Socially Responsible Investing

Socially responsible investing describes an investment strategy which combines the intentions to maximize both financial return and social good. In general, socially responsible investors favor corporate practices which are environmentally responsible, support workplace diversity, and increase product safety and quality. Some (not all) also avoid businesses involved in alcohol, tobacco, gambling, weapons and other military industries, and/or abortion.

Modern applications

Socially responsible investing (SRI) is a booming market in both the US and Europe. SRI in the United States remained robust during 2001 and 2002, even as the rest of the investment world was stagnant. Assets in socially screened portfolios climbed to $2.15 trillion in 2003, an increase over the $2.01 trillion counted in 2001. Screened portfolios grew 7 percent from 2001, while the broader universe of all professionally managed portfolios fell 4 percent during the same period, according to the Social Investment Forum’s 2003 Report on Socially Responsible Investing Trends in the United States.

Screened portfolios, with $2.15 trillion in assets, represent the largest amount of assets in SRI. Community investing and shareholder advocacy contribute additional assets, resulting in a total of $2.18 trillion in professionally managed assets for all SRI.

Research estimates by financial consultancy Celent predict that the SRI market in the US will reach $3 trillion by 2011. The European SRI market grew from €1 trillion in 2005 to €1.6 trillion in 2007.

Mutual funds

Socially responsible mutual funds counted by the 2003 Trends Report increased in number to 200 in 2003, up from 181 in 2001, 168 in 1999, and 139 in 1997. Assets in socially screened mutual funds identified by the Trends Report grew by 19 percent, to $162 billion, up from $136 billion in 2001. More than half (51 percent) of this growth is attributed to both newly identified and newly created funds, and 49 percent represents growth in existing assets. In terms of attracting investor assets, socially screened mutual funds grew on a net basis in 2002 while the rest of the mutual fund industry contracted. According to Lipper, socially responsible mutual funds saw net inflows of $1.5 billion during 2002. Over the same time, U.S. diversified equity funds posted outflows of nearly $10.5 billion.

Separately managed accounts

Of the $2.15 trillion in socially screened portfolios, $1.99 trillion are found in separate accounts (portfolios privately managed for individuals and institutions) with the remaining $162 billion residing in mutual funds. Assets in socially screened separate accounts grew by seven percent since the “2001 Report.” Screened private portfolios climbed to $1.99 trillion in 2003, as compared with $1.87 trillion in 2001, $1.34 trillion in 1999, and just $433 billion in 1997.

Shareholder advocacy

Between 2001 and 2003, shareholder advocacy activity increased by 15 percent, growing from 269 social and crossover resolutions (which combined aspects of both “social” and traditional corporate governance issues) filed in 2001 to 310 in 2003. Likewise, the average percentage of votes received on these resolutions increased from 8.7 percent in 2001 to 11.4 percent in 2003. Of the total $2.15 trillion in all socially screened portfolios, $441 billion are in portfolios controlled by investors who are also involved in shareholder advocacy on various social issues.

Shareholder resolutions are filed by a wide variety of institutional investors, including public pension funds, faith-based investors, socially responsible mutual funds, and labor unions. In 2004, faith-based organizations filed 129 resolutions, while socially responsible funds filed 56 resolutions]

Regulations governing shareholder resolutions vary from country to country. In the United States they are determined by the Securities and Exchange Commission, which also requires mutual funds to disclose how they voted on behalf of their investors[2]. U.S. shareholders have organized various groups to facilitate jointly filing resolutions. These include the Council of Institutional Investors, the Interfaith Center on Corporate Responsibility, and the Social Investment Forum.

Community investing

Community investing climbed 84 percent between 2001 and 2003. Assets held and invested locally by community development financial institutions (CDFIs) based in the United States totaled $14 billion in 2003, up from $7.6 billion in 2001.

Investing strategies

Social investors use four basic strategies to maximize financial return and attempt to maximize social good.

Screening excludes certain securities from investment consideration based on social and/or environmental criteria. For example, many socially responsible investors screen out tobacco company investments. This is an example of a social screen at work.

