What is socially responsible investing and how has it performed?

At a glance:

• Socially responsible investing has become a mainstream concern and is not a 'fad'.
• Environmental, social, and corporate governance (ESG) are the three recognised strands of the approach.
• Many of the world's largest companies have demonstrated ESG credentials, and so are included in SRI indices.
• SRI portfolios have had a tough three years, due in part to trends in the energy sector, but long-term performance is strong compared to non-SRI investing. 
• Nutmeg offers a dedicated socially responsible Investing portfolio range.  

What is socially responsible investing?

Socially responsible investing (SRI) is a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions. It's about overweighting towards companies with strong sustainability profiles, while avoiding those that engage in controversial activities.

SRI has been around for many years, though the approach has really come to the fore in the past decade. During this time, there has been increasing focus around how to invest responsibly and how funds are labelled. Listed companies have become more transparent in reporting on their non-financial targets (such as carbon emissions and board diversity), and the universe of available funds and investment in them has grown significantly. 

This has meant wealth managers like us have more flexibility in being able to offer products such as our Nutmeg SRI portfolios, giving clients greater choice in how they want to invest by being more closely aligned with their values. 

What is ESG investing?

Environmental, social, and corporate governance (ESG) are the three most recognisable strands of SRI. ESG is used to screen companies in terms of how they are matching up to responsible criteria, and often to break down the profile of a company for investors. 

• Environmental includes topics such as: pollution, deforestation, resource waste, water stress and climate change.
• Social includes topics such as: working conditions, health and safety, community engagement, diversity and child labour.
• Governance includes topics such as: bribery, corruption, executive pay, leadership diversity, data security and tax strategy.

What regulation is there around ESG investing?

The FCA has recently introduced rules and guidance to help consumers navigate the market for sustainable investment products. 

These are:

• An anti-greenwashing rule that applies to all FCA-authorised firms who make sustainability-related claims about financial products and services.
• Investment labels, disclosure and naming and marketing rules that apply to UK asset managers. (Sustainability Disclosure Requirements  - "SDRs")
• Targeted rules that apply to distributors of investment products to retail investors in the UK.

The FCA has also consulted with the investment industry about expanding the SDR rules to portfolio managers. 

The FCA’s stated goal is to ensure that “financial products that are marketed as sustainable should do as they claim and have the evidence to back it up”. 

Rules around SRI and ESG are likely to be developed further as the sector expands and matures.

Why choose a socially responsible investment portfolio?

While an SRI portfolio is not built bespoke to your own exact preferences, they tend to exclude the most controversial sectors. For example, if you do not agree with investing in fossil fuels, tobacco, weapons manufacturers, then you are likely to find that these will be excluded in most SRI portfolios. The portfolios have increased exposure to companies that have been identified by MSCI's ESG/SRI screening process as engaging in areas such as social justice, environmental sustainability, and clean energy. SRI model portfolios can be an ideal choice for those who want to invest and 'do good' while potentially building their wealth. 

While Nutmeg will only build portfolios through investing in ETFs tracking established equity SRI indices, this universe of stocks already includes some of the largest listed companies in the world. For example, among the largest components of the MSCI World SRI Index are Microsoft, Coca Cola, and Walt Disney. These may not be the first companies you think of as 'doing good' but all have made separate commitments, from reducing carbon emissions, to waste management, and inclusion and diversity. In building its SRI index, MSCI uses an ESG rating system to rank companies overall and relative within their industry. If investing in individual stocks yourself, you should always do your own research to make sure that a particular company's values do in fact align with yours. 

SRI is now very much a core investment approach and not a short-term trend. As Jennifer Wu, Global Head of Sustainable Investing at J.P. Morgan Asset Management, put it recently: "Sustainable investing is investing". 

She added: “There is a view that sustainable investing is just a fad that will just go away, but this is a complete misunderstanding of what sustainable investing is. Unless you consider climate change to also be just a fad, which it isn't, sustainable finance and investing will be needed even more”.

According to research from Bloomberg Intelligence, global ESG assets surpassed $30trn (£24trn) in 2022 and are on track to surpass $40trn by 2030. European investors are the biggest contributors to this trend. 

