a satisfactory degree.
Conversely, positive screening can be used to seek out companies or industries that actively pursue sustainable business practices and are involved in industries that have a positive social impact.
Companies that are working on developing alternative energy technologies, water desalination or improving waste disposal methods may be identified as reasonably obvious positive environmental contributors.
But from there it gets more difficult. There are few businesses that will come through an SRI evaluation process with a faultless record.
At first glance, Australian supermarket giant Woolworths would appear relatively benign when considering companies with questionable social motives. But while the company operates a relatively unobtrusive supermarket operation for the most part, it is also the largest alcohol retailer, the largest pub owner and the largest poker machine operator in Australia.
However, Woolworths is committed to reducing its carbon footprint by 970,000 tonnes over the next few years by reducing its water use, using less packaging and recycling more often. It has implemented ethical sourcing policies for palm oil and it donated A$18.5 million ($23.8 million) to the Australian flood appeal.
As an electricity generator that produces energy only from hydro and wind generation, TrustPower is a great candidate for an SRI portfolio. But there are negative environmental impacts associated with hydro dams that temporarily alter the natural flow of rivers, and windmills, which don't mix well with birds.
Fletcher Building might not be the most obvious candidate at first glance with its construction and manufacturing divisions. But it has policies that aim to minimise waste from its products and workplaces. It focuses on energy-efficiency and includes the use of recycled raw materials where possible.
Determining which investments fit the definition of socially responsible is difficult, not to mention subjective. What one investor considers ethical may be very different from another's and all of us draw the line in different places. Some investors may exclude entire industries, while some may be happy to focus on the companies that are simply "less bad" than the others.
TrustPower would probably be included in a list of potential SRI investments because the balance of positives far outweighs the negatives. It remains a much more sustainable proposition than many energy generation alternatives (such as those reliant on fossil fuels) and it is a well-run company with high ethical standards.
Fletcher Building could also make the grade for having sustainability awareness and some sensible policies that make the effort to minimise and mitigate any negative impacts.
Woolworths would pass the test on environmental concerns, but some investors might ask questions of its suitability from a social perspective.
Most SRI investors take a pragmatic rather than a purist approach. Many others have an element of socially responsible investing in their methodology already without even realising it. Once an approach has been formalised, the key challenge with putting it into practice is that SRI investors inevitably limit their investment universe because they have fewer options to choose from.
Despite this limitation, it's important to maintain usual investment standards. There's no point supporting a range of sustainable companies and industries while compromising the sustainability of your investment portfolio. Socially responsible considerations must also fit within the usual investment criteria and financial assessment.
The question of whether socially responsible investors do better or worse than those who make their decisions purely on the basis of financial opportunity is debatable. One would cynically think limiting your options would put you at a disadvantage from other investors.
Others would suggest there is a strong case for sustainable and ethical companies to provide higher long-term returns. They would argue that those companies that embrace a best-practice approach to environmental, social and governance factors will ultimately rise above those that take a less responsible, more short-term attitude to their business.
The Dow Jones Sustainability World Index identifies sustainability leaders across 57 industry groups and tracks their performance. This index is 43.4 per cent higher than it was 10 years ago, compared with the MSCI World Gross Index, which is 50.9 per cent higher. That statistic would suggest the cynics are correct, although there are several ethical funds that have managed to do better.
I would also suggest that for many companies and industries it may take time for the most sustainable to rise to the top. Some ethical investors might choose to give up some return for the satisfaction of investing in line with their values.
The company that was in control of the Rena is privately owned, although the Greek company that built the vessel is listed on the New York Stock Exchange. Whether it would have passed an SRI assessment remains to be seen.
There is a definitely a place for ethical investing and it is something that many of us should take note of when deciding who deserves our hard-earned capital. A balance between the two extremes is probably about right for most people and such considerations represent a commendable way of thinking when looking across investment options.
Disclosure of interest: Craigs Investment Partners operates a Socially Responsible KiwiSaver fund. Mark Lister is head of Private Wealth Research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as personalised investment advice.
