• Bridget Sullivan Mermel CFP(R) CPA

Socially Responsible Investing for Good Returns: How to Invest in ESG without Lower Returns

Updated: Jan 7


Socially Responsible Investing means lower returns to some people. It doesn't have to. In this video, we explain how to get market returns with ESG investing.


When socially responsible investing (also often called Environmental Social and Governance (ESG) factor investing and sustainable investing) started, investment returns weren't as good as other mutual funds. That reputation for lower returns has stuck in the minds of many people.


But it doesn't have to. In this episode, we talk about how socially responsible investing and ESG funds have adapted so that, if they want to, they can have returns comparable to that of other mutual funds and exchange traded funds (ETF.)


In other words, you can invest according to your values and get market returns.


When investing according to your values was new, many mutual funds excluded entire industries that were considered "bad." For instance, gambling was considered bad, so some socially responsible investing mutual funds didn't invest at all in the gaming industry.


When social mores changed, it created a big opportunity not just for hotels and casinos, but Bridget's uncle's coin counting machine company. There was a mini boom in gaming company stocks.


Many SRI mutual funds that omitted this industry, causing socially responsible investing mutual fund’s returns to suffer compared to the broader market.


After discovering that excluding entire industries exposed them to the risk of lower returns, some mutual funds decided to not exclude entire industries, but to include the best companies in all industries.


This approach has shown to help ESG mutual funds get comparable returns to the broader market of mutual funds.


Another innovation in socially responsible / ESG investing has been the advent of standards and reporting requirements on environmental and governance factors that help mutual fund companies create passively managed environmental mutual funds. These funds have lower costs than actively managed mutual funds, which increases the fund returns.


If you're interested in investing according to your values and not give up investment returns, look for mutual funds that invest in all industries, and look for lower expense ratios--a hallmark of passively managed mutual funds.


If you've got questions on this episode, please enter them in the comments section! We'd love to hear from you.


Here's Bridget's firm website: www.sullivanmermel.com


John's firm website: www.trinfin.com


For advisors around the US: www.acplanners.org


Thanks for watching and please subscribe!


TRANSCRIPT:


John: Conventional wisdom used to say that investing according with your values came at a cost and loss of investment return. On today's episode of Friends Talk Financial Planning, find out why that's not necessarily true. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.


Bridget: And I'm Bridget Sullivan Mermel, and I have a fee-only financial planning practice in Chicago, Illinois. But before we start, John, I just want to remind people to subscribe. That helps us with Google, and we're trying to get more subscribers so that we can get our word out more effectively.


John: That's great. Hit that subscribe button. And then I want to jump right into things today, Bridget, on that conventional wisdom. And I've long thought while I've been starting in business that jeez, you can invest in a socially responsible fashion, or according to values, but then it comes at a cost. You give up some returns.


And so, I never really did much of that for clients, if any. And I know that the landscape has changed, and things are different these days. And you've done a ton of work on that. Just give me some background if you would. And for our viewers on why that's not necessarily the case anymore. And how you look at it.


Bridget: Great. So back in the day when socially responsible, or ESG, first started, companies started eliminating whole industries and then said, “Okay, we're going to exclude everybody that we don't like. And we'll just include in our investments to things that we do like.”


John: I don't like tobacco stocks, so anybody that does tobacco is not in the portfolio, right?


Bridget: Exactly. Then when they started doing studies about socially responsible investing or what's now also known as ESG, or environmental social and governance factors, they said, “Oh, there're less returns.” And that conclusion has stuck with the industry a lot. However, when they dug beneath the hood or they looked under the hood of the studies, they said, “You know what the problem is? When we exclude entire industries, we miss the hot industries, so the returns suffer.”


So, what happened, for instance, in the gambling industry—I don't know if you remember this, John—but back in the day, gambling was bad. John: That’s right. Bridget: And a lot of people didn’t want any gambling stocks. The social mores have changed over the years, and gambling is now a good source of income for a lot of States. And they said, “Okay, great!” And so, then there were a lot of private companies that were involved in making the transition.


