Schwab’s 3 Myths of Responsible Investing Are Actually True

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In March 2019, Schwab Perspectives published an article entitled, “Responsible investing: Signs of a growing opportunity? ” The article was ultimately an excuse for Schwab to advertise their custody services and “Socially Conscious Funds List.” However, in the writing, the author attempts to dispel three so-called myths about socially responsible investing (SRI) funds. In reality, all three “myths” are cause for real concern about SRI; environmental, social, and corporate governance (ESG); and other so-called impact investing.

1. Responsible investments underperform.

To assess this claim, the Schwab author compared the three-, five-, and ten-year returns ending on December 31, 2018 of “socially conscious” vs “non-socially conscious” mutual funds. As the Schwab’s source credit says, “The number of socially conscious funds with three-year returns is approximately 316, compared with over 6,500 non-socially conscious funds. Morningstar defines funds as socially conscious if they invest according to noneconomic guidelines such as environmental responsibility, human rights, or religious views.”

The problem here is that the comparison is between every possible fund you could invest in rather than merely socially conscious compared to the best alternative. There are hundreds of terrible funds you should never invest in. Many funds even the fund companies will close in just a few months.

For the socially conscious funds to be better than the non-socially conscious funds only means that they need to be better than the average you get when you include the most terrible funds out there alongside the best ones.

Second, comparing socially conscious funds to non-socially conscious funds without regard to sector is irresponsible. There are known factors which outperform under certain conditions. If socially conscious funds were to tilt more towards one of these values, then any advantage found might just be descriptive of this underlying known factor and have nothing to do with the socially conscious fund. In fact, if that is the case, there are likely other funds specifically targeting this factor which are far superior to the socially conscious funds. These superior funds are merely being averaged in the Schwab study with terrible funds and funds tilting the opposite way so you cannot see their effect.

To really assess how responsible investments perform, you need to compare them to non-socially conscious funds which are the real alternative, meaning in the same sector and tracking the same index.

2. Responsible investments are not affordable.

To assess this claim, the author writes, “Out of the 395 mutual funds that Morningstar identifies as ‘socially conscious,’ over half (53%) had expense ratios that were lower than their category’s average.” Alas, the category averages are outrageously expensive.

This sentence is like saying, “Out of all the people analyzed, over half of them smelled better than the primate average.” The average primate smells like a monkey, so the fact that only half of the humans analyzed smell better means the lot of them smell as bad as or worse than a zoo animal.

The industry standard for a so-called good expense ratio is below 0.75%, but you should not buy a fund near this target. We usually don’t even consider funds with expense ratios above 0.50% and are proud that our Investment Committee typically builds portfolios with average expense ratios of 0.24% or less.

3. It’s too complicated.

In this section, the Schwab author describes how there is “industry jargon” with unclear definitions that create “real barriers” that “are now becoming surmountable.” “The answer is education,” the author concludes, forgetting that he or she was trying to claim it wasn’t complicated.

In other words, I think even the Schwab author would have to admit that it is complicated.

What issues the managers of a socially conscious fund care about may be completely different from what you care about. Let’s imagine that you want to avoid carbon emissions and vices, like tobacco. You may be able to find one fund that tries to target low carbon emissions and another that tries to avoid morally questionable companies. Alas, your moral fund may still have carbon emissions and your low-emissions fund may have morally questionable companies in it. After hours of searching, you may be able to find a third fund that targets both social issues, but the expense ratio might be prohibitively high and it may be targeting yet more social issues you don’t care about.

It is not a simple process.

The Schwab author acknowledges this problem writing, “Because few regulations govern what funds can be categorized as a socially responsible investment, investors could end up supporting activities they oppose.”

Although I agree with the stated problem, regulation will not solve this problem any more than it has solved the organic food problem. Any definitions made will be corrupted by lobbyists, require hours and thousands of dollars in compliance costs, and ultimately be as polluted and confused as before.

The world has a plurality of viewpoints and perspectives. No amount of regulation or standardization will be able to create the perfect socially conscious fund.

Two years ago, I wrote the article “My Best Case for Socially Responsible Investing.” If you find yourself interested in Socially Responsible Investing, I recommend that you read it. At the end of that article, I conclude:

If your conscience isn’t clear, then you should either educate your conscience or change your investments.

To educate your conscience, make sure you understand that stock ownership is a bad strategy for social change and SRI does not work the way it claims.

If you still feel guilty because of your stock ownership, change it. There are so many funds out there, finding investments that exclude companies you dislike is not insurmountable.

Change your ownership not because it is financially profitable, not because it is an investing strategy, not because everyone should do it or even anyone else should do it. But change it because you don’t believe that your conscience is mistaken and a clear conscience is worth something to you.

If your conscience isn’t clear, rather than turning to a higher cost socially responsible fund, I would recommend seeing if you can find a different low-cost fund which avoids whatever companies you seek to avoid.

Alternately, if you have sufficient assets, diversify your portfolio by buying individual companies that you are comfortable holding. While individual stock investing has some dangers, it also has no expense ratio.

If you are a client of ours, we’ll make sure that you have all the education about how stock ownership works, because that’s what a good advisor should do. But if you still have issues with a company or fund, we would be glad to seek a suitable alternative investment to accommodate the concerns you have.

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.