Can Couch Potatoes Be Socially Responsible?

In my latest MoneySense column, I explored whether socially responsible investing is compatible with the Couch Potato strategy. If you’re not familiar with SRI, it’s about finding investments compatible with your ethics, which often means avoiding so-called sin stocks and companies with poor environmental records. It may also involve selecting investments that have a positive social impact.

My main source for that column was Timothy Nash, president of Strategic Sustainable Investments, a company that helps institutions and individuals create portfolios aligned with their values. Tim also has a blog called The Sustainable Economist and recently wrote a post called The Organic Couch Potato, where he shared his ETF suggestions.

Tim is a thoughtful, articulate advocate for SRI and I thought readers would like to hear more from him, so here’s an excerpt from our interview. I’ll run another in a few days, and next week I’ll go into more detail about specific investment products that combine passive investing with SRI principles.

In many ways passive investing and SRI seem incompatible. One of the fundamental ideas behind indexing is that you don’t pick individual companies. But with SRI, that is often what you’re doing.

TN: I actually see a lot of overlap between the two strategies, primarily in the sense that both are about long-term investing.

When it comes to choosing individual companies, I don’t think that’s what socially responsible investing is about at all. There are different approaches, and by far the most popular is negative screening. This started with religious communities that would exclude “sin stocks” like tobacco, firearms, and things like that. That has evolved to the point where the majority of socially responsible funds rank every company according to a sustainability score—the lingo we use is ESG, for environmental, social and governance. So every company will get an ESG score, and then the fund will drop the bottom 20% in each sector. This is the methodology used by the Jantzi Social Index, for example, and most of the SRI funds use a similar approach to that.

In some cases, rather than just dropping the bottom 20% they will have black list: if there has been a controversy, they will exclude that company. For example, Enbridge is excluded from the Jantzi Social Index because of the big oil spill that happened in Michigan in 2010. BP is another classic example: in fact, that company was in a number of SRI portfolios before the Deepwater Horizon oil spill, but as soon as that happened it was excluded.

Another strategy, which is important to many passive investors, is shareholder engagement. With traditional mutual funds you don’t go to the shareholder meetings yourself: you’ve got proxies, and the default policy is to simply vote with management. Let’s say there’s a shareholder resolution that would require the company to report their carbon emissions, and management says that’s a burden. Traditional investors will have their votes go with management against the resolution. Whereas with socially responsible investments, if they do shareholder engagement your vote will be used to push that company toward greater transparency, greater disclosure, greater sustainability.

Not all index funds do shareholder engagement: the iShares Jantzi Social Index Fund (XEN) doesn’t do it, but the US-listed iShares SRI funds do [These are the iShares MSCI Socially Responsible (DSI) and iShares MSCI Select Socially Responsible (KLD).] I’m really shocked the Canadian one doesn’t, because they are all iShares, and it’s all the same company, but the two funds in the US have a voting policy statement that says they will vote for any measure that promotes transparency and sustainability. I can’t tell you why the Canadian Jantzi ETF doesn’t.

What other strategies are used by SRI index funds?

TN: Another strategy is positive screening. With negative screening you get rid of stuff you don’t want: the worst of the worst. Positive screening is about including companies in sectors you do want. For passive investors there are a number of ETFs that follow what I would call green themes. There is a solar ETF, a wind ETF, and also a couple of water ETFs—as we move forward in a world that is experiencing climate change, I think water is going to become a huge issue. The one I put in my own Couch Potato portfolio is the PowerShares Cleantech Portfolio (PZD), which is diversified across a number of green themes.

The last strategy is called impact investing. This is a really hot topic right now in certain circles, but it hasn’t really made it into the mainstream yet. Impact investing involves going outside of financial markets and investing directly in projects that have both a positive financial return and a positive social or environmental impact.

One example is microcredit financing: that has been around for the longest. Another is community bonds, which are usually are centered around non-profit real estate. There’s a website called socialfinance.ca that follows a lot of these trends. They’re still very new and there aren’t many available, but it’s a very cool option for socially responsible investors because instead of SRI meaning you’re not going to invest in tobacco, military, and firearms, this is a way for investors to have direct impact and generate a financial return.

17 Responses to Can Couch Potatoes Be Socially Responsible?

  1. Holger May 13, 2013 at 9:55 am #

    Interesting subject. While there are, doubtlessly, ways how you can perform SRI, another question is if you should.

