Socially Responsible Investing, or SRI, is growing in popularity for personal finance, and for good reason. Investors want to know that their money is making a positive impact in their local communities, as well as in society as a whole.

According to a 2020 survey by the U.S. Forum for Sustainable and Responsible Investment, socially responsible investing accounted for more than a dollar out of every three dollars invested under professional management in this country. This is an amazing jump from when these concepts emerged following the Great Recession and the ensuing global financial crisis!

The rapid growth of socially responsible investing is proof that investment strategy can make fundamental distinctions to deliver benefits to society without sacrificing financial return. In some cases, returns from sustainable and responsible investment outpaces conventional offerings due to the growing demand for well-run companies delivering more than hard-nosed financial profit alone.

Both SRI and ESG, which stands for "Environmental, Social, and Governance", are also sometimes referred to as values-based investing, sustainable investing or impact investing. Regardless of the term used, and though there are distinctions between them worth understanding, these terms represent an active effort many informed investors are incorporating to make positive, material impact on the world.

Let's get to it!

What is ESG?

ESG investing refers to an evaluation method that incorporates a company's collective conscientiousness for social and environmental factors. These are non-financial factors investors use to measure an investment or company's impact on the greater good.

Individual investors like you and me aren't typically grading companies or management teams on their adherence to ESG factors. Individual investors typically don't have the knowledge to make an informed assessment without a ton of research.

Instead, these ratings are assigned to a company by specialty financial services firms.

How is an ESG Rating Given to a Company?

There are lots of financial services companies that perform ESG assessments on behalf of investors. These financial services companies often have complex proprietary models that pull information from a variety of company disclosures to come up with an ESG rating. In many cases, information to base these decisions are self-reported by companies. We'll review some of the questions and concepts that are incorporated into an ESG Score Card later on in this article.

Two of the most well-known ESG measurement companies include MSCI, and Sustainalytics. Within the values-based investment community, there is increasing interest in standardizing the ESG accounting and reporting standards in order to bring greater transparency and trust to this system. The movement to create standardization within ESG ratings is gaining significant momentum in Europe.

How do Portfolio Managers Incorporate ESG into their Investment Vehicles?

Following on the increased demand from retail (individuals) and institutional (big funds) investors, more and more portfolio managers are trying to incorporate ESG strategies into their their investment vehicles.

ESG investment vehicles may stress different aspects of an ESG scorecard. Companies can receive high ratings for social or governance risks, for example, but score poorly for environmental issues. Alternatively, companies can receive high marks for minimizing their environmental footprint, but have weaker governance standards.

What's important to note is that the term ESG is very broad. For this reason, many portfolio managers will seek to offer investment alternatives that are far more specific, tailored to investors that have a defined value set and are seeking a more specific outcome. Those investment vehicles will more heavily weight portfolio companies with

Many portfolio mangers may try to market their ESG funds as socially responsible or environmentally focused because the concept of ESG can be so broad. The companies they include in those funds would weight the issues they are seeking to focus on.

Now, let's dive into each category.

Environmental

More investors are focusing on environmental investing opportunities now than ever before. It is a strategy that includes making investment decisions to emphasize the positive impact on the environment and/or minimize the negative impact on the environment. You shouldn't find any of the big fossil fuel companies in an ESG list, but you might expect to see manufacturers of electric vehicles or renewable energy.

A company's stance and business practices on any of the following could have a direct impact on its environmental ratings:

• Energy consumption
• Animal welfare
• Climate change
• Waste production
• Pollution
• Natural resource preservation
• Toxic waste

Social

Social factors are an important component to ESG ratings. Factors that might be incorporated include any of the following:

• How does the company source its raw materials to make its products?
• Do they offer fair trading prices?
• Do they treat their employees fairly and offer strong benefits packages?
• Does the company have diverse hiring practices in place?
• Do all employees have the same opportunities for advancement and receive equal benefits?
• Does the company engage with customers and readily take feedback to improve on its product suite?

The following are just some of the criteria that are important for the social qualifications for ESG investors:

• Child and forced labor
• Community engagement
• Employee relations
• Health and safety
• Human rights
• Stakeholder relations

Governance

The third qualifying characteristic of ESG ratings incorporate a company's corporate governance practices. Ensuring that there is a strong system for checks and balances is critical for a well-run, diverse enterprise to bring value to multiple stakeholders.

Many large companies qualify for less-scrutinized ESG funds based on their governance practices alone. Investor activists are often critical of existing ESG investing rating agencies and methodologies due to the relative ease with which many seemingly unaligned companies can qualify despite having severe environmental impact or negative societal impact.