Divesting is the act of removing stocks from a portfolio based on mainly ethical, non-financial reasons. An investor divests upon realizing that, at some point, “the cup of endurance runs over, and (is)..no longer willing to be plunged into an abyss of despair”^{[citation needed]} over certain business activities of a corporation. Recently, CalSTRS (California State Teachers' Retirement System) announced the removal of more than $237 million in tobacco holdings from its investment, portfolio after 6 months of financial analysis and deliberations.

Shareholder activism efforts attempt to positively influence corporate behavior. These efforts include initiating conversations with corporate management on issues of concern, and submitting and voting proxy resolutions. These activities are undertaken with the belief that social investors, working cooperatively, can steer management on a course that will improve financial performance over time and enhance the well being of the stockholders, customers, employees, vendors, and communities.

Positive investing involves making investments in activities and companies believed to have a high and positive social impact. Positive investing activities tend to target underserved communities. These efforts may support activities designed to provide mortgage and small business credit to minority and low-income communities.

Speculation

Speculation, in the narrow sense of financial speculation, involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculation or agiotage represents one of three market roles in Western financial markets, distinct from hedging, long- or short-term investing, and arbitrage.

Speculation areas

Convention, and especially satire, sometimes portray speculators comically as speculating in pork bellies (in which a real market and real speculators exist) and often "losing their shirts" or making a fortune on small market changes. Speculation exists in many such commodities, but, if measured by value, the most important markets deal in futures contracts and other derivatives involving leverage that can transform a small market movement into a huge gain or loss.

Type of speculators

Most non-professional traders lose money on speculation, while those who do make money tend to become professionals. Occasionally some dramatic event will occur, such as the effort of the Hunt brothers to corner the silver market or the currency speculations of George Soros or the speculative trading of Nick Leeson, which caused the collapse of Barings Bank.

By some definitions, most long-term investors, even those who buy and hold for decades, may be classified as speculators,^{[citation needed]} excepting only the rare few who are not primarily motivated by eventually selling at a good profit. Some dedicated speculators are distinguished by shorter holding times, the use of leverage, by being willing to take short positions as well as long positions (in markets where the distinction can be reasonably made). A degree of speculation exists in a wide range of financial decisions, from the purchase of a house to a bet on a horse; this is what modern market economists call "ubiquitous speculation."

In Security Analysis, Benjamin Graham gave a definition of speculation in relation to investment: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

The economic benefits of speculation

The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs.

For example, if a certain market - for example, pork bellies - had no speculators, only producers (pig farmers) and consumers (butchers, etc.) would participate in that market. With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant in the market who wants to either buy or sell pork bellies will be forced to accept an illiquid market and market prices that have a large bid-ask spread or might even find it difficult to find a co-party to buy or sell to. A speculator (e.g. a pork dealer) may exploit the difference in the spread and, in competition with other speculators, reduce the spread, thus creating a more efficient market.

Another example of the value of speculators is the ability of a pig farmer to sell his pork on a futures exchange at a known price ahead of its production.

Some side effects

Auctions are a method of squeezing out speculators from a transaction, but they have their own perverse effects; see winner's curse. The winner's curse is however not very significant to markets with high liquidity for both buyers and sellers, as the auction for selling the product and the auction for buying the product occur simultaneously, and the two prices are separated only by a relatively small spread. This mechanism prevents the winner's curse phenomenon from causing mispricing to any degree greater than the spread.

Speculative purchasing can also create inflationary pressure, causing particular prices to increase above their "true value" (real value - adjusted for inflation) simply because the speculative purchasing artificially increases the demand. Speculative selling can also have the opposite effect, causing prices to artificially decrease below their "true value" in a similar fashion. In various situations, price rises due to speculative purchasing cause further speculative purchasing in the hope that the price will continue to rise. This creates a positive feedback loop in which prices rise dramatically above the underlying "value" or "worth" of the items. This is known as an economic bubble. Such a period of increasing speculative purchasing is typically followed by one of speculative selling in which the price falls significantly, in extreme cases this may lead to crashes. Overall, the participation of speculators in financial markets tends to be accompanied by significant increase in short-term market volatility. This is not necessarily a bad thing, as heightened level of volatility implies that the market will be able to correct perceived mispricings more rapidly and in a more drastic manner.