    One important benefit of a couch potato strategy is to lessen the risks of sub-optimal stock picking by diversifying across the broad market. Isn’t SRI deviating from this? After all, you define arbitrary criteria and select certain stocks based on these.

    That said, is there any evidence that SRI or the avoidance of “sin stocks” consistently yields results comparable or above broad market performance? If these exist, I’d love to see them.

    In the absence of such evidence, charitable giving to good causes seems preferable, as it at least triggers a tax credit.

  2. Canadian Couch Potato May 13, 2013 at 11:38 am #

    @Holger: Many SRI index funds try to roughly match the overall market in terms of sector diversification. So the question then becomes, “How much of a difference does it make if I hold a few hundred stocks instead of a few thousand?” Some difference, certainly, but probably not that much.

    I would agree that any SRI portfolio is “sub-optimal,” but as Nash points out, many people are willing to accept that trade-off. The goal here is not to achieve higher returns, but to achieve close-to-market returns you can live with. For the record, the 10-year performance of the Jantzi Social Index is 9.03% versus 9.31% for the S&P/TSX Composite. I’d call that comparable.

    Personally I agree with you that directly supporting specific charities probably does more good, but I respect people who feel differently.

  3. Pat May 13, 2013 at 1:03 pm #

    I feel that index investing is a form of socially responsible investing, though not to the degree of SRI investing. By indexing, you don’t have much stake in a particular company or companies that are doing harm, so you’re not concerned how well they do. That leaves you free to, say, support government policy and regulation that hurts those companies’ bottom lines but lessens the harm they do.

  4. Timothy Nash May 13, 2013 at 5:58 pm #

    @Holger

    It totally depends on geographic region and time-frame. It’s so easy to distort statistics to reinforce one’s own particular views. I like this meta-study because the author assessed 517 separate studies:

    http://www.uni-salzburg.at/pls/portal/docs/1/1759214.PDF

    If you’re not keen to dig through the data, here’s an excerpt from the conclusion:
    “Almost 75% of the performance comparisons (SRI with conventional funds) do not
    find any significant performance difference. A significant out- and underperformance is virtually found to the same degree (13%-14%).”

    Hope this helps!
    Tim

  5. Danno May 13, 2013 at 6:01 pm #

    @CCP, Holger,
    “Personally I agree with you that directly supporting specific charities probably does more good, but I respect people who feel differently.”

    I cannot disagree with this, if one is specifically focused on the short term impact of your dollars. But for me, that’s not what a desire for socially and environmentally responsible investing is about. It’s about slowly, over time, positively reinforcing the behavior you want to see from corporate citizens. If I merely cash out 10% of my portfolio and give it to charity, then the companies (the thousands of them) in which I am invested really don’t have any means of correlating that with their behavior. Conversely, if I take that 10% and invest it only in socially or environmentally responsible companies, then I am sending them a direct message (and their less responsible competitors as well) that I value their practices.

    Okay, so if only I do it, it’s not likely to make a difference. But imagine if every Canadian devoted 10% of their portfolio that way. That would be significant. Imagine if we all invested all of our money that way?

  6. My Own Advisor May 13, 2013 at 10:01 pm #

    Interesting subject indeed. Took a quick look at the top holdings of XEN. All big-5 banks, top-3 telcos and some big O&G stocks as well. Starts to look like my portfolio!

    Kidding aside, I’m all for avoiding sin stocks where I can. I can’t bring myself to invest in tobacco companies like Philip Morris for example. It just feels wrong although I guess I own it indirectly via VTI. Not much I can do there…

    Mark

  7. Doug Morrow May 14, 2013 at 10:01 am #

    Integrating sustainability factors into valuation frameworks can be advantageous. Looking at indicators such as how energy efficient a company is, its health & safety track record, its approach to managing communities can yield insights into management quality, which can definitely affect stock returns. So while I don’t personally believe in SRI portfolios, I think there is room to integrate some sustainability analysis into how managers choose or weight securities in a given portfolio. In a passive context, I think the best application is using an enhanced indexing strategy where stocks are tilted off a mkt cap-weighted basis to reflect their sustainability performance or even a blend of their sustainability and financial performance a la RAFI.

  8. J A H May 14, 2013 at 11:44 am #

    Last year our RSP options were changed at work, and included a range of index mutual funds and a few managed funds, including a socially responsible one. And boy did I not like the performance results for the management fee on the SR fund. There was no logical reason to buy it.

