All the various terms surrounding responsive investing can leave folks a little confused. What are the differences between SRI and ESG? Is one better than the other? Which should I use? My opinion is don't overthink it. All of these terms have far more in common than not. It's less important what a strategy is versus what a strategy does. And you can have impact in so many different ways, ranging from investing in a venture capital portfolio of companies owned and operated by women, to a mutual fund investing exclusively in companies focused on renewable energy, or even as simple as having your checking account with a local credit union.
All of these are seeking both that financial and social impact, but they run the gamut in terms of level of risk and level of reward. So don't think of responsive investing as an asset class. It's an additional arrow in your quiver that runs up and down the asset class spectrum. But probably the two most commonly known terms, are SRI and ESG, and certainly the older of the two is SRI, which dates back decades and has kind of historically been defined as strategies that excluded particular stocks or industries, things like alcohol or tobacco or gambling or investments in South Africa a couple of decades ago. The idea being get rid of the things that we disagree with, starve the industry of capital, and you can reduce its negative impact and force change.
ESG carries with it a bit more holistic process. So it certainly will exclude stocks or sectors, but also takes into consideration what that excluded stock brought to the portfolio. Was it yield? Was it diversification? Downside protection? So where can we find a different security that offers those characteristics? ESG will identify a problem, say excluding fossil fuels, but will also proactively look for investments that may have the solution to those problems. Over the past 10 or 15 years, we've seen a deeper look at responsive investing by strategies, not just excluding the negative, but also including companies that have positive social trades. Companies that have a positive work environment, companies that have a strong environmental record, companies with diversified boards. These characteristics may very well give a company a competitive advantage. So there is an increased return potential and maybe traditional financial analysis doesn't fully take these things into account. So a portfolio manager that factors in ESG criteria may have a competitive advantage over other managers.
Maximizing positive factors, like treating employees well, treating the environment well, recognizing blind spots and working to reduce them, if all of these can improve society and can improve shareholder return, then there should be efforts to dialogue with corporate management and try to use your voice as a shareholder to maximize that positive impact. The last several years, we've seen an explosion of investment opportunities within the responsive investing network, everything from a passive S&P 500 fund that excludes tobacco to venture capital focused on global hunger and racial diversity. What's clear is that the investor base is demanding new and innovative ways to align their mission with their investments.
The industry has responded by providing investment solutions for sure, and that's been a plus and it's been a negative. ESG strategies are truly seeking to address societal challenges and are disrupting portfolios in a manner to see measurable financial and social return. There are other strategies that are perhaps a bit more marketing driven versus impact driven. That can lead to some tough questions to answer: Are my managers actually seeking to affect change? Is their process sound and is it repeatable? Is this just greenwashing?
Whether you're looking for a single manager to add your portfolio, or you're looking to outsource your entire portfolio management to an impact investing specialist, the decision of who to partner with is vital. So you have a greater chance of accurately answering these questions.