With ESG factors already integral to many companies' reporting practices, it's those that are less transparent about social impact that risk being left behind. Whatever your own personal values, an SRI-focused approach can mean you invest in some of the most progressive listed companies from an ESG perspective. These may be at the forefront of change in the way they do business and engage with their shareholders in the coming years. For this reason, we believe that SRI portfolios have the potential to deliver strong long-term returns. 

How has socially responsible investing performed versus other investments?

On a long-term basis (5 years plus), SRI has marginally outperformed non-SRI investing benchmarks. The best way to illustrate this is the performance of the MSCI World SRI index versus the MSCI World, the most recognisable measure of developed market equity performance. The table below shows the performance of both indices in dollar terms, over one, three, five and 10 years to end May 2024. 

Table: MSCI World index performance to 28 June 2024 (%)

Source: MSCI.com. These figures refer to past performance, which is not a reliable indicator of future performance.

However, the SRI measure has underperformed on a one and three-year basis. One of the key reasons for this has been dynamics within the energy sector. Traditional fossil fuels, which are excluded from SRI portfolios, funds, and indices on the basis of the environmental impact, significantly outperformed in 2022 and 2023. This was in part due to the initial supply shock and fallout following Russia's invasion of Ukraine, a topic we covered in greater detail last year in our article: Oil prices are rising - what does this mean for investors?.

While this lack of fossil fuel exposure has been a clear drag on SRI performance, it's worth noting the demand for alternative energy sources is expected to continue to grow in the coming years with listed companies involved in this space likely to be beneficiaries of this. 

SRI indices also tend to have higher exposure to medium-sized or 'mid cap' companies - those with a market capitalisation of between $2bn and $10bn - compared to broader market indices which have outperformed them. During more volatile, uncertain times, like we've seen in recent years, investors have tended to flock more towards large and 'mega cap' companies, which can have a market capitalisation in the hundreds of millions of dollars. While, as we've discussed earlier, many of these blue chip companies are now part of the SRI universe, they make up a smaller proportion of SRI indices compared to underperforming mid caps. This can be further exacerbated by differing index approaches. For example, as part of its index methodology, MSCI can cap the size of the company within its indices.

J.P. Morgan Asset Management's Jennifer Wu added: “In very volatile times, sustainable investors really need to do the work in order to identify the companies that produce green goods or are in green sectors that are proven to be more resilient and better positioned than their peers, because these are likely going to be the future winners.”

Given how difficult it is to pick these winners in any market, especially in the SRI space, investing in diversified ETFs as part of a managed portfolio can be an ideal solution for investors. This is how we at Nutmeg invest, with our investment team carrying out extensive research to select which markets and ETFs best suit our clients' risk profiles. 

How is Nutmeg currently positioned in its Socially responsible portfolios?

When it comes to Socially responsible investment portfolios, the Nutmeg investment team follows a similar approach to that of its Fully managed range - in terms of allocation between two asset classes - equities and bonds.

Within fixed income, the SRI portfolios currently hold more corporate bonds and fewer government bonds compared to equivalent Fully managed portfolios. This is because the SRI portfolios are required to hold at least 80% of assets in investments with an ESG tilt, and SRI corporate bonds is a more mature and developed sector than SRI government bonds at this time. 

A separate area that is still very much in its infancy, but which we currently don't explicitly allocate towards, is 'green' bonds. These are designed to support specific climate-related or environmental projects. We expect to see continued growth of green bond ETFs and look forward to the point when these funds meet our ETF selection requirements so that we will be able to add them to our portfolios. 

Where can I find out more about socially responsible investing?

You can read more about Nutmeg's SRI portfolios on our dedicated page, where you can also download a white paper which talks about our approach and wider views on the topic. 

If you have questions about our SRI portfolios, or want to find out more about how Nutmeg can help you on your investment journey, you can book a free call with one of our experts. 

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. 

These figures refer to past performance, which is not a reliable indicator of future performance. Forecasts are also not a reliable indicator of future performance.