    [It is another story being given the option to purchase index funds and not have their best use explained to you, and I decided it wouldn’t make good office politics to go on a crusade suggesting what people should do with their retirement money; I was still impressed that the option was there for the taking.]

    I remain a “conservative” couch potato. Best not to tinker with a simple method that works.

  9. brad May 14, 2013 at 6:36 pm #

    The main problem I have with traditional socially responsible investing is that the stock market is a secondary market. When you buy and sell shares, you’re buying from or selling to another investor; in most cases the companies whose shares you’re buying and selling don’t benefit from the sales, nor do they suffer losses when you sell.

    As such, it seems like a stretch to say that you’re investing in a “socially responsible” way, because your investment decisions have virtually no impact on the companies you choose to buy or those you choose to avoid. There’s an ethical argument to be made that if you buy shares in an “evil” company that pays dividends, you are personally benefiting from that company’s bad practices when you receive your dividends (or if you sell any “evil” stock at a profit you’re benefiting as well). True, but again I fail to see how this will help make the world a better place or encourage companies to act more responsibly.

    This is why impact investing is such an attractive alternative: you’re investing directly in companies, organizations, and projects that are doing things you want to support. Because you’re investing directly, you’re taking on much more risk. There are examples of impact investors who’ve earned greater than 200% returns, and examples of impact investors who’ve lost everything. Diversification is hard, because impact investing opportunities are limited. Right now, most retail investors in Canada can only choose debt investments, which offer returns that barely beat inflation, or don’t even keep up.

    I’ve started adding impact investments to the cash portion of my portfolio, using GICs from a credit union that lends the money to social and environmental projects. I’m also intrigued by an Ottawa-based fair-trade chocolate company that offers “dividends” in the form of chocolate for the first few years, and 5% after that. Even if my bottom line doesn’t grow much, my waistline certainly will!

  10. Danno May 14, 2013 at 9:32 pm #

    @brad: While I’m certainly a fan of impact investing as well, I’m not sure that I agree that choosing SRIs has “virtually no impact”. Sure, one purchase by one investor alone isn’t going to do much, but if a critical mass start investing differently, then it will.

    This is like going to a store and having a choice between purchasing two similar products, one from a company that commits to responsible operation, and one that doesn’t. You might argue that, well, they’re both already fabricated, and in the store in front of me. So really at this point, whether I buy one or the other is not going to have any material impact on those companies that manufactured it, and of course, you’d be right. One certainly won’t. But now imagine if 50% of the people that went to the store for that product made a decision to choose the sustainable product over the other. Now all of a sudden the store will start seeing a difference in sales. They’ll order less of one product and more than the other. And the company that is selling less will determine that they are being beaten by their competitors and, if they’re smart, figure out that some of their irresponsible practices are the reason, and will either change or continue to lose.

    I do not see why the same is not true for investing. Imagine if 50% of the investing community, fund managers, etc., decided they would not own Tobacco companies, or Big Pharma, or Big Oil (or whatever). That would have a material impact on those companies, to the extent that will have no choice but to reevaluate their practices.

    I have no delusions about the size of the impact from my personal, very small investment. I don’t expect miracles, and one man with a few thousand dollars certainly isn’t going to do much. Nor is it going to make any difference if I recycle one bottle, or compost one piece of fruit. But I do those too. There is significant power in numbers, and to hide behind the idea that your contribution is too small to make a difference is, I think, an abdication of responsibility.

  11. Death and Taxes May 15, 2013 at 1:49 am #

    I am actually morally opposed to SRI. One area in particular. Carbon tax credit is nothing more than UN pressure to have industrial nations “buy” from undeveloped nations. It is one of the worse cases of egalitarianism and coersion. Canada for example is responsible for less than .02% of the world’s carbon foot print. China in particular is the WORST offender. Are they paying?

    If a company screws up (like BP did). They pay for it, and are responsible for rectifying the situation. Same goes for Enbridge, I for one would still be buying Enbridge stocks. Why? Because they have a history of increasing their dividends since 1996 and has payed dividends for over 60 years. (Currently do not own but will in future).

    God forbid this crap ever builds traction in the market or becomes yet another regulation. I too will put my money to use directly into social responsible programs I believe in. Boycotting Sturm-Ruger because some nutjob went on a rampage is not one of them. (No I do not own any of their stock at present either.)
    I do own STEI though!

