Socially Responsible Investing: A Small Step Toward a Better World

During the last twenty-five years socially responsible investing (known by the acronym “SRI”) has nibbled at the margins of American capitalism’s ills by slightly reducing bid pressure on the stocks of companies involved in tobacco, alcohol, weapon systems, and gambling. During the last fifteen years many SRI oriented mutual funds have broadened their “negative screens” (i.e., means of identifying alleged social irresponsibility). Some SRI mutual funds now boycott the stocks of companies with supposed policy shortcomings in animal testing, environmental responsibility, human rights, employment equity, unsustainable development, and various matters of corporate governance. Notably, during the last ten years some of the SRI funds have moved toward “positive screens” which aim to identify public companies that excel on selective metrics of social accountability.

The newest expression of SRI is impact investing, an ethics based investment fad that is gaining momentum because of the attention it is receiving from some big name philanthropists. Impact investing is a niche play for now but could become much bigger as interest snowballs. The idea is to play the venture capital angle within so-called positive investing: namely, fund responsible new era corporations rather than placing money into the hands of those who entered the SRI betting pool early.

Does SRI Make A Difference?

The financial outcome of the socially responsible investment movement has been to marginally raise the cost of capital for SRI boycotted companies. One should not make too much of this, however, for the effect has been just north of negligible in an environment where demand for socially irresponsible goods and services has been climbing while the cost of borrowed money has been in decline. As long as the nation’s central bank has no negative or positive screens on the use of cheap money it generates for the banking industry (it uses a ‘morality-agnostic’ approach), the impact of SRI will be marginal. Interestingly, market cynics say SRI does more to ease consciences than it does to mitigate unhealthy world conditions.

The more notable impact of the SRI movement has been to elevate awareness that the way investment money flows in an economy helps shape society and prospects for social justice. This building awareness sets the stage for more consequential initiatives after Wall Street pays for its sins. Like the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), impact investing is a small step in the right direction — the benefits of the congressional act constrained by the politics of strategic loopholes. By contrast, a real overhaul of capitalism’s financial infrastructure would constitute giant steps in the right direction. But don’t hold your breath: Such steps that will not be taken until cultural reform produces sufficient insight and courage.

SRI Not “Responsible” Within Current System

Socially responsible investing cannot be very socially responsible in the context of an irresponsible financial architecture for capitalism. SRI investors are still stuck with the prospect of putting money into a giant Ponzi arrangement. How sustainable is that? How fair is the architecture to future generations? How socially just is it to obtain gains puffed by money flow dynamics when those gains effectively wash out the buying power of poor working people who are supposedly the focus of socially responsible concerns? In this respect the current stock market is little more than a massive multi-level marketing operation. People can only protect themselves against the game by obtaining a pro rata share of inflated money that is generated. SRI provides some appeasement of conscience to those — regardless of financial class — who believe they cannot afford to boycott the most accessible way to help retirement savings grow.

By analogy, the stock market looks like a labor union in a state where most of the residents are non-union workers. People without high union wages must subsidize the wages of those within the union when purchasing non-substitutable union products and services. Likewise, people with little money in tax-sheltered retirement savings (say $50,000) must massively subsidize individuals with much larger sums of protected money (e.g., say $500,000 or more). If share prices increase 100% (as they’ve nearly done since March 2009), the people on the bottom lose $450,000 of buying power relative to the people who invested a half million of new money at the turn. What is socially responsible about this outcome? An SRI fund changes little about the justice of aggregate wealth distribution, or wealth gains relative to contributory merit.

Why should many families get washed out (in terms of relative buying or investing power) so that financial power can be concentrated to the benefit of a few others? What is the merit of passive investing that justifies massive returns on betting pool capital, especially when such gains could not be remotely matched across an entire lifetime of productive contribution and frugality by general members of the working class? What drives us to deny the injustice? Do we hope to get our share of injustice-based bounty? Is our stock market loyalty a psychological salve to offset frustration with welfare entitlement programs? If so, why not reform abuse on both sides?

In the 1980s I turned away from opportunities in the just emerging socially responsible investing field after previously working in the area of financial futures at Dean Witter Reynolds. One SRI opportunity came to me from my employer, PruBache Securities in Scottsdale, Arizona. A larger opportunity was offered by Merrill Lynch in the Beverly Hills area of Southern California. But I couldn’t find peace, disquieted by my perception that momentum games are not sustainable, capital efficient or socially just. I didn’t want to pretend to serve the common good under a guise of social responsibility: thus, I left the financial industry. Maybe it was idealism, but it had its roots in a genuine desire for just laws and a better world. Hundreds of thousands of Americans have made similarly motivated decisions. So there’s hope!

