Socially Responsible Investing or SRI involves investing only in companies that are considered positive for society. It does so by screening against a stringent list of environmental, social and governance benchmarks, the so-called ESG criteria.
While no doubt ethically admirable, critics of SRI maintain that it leads to portfolio underperformance. Restricting the universe of possible investments, they say, reduces diversification benefits. The extra cost associated with SRI portfolio selection potentially eats away at returns.
While the verdict is still out, mounting evidence suggests that this is not the case. When for instance we compared MSCI SRI indices against their parents, we found that passive SRI investing using these indices did not result in reduced diversification. It also generally translates into higher returns, among other things due to the low cost of the ETFs used to invest in these indices.
Proponents of SRI point out that ESG screening not only identifies companies that are good for society. It also identifies companies that are well run, employ sustainable business models and are long-term oriented. Hence there need not be a tradeoff in SRI: it can be a means for investors to do both good and well.