  12. brad May 15, 2013 at 6:54 am #

    @Danno: you wrote “Imagine if 50% of the investing community, fund managers, etc., decided they would not own Tobacco companies, or Big Pharma, or Big Oil (or whatever). That would have a material impact on those companies, to the extent that will have no choice but to reevaluate their practices.”

    Perhaps, but even if a large percentage of investors sold their shares, that would create a bargain for other investors who don’t care about being socially responsible. If enough investors sold shares in Evil Company A to drive down the share price, other investors would jump at the chance to buy them at that price. There might be a drop in price for a few days, but it would bounce back up.

    The majority of investors view investing as a way to make money, full stop. They don’t see it as a way to advance social or environmental progress. Personally I think that’s an arbitrary distinction and one that doesn’t stand up well to scrutiny: if you care about making the world a better place, everything is fair game and there’s no reason to leave investments out of the picture. But I would argue that most investors are driven by self-interest, so actions by a minority of socially minded investors are likely to be swamped by those who care only about growth.

    I do think that positive screening might have a useful effect for some companies: it helps maintain their share price, which in turn allows them to grow. But it’s a very temporary impact. When you buy shares in a “good” company, you’re helping to maintain their share price for a day or two, until some other investor sells their shares. In contrast, with impact investing your principal goes directly to the company or organization you’re investing in.

  13. brad May 15, 2013 at 9:17 am #

    @Death and Taxes: you wrote “If a company screws up (like BP did). They pay for it, and are responsible for rectifying the situation.”

    Substitute “country” for “company” and you’ve just made an argument for why countries like the United States and Canada should pay carbon taxes. Carbon dioxide sticks around in the atmosphere for about 100 years. The vast majority of the increase in CO2 and other greenhouse gas concentrations in the atmosphere over the past two centuries can be attributed to industrialized nations. Developing countries are newcomers on the scene. Who caused the problem? It wasn’t China. China has to be a big part of the solution going forward, but it played only a minor role in committing us to the changes in climate that are in store over the next five to six decades.

  14. Danno May 15, 2013 at 12:31 pm #

    @brad: Good discussion. I am no market expert, but I’m not sure I can totally agree with the idea that any sales/loss of share price would instantly be eaten up. If that were true, then companies wouldn’t care about being in the S&P500 index, or paying dividends, etc., so that they are included in other indicies. The fact is that they do, because in some dimensions, being included in those indicies effectively “broadens the market” for their shares, which drives price. Social indicies are small today, but were they larger and more relevant, like other indicies, I think it would matter. Agree though that I am more interested/keen on learning more about the “positive screening” concept.

    @Death and Taxes: “Canada for example is responsible for less than .02% of the world’s carbon foot print.” Not to be argumentative but I am going to have to ask for a reference on that one. 0.02% is way to low. Canada’s population is 0.5% of the planet, so even if our GHG emissions were equal, per capita, to the global average, we would be 25x higher than your number. And I am willing to bet that our per-capita emissions are several times higher than the global average.

    And that’s really the point, isn’t it? Per capita emissions? If we have 1/10th the population of the US, but emit 1/5th as much GHG, that’s not reason to celebrate. That’s not reason to shy away from improvements saying “well, we only emit 20% as much as they do”, when in fact we are emitting 2x as much per person. I fully believe I’m not saying all carbon tax regimes are perfect, and certainly China is likely the worst offender. But there are well over a billion people here, and only 30mil here in Canada. If all 1.2 billion of them look at the 30million of us, and decide that they want to “do as we do”, then we’re going to be in trouble. Like SRI, the point here is not that one man can save the world. The point is to walk the walk, lead change, and do as you want others to do. If everyone just abdicates responsibility, who will?

  15. brad May 15, 2013 at 12:55 pm #

    Canada actually accounts for 2% of global CO2 emissions: http://epa.gov/climatechange/ghgemissions/global.html#four

    Per-capita comparisons of countries are available at http://en.wikipedia.org/wiki/List_of_countries_by_carbon_dioxide_emissions_per_capita. Canada ranks 14th out of the roughly 200 nations in the world.

  16. Canadian Couch Potato May 15, 2013 at 1:28 pm #

    Please confine your comments to the topic at hand. This is an investing blog, and heated political debates have no place here. I very rarely moderate comments, but I will if I think they are detracting from the spirit of this site. Thanks for your understanding.

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