Challenges of building a socially responsible investment portfolio (2024)

Socially responsible investing, or SRI, is an investment strategy that aims to help foster positive social and environmental outcomes while also generating positive returns. While this is a worthwhile goal in theory, for a personal investor trying to achieve it on their own, there may be some challenges in trying to build a portfolio of stocks and other assets.

One side of the equation, building positive returns will be based on fundamental analysis of an investee company’s financial performance, level of debt and ability to grow and deliver profits, for example.

A starting point here will be analysing the financial accounts of that company; in doing so, particularly with listed stocks, an investor can take comfort from the fact that the accounts have been put through a rigorous review process and the information that they are analysing has been prepared to a high standard, is robust and reliable.

Deirdre Timmons, sustainable finance lead, ESG reporting and assurance, at PwC Ireland, says that to get an understanding of non-financial criteria such as whether a company is fostering positive social and/or environmental outcomes, investors have to dig a little deeper.

“In doing so they will be faced with reviewing a sustainability report or statement,” she explains. “And the initial challenge they will have is that, unlike financial accounts reporting, there is a myriad of reporting standards out there covering ESG [environmental, social and governance] and sustainability.

“Unless they are a professional SRI investor, they are highly unlikely to be able to fully understand, let alone interpret, many of them.”

In addition, two companies within the same sector will often adopt different reporting frameworks. Therefore, like-for-like comparison across sectors “remains elusive to the uninitiated”, says Timmons.

“In addition to this, there is also an issue that non-financial reporting by a company is not required to be audited at present. Therefore, a company can make non-financial disclosures that are not necessarily backed by evidence,” adds Timmons.

Even when there is such evidence, often it has not been put through the same rigorous auditing process as with financial information, she says.

RBC Brewin Dolphin has a dedicated socially responsible investing list for funds with a sustainability focus and with restrictions on investment in harmful activities. According to Conal Cremen, head of sustainable investing at the firm, these funds aim to deliver attractive investment returns while contributing positively to global environmental and social challenges.

“As a signatory of the United Nations Principles for Responsible Investment, we ensure that the investment fund managers selected for inclusion in our Sustainable Portfolio promise to incorporate ESG factors into their investment decisions and are active investment owners,” says Cremen.

“Furthermore, we run a qualitative screen, which considers financial and non-traditional risks, our exclusion policies, and also includes ESG risks and opportunities. When selecting each individual sustainable fund, we focus on funds that are industry leaders in integrating ESG factors into investment decisions and stewardship activities, and funds that invest in companies which contribute positively and measurably to social and/or environmental challenges.”

At RBC Brewin Dolphin, all funds go through a robust ESG selection process, which consists of three parts:

1. Exclusions – funds that seek to exclude companies involved in tobacco, controversial weapons, thermal coal, gambling and adult entertainment.

2. ESG leaders – funds that are industry leaders in integrating ESG factors into investment decisions and stewardship activities.

3. Impactful companies – funds that invest in companies which contribute positively and measurably to social and/or environmental challenges.

“From environmental pollution and animal welfare to gender equality and human rights, investors are increasingly looking for ways to use their money as a force for good.” says Cremen. “While individual investors can aim to build their own responsible portfolios, the resources and due diligence required to ensure the portfolio is having a positive impact on global environmental and social issues is challenging.”

Given that this information is a large part of the determination by a socially responsible investor as to whether to invest or not, can it be trusted? A recent PwC investor survey showed that institutional investors are hampered by a trust deficit in much of the sustainability information shared by the market. More than nine out of 10 respondents (97 per cent) who invest in or cover Irish companies are of the view that corporate reporting on sustainability performance contains unsupported claims.

“In addition, very few companies have been willing to quantify their environmental or social impacts, risks or opportunities and, even if they have done so, are often unwilling to publish them,” says Timmons.

“How then can an investor complete the link between the likely financial performance of a company in the future and the financial performance when these ESG determinants are added into the equation? In that recent PwC survey, two-thirds, (67 per cent) of those investors agreed that companies should disclose the monetary value of their impact on the environment or society.”

Alison McMurtrie is chief operating officer of Trrue, a layer-one blockchain protocol which is an ecosystem for financial solutions using equity crowdfunding. Trrue has worked with the FCA in the UK, the Dubai FCA and the Taiwanese Control Authority to help refine the reality of sustainable green funds, using blockchain to promote transparency.

“Currently, it is very hard to prove or otherwise the veracity of the green claims,” she says. “The value of being green is very apparent, with companies accessing better interest rates, insurance premiums etc. What we do with our platform is verify these claims for the benefit of investors and the company itself.”

In the experience at Davy Private Clients, the costs of constructing a Socially Responsible Investment (SRI) portfolio are in line with non-SRI portfolios, according to Patrick McLaughlin, head of SRI Multi Asset Solutions.

“Do my preferences for sustainability sacrifice investment returns?” is a question he is commonly asked.

Strong focus on screening can reduce the investment universe, which can increase the level of overall portfolio risk, as diversification becomes more difficult

— Patrick McLaughlin, Davy Private Clients

“An increasing body of evidence points to this not being the case,” McLaughlin says. “However, it is dependent on the approach taken by the investor. An investor who follows an approach that integrates ESG data into the investment decision process can enhance a portfolio’s risk-return profile.

“Consideration of this data can enhance risk management and highlight potential opportunities.”

But he warns that an approach with a strong focus on screening “can significantly reduce the investment universe, which can increase the level of overall portfolio risk, as diversification becomes more difficult”.

It is worth noting, McLaughlin adds, that the tail risk associated with SRI portfolios can be lower as they are less exposed to extreme ESG outcomes, such as stranded assets.

Cremen says: “We have created a dedicated Sustainable Investing Portfolio as we know that our clients have high aspirations for themselves, for their families and their futures, which includes the future of our planet. Our aim is to support them in taking a responsible and long-term view throughout their financial journey.”

If information is power, then the tide is slowly turning in the personal investor’s favour when it comes to non-financial information relevant for building an SRI portfolio.

“In the meantime and possibly short to medium term, although not a perfect solution for financial empowerment, it is perhaps best left to the professionals who have the skill sets, resources and expertise to attempt to cut through the opaqueness of the current non-financial reporting infrastructure to deliver the twin objectives of financial returns and positive environmental or social outcomes,” says Timmons.

The European Union has been trying to address all of this with the introduction of the Corporate Sustainability Reporting Disclosures which will require companies to adopt a standardised approach to sustainability reporting in the EU, to quantify their ESG impacts, risks and opportunities, and to have their disclosures assured. This will certainly, in time, help to address these issues for those wanting to develop their own portfolios with any degree of confidence.