I have a funny story. My uncle worked for a coin counter business, and he ended up delaying his retirement because he was selling so many coin counting machines at this point. So that's a good example of the ripple effect. You wouldn't necessarily think coin counting machines would boom…


John: Right.


Bridget: …and affect economy, but all those things really boomed. And so, then the socially responsible funds that just eliminated that missed out on that action. So then some mutual funds started taking a different approach, and they said, "Okay, instead of just eliminating entire industries, let's not be so idealistic and purist. And let's just compare companies in different industries and take the best.” And so those were called excluders, the ones that said, “No gambling!” and includers were the ones that said, “We'll take the best.”


So, for instance, right now, a lot of people don't want to invest at all in fossil fuels, no matter what. John: Right. Bridget: And so, some funds will say, “Okay, no oil.” But then some other funds will say, “We're going to compare the companies, and if they've got enough windmills and enough batteries—if they're working on enough other stuff—we’ll be okay; we'll take it.” And they look at both fossil fuels, but then also the utility industry comes into play, too. So, the mutual funds that don't eliminate entire industries, do better.


John: Yeah. And it's sort of like, if I'm hearing that right, it's taking a more pragmatic approach. Ideally, we don't have any, but the reality is, “Listen, we're sacrificing so much that let's do better.” Right? Let's eliminate the worst offenders, if you will, if you think of it in those terms and say, “Listen, we need to have some exposure to energy,” in this example, “but what's the best one we can do?” Right? Not perfect, but better than just the blanket approach. Is that accurate?


Bridget: Absolutely. The second big factor is the expenses. So when you run a fund—and this is true if it's socially responsible, ESG, or not—if you run a fund and you've got to actively manage, or have a whole group of people get together and powwow about what investments you're going to make and evaluate all the different companies in the world, that's expensive, versus if you've got a system where you have computers run the thing, that makes it cheaper. Okay.


John: Yeah.


Bridget: And so, then you get higher returns. Now, what's happened is a lot of people have done the work to make index funds possible for socially responsible investing, particularly in the environmental and governance areas. So, the social part of it is coming along, but it's a little slower. Okay. So that means that they can get reporting from companies and have big data feeds, just like they do with their financial information. And so, they have a big data feed, instead of having people go out to each individual company and trying to scout it out and pick.


John: Sure.


Bridget: So that has been another major development in the industry. And again, developing those standards is difficult. It takes a lot of time; it takes a lot of conscious effort, which has happened over the last 10 to 15 years. So that's one of the reasons why we've been able to have passive investing or index funds or basically index funds in the socially responsible and ESG space.


John: So, as I hear, to sort of sum things up, the difference is that back in the old days, it was, golly, you give up a lot of returns. Today, that's not necessarily the case. And if I heard it right, Bridget, it's for two reasons. One that you just explained. Just like the rest of our investments, expenses matter. And now it's possible to have lower expenses with those funds that invest according to a person's values.


And then the other thing is taking that more practical approach instead of the absolute. Instead of, "we’re not going to have any of these sorts of stocks in this given category." It's, "Listen, we need to have some, from a practical standpoint, to have a good return, but let's have the best of those and eliminate the worst of those," or that graded approach to things. And so, as I heard, those two things make it now where instead of “Oh, jeez, that's a pretty tough way to invest.” No, this is something that people should be considering, at least as part of their portfolios.


Bridget: Absolutely. So, I'm really happy to be talking about this. I would love to hear people's questions on our YouTube channel. If you've got them, please either forward them to me or go ahead and put them on our YouTube channel. And the responses—I’d love to hear it.


John: That’s great.


Bridget: So, with that, let’s wrap it up. I want to mention my name again—Bridget Sullivan Mermel. I’ve got a fee-only financial planning practice in Chicago, Illinois, and I want to say that John and I are both members of ACP or the Alliance of Comprehensive Planners. If you like the way that John and I talk and think about these financial planning topics, and you're looking for an adviser in your area, you can check out acplanners.org.


John: That's right. Thanks so much for sharing, Bridget. Till next time.


At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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