The following are all taken into consideration:

• Executive compensation
• Shareholder rights
• Stakeholder representation
• Quality of management
• Conflicts of interest
• Board independence
• Transparency and disclosure

Pros and Cons of ESG Investing

Pros:

• Sustainable investing opportunities
• Readily available fund options at most brokerages
• Strong corporate governance leads to less risk

Cons:

• More scrutiny is needed
• Lack of unified disclosure systems lack transparency
• Overly broad rating system
• Based on self-reported information from companies

What is SRI?

SRI is similar to ESG in concept. Socially responsible investing promotes ethical and socially conscious themes including environmental sustainability and social justice, and seeks to screen out investments that have harmful environmental effects and social impacts.

Socially responsible investing can include an investor's personal, political, or religious beliefs too. It can broadly include private funds or alternative investment vehicles or commonly available mutual funds.

Some examples of negative SRI screens include:

• Gambling
• Firearms
• Environmental impact
• Addictive substances like cigarettes and alcohol
• Affiliations with terrorist organizations

Like ESG investments, there are various SRI strategies that portfolio managers can offer their customers and many SRI investment vehicles incorporate similar screening methodologies used for ESG integration. Beyond negative screens, socially responsible investment can seek to incorporate positive screens to deliver outcomes and impact beyond financial performance.

Some investment strategies might include hyper-local investment, investments in favor of women-owned or minority-owned businesses, investments in companies making positive environmental change or investments in historically underserved communities.

SRI and ESG investment approaches still seek strong financial return, but there is a balance that must be maintained in recognition of the power of what our money can create in the world. Impact investors of all types recognize that money has the power to heal, For many investors, these investment approaches don't sacrifice values in search of profit, but instead seek a "triple bottom-line" return in favor of positive impact on People, Planet and Profit.

Pros and Cons of SRI Investments

Pros:

• Available to the public market
• Based on personal values, which are dynamic
• Less volatile from public relations risk
• Financial returns

Cons:

• Fewer investment options, and not always available to the public market
• May incorporate higher fees

Why is Impact Investing Important?

The principles of ESG investing and SRI make up the pillars of impact investing. Impact investments need to have positive social and/or environmental outcomes beyond the financial return alone. Sustainable investing and ESG investing considers all sorts of factors when it comes to creating positive impact.

It's important to look at these qualitative factors critically and understand how a company's actions can impact all of its stakeholders up and down the supply chain to end customer and beyond. Impact investors often have a deeper understanding of how their money circulates through the economy and creates value.

Here are just some examples of impact themes and the sample metrics those themes may include:

Quality Jobs and Generating Income

• How many jobs have been created from traditionally underserved demographics?
• What is the average income created and does that represent more than livable wages?

Environmental Sustainability

• Have greenhouse gasses been reduced or avoided?
• Are waste levels being reduced to a sustainable load?
• What is the permanent environmental impact of a product?

Infrastructure Development and Affordable Housing

• How many individuals have found housing?
• How many development units have been completed?

Management and Corporate Governance

• Is the company women-owned or minority-owned?
• Does the company provide wealth-creating opportunities for broad employee base and stakeholders?

Impact investing is important because it exemplifies an opportunity to redefine our relationship with money. It can be used to heal and create improved living conditions for all.

Challenges of Impact Investing

Impact investing does have it's own challenges. In some cases, subject to the types of investments you have, impact investments may be illiquid or difficult to find. Impact investment opportunities are still a small fraction of the overall investable market so it may sometimes feel difficult to find the right investment vehicle for you.

In some cases, impact investing has lower financial return. While this is not always the case, certain investment alternatives will price in the social or environmental impact to make up financial performance. This is known as a "concessionary return."

As an informed investor, you can choose what investment vehicle is right for you to make sure you are optimizing for social or environmental impact as well as financial gains.

Conclusion

Learning about the differences between the difference forms of impact investing is a critical step to aligning your money and personal finance with your values. There are a variety of diversified ESG and impact investing options out there for you. From publicly traded assets to non-public crowd-sourced alternatives, there is no shortage of opportunities for values based investing.

Impact is not limited to your investments. For many people, banking is an even easier way to engage your money to make positive change in the world. You can support values-based investments through your everyday banking with an entity like Atmos. Atmos utilizes 100% of your liquid, FDIC-insured deposit balance to build clean energy and other climate-positive infrastructure.

And it's never been a better time to get started. The world needs each of us to care just a little bit more.

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