Why SRI Has Been Winning In The Market

Socially responsible investing has become fashionable since the mid-1990s. Experienced investors know that fundamental and technical analysis, while important, takes a backseat to money flow expectations, speculative pressures and pricing distortions. Socially responsible investing has returned attractive gains in the last 30 years not only because of the underlying bull market but because people perceive it will continue attracting investment capital. SRI promoters argue that corporate managers concerned with social responsibility are smart managers; hence, their companies may outperform. The assertion’s realism aside, the fact that many people thought the assertion had legs generated money flow. Money that was directed into a screen-narrowed group of stocks had the effect of snowballing a build-up of pressure on the bid side. Like the curve on the leading edge of an airplane wing, the effect was lift — share price lift.

Year by year as more mutual funds entered the SRI area the lift became greater, especially as more screens were devised to provide for concentrated buying activity. In effect, SRI became a buying fraternity where investors’ desire to serve their consciences — while getting exposure to outsized gains — promised a continuing stream of supportive buying. Little wonder, then, that SRI mutual funds generally outperformed peer funds: A specialized buying club had been created.

Unlike the hedge funds that pump up prices then dump stocks on unwary mutual funds, SRI had the potential to be less cyclic. SRI investors were not looking solely for return on investment (ROI) but for a sense of accountability in supporting the alleged social good. Ironically, this reduction of interest in maximizing gains made it possible for SRI funds to better maximize gains, since SRI investors tend to sit on their contributions and not take profits. After all, when rewards for “conversion” out-measure alternative rewards, who is going to leave the fold?

What Is The Future Of Socially Responsible Investing?

SRI funds will continue to outperform ... until they don’t outperform. It’s that simple. Contrarian investors: perk up your ears. SRI has functioned as a contrarian play against general investment strategies. It has been the David confronting Goliath. SRI’s geniuses know that if the play ever fails to attract new money, SRI fund shrinkage (relative to alternatives) may prompt an exodus of SRI money. Why? Because the success of SRI has had less to do with social justice impacts than money flow dynamics.

The theoretical prospect of an SRI category bear market points to the fundamental flaw of current stock market architecture: The reward is not measured primarily by the metric of investment prudence or social responsibility but to early entrance and timely exodus from investment categories that are poised to be puffed up or drained. It is an unjust game that rewards the adept, ruthless and informationally advantaged, not the meritorious, productive or concerned with true sustainability. It takes millions of the best minds in society and distracts them with gamesmanship instead of motivating them to concentrate their energies on serving the lasting public interest. While SRI is a comparatively stable version of the game, it nonetheless substitutes inadequate solutions for better ones.

What Might A New Architecture Look Like?

The Wikipedia entry on socially responsible investing includes an insightful paragraph toward its end under the subheader, “Community Investment.” It reads, “By investing directly in an institution, rather than purchasing stock, an investor is able to create a greater social impact: Money spent purchasing stock accrues to the stock’s previous owner and may not generate social good, while money invested in a community institution is put to work” (viewed Jan. 15, 2011). This observation meshes with my own push for a new financial architecture for capitalism.

The U.S. Congress is heavily to blame for laws that subsidize Wall Street’s current financial architecture. What we need now is for Congress to wake up from its delusions and create a new capitalism infrastructure where people invest directly into companies that further the sustainable public good. (Investors would be rewarded by aggregated income flow rather than price appreciation.) As argued by one Yale professor, Immanuel Wallerstein, the present system is too far out of equilibrium to survive. The question is: What kind of system will replace it?

Will meritorious contribution be matched with investment rewards in the next decade? Not likely. A proper architecture would cut off at least 80% of Wall Street’s revenues, shrinking the American financial sector and ending its overpowering control of our society. Wall Street would fight that result tooth and nail, since justice would put an end to Wall Street’s dream of a democratic plutocracy.

There is an additional disincentive for satisfactory financial reform in the current cultural milieu. Once reformed, the economy would provide rather steady, sustainable returns on investments. The business cycle would be muted, the gap would narrow between winners and losers, and the security of investments would increase. The disincentive is that returns on investment (i.e., the national aggregate) would drop substantially to sustainable levels, perhaps around 4-6% per annum. The necessity of more savings and less consumption would slow economic growth, thus damping get rich quick prospects for many speculators. Happily, the world would move forward more briskly on the prospects of natural resource conservation and ecosystem sustainability.

Interested persons can take action by demanding a different central bank and a sustainable financial architecture. If political conservatives would shoulder responsibility in this area they would soon find that many populist liberals would cross the aisle in appreciation. (Many conservatives want to return to the former free market status quo, so reform culpability is greater in the conservative camp.) A proper architecture for capitalism — direct investment vehicles without betting pools — would cause many other polarizing ills to naturally fade. A capitalism that rewards merit will exert a constructive feedback loop on the nature of culture and the prospect of a sustainable ethos. In the meantime, socially responsible investing is at least a step in the right direction.