By Debbie Gallo
A profitable microcap portfolio that upholds your values so you can sleep peacefully
at night. Is it just a dream or could it be reality?
If you’ve ever hesitated to invest in a company because its products or practices were contrary to your personal principles, you’re not alone. A recent poll found 71% of Americans would be more interested in investing in a company that ranked high in social responsibility than one that didn’t.
Socially responsible investment (“SRI”), also called responsible investment, involves the factoring of ethical, social and environmental concerns into investment decisions. Investors consider the consequences, both positive and negative, of an organization’s actions, policies, products and services by assessing its corporate social responsibility (“CSR”). CSR is the company’s commitment to improving conditions for all its stakeholders and the environment. Stakeholders include customers, employees, suppliers, distributors, investors and communities in which the company operates. Currently unlegislated, CSR is largely voluntary and difficult to verify due to a lack of consistent reporting methods.
Despite a surge in popularity in recent years, CSR has long existed in the form of corporate philanthropy. Reaction to the Vietnam War and Apartheid spurred the practice of SRI in the 1970s and 80s. However, the 1992 Earth Summit, focused on reconciling economic growth with environmental protection, is credited for driving the demand toward more generalized corporate social responsibility.
In Calvert’s 2006
“Attitudes Toward Socially Responsible Investing” survey, 77% of respondents
stated they would purchase more products and services from a company with a
higher social performance rating than a lower rating. As consumers increasingly
support organizations practicing responsible employee, community and
environmental policies, a company’s CSR becomes a valuable, intangible asset to
be evaluated and protected.
Despite all this, many investors view SRI as a choice between ethics and profits.
All this bodes well for microcap investors wishing to include socially responsible investments in their portfolio.
Although CSR is not capitalization dependent, some characteristics of microcaps are particularly conducive to responsible investment.
· Alternative products: Microcaps frequently grow out of innovative solutions to existing problems or needs. This gives them the advantage in a market where consumers opt more often for beneficial products and companies.
· Size: A smaller suite of products or services is easier to assess for responsibility.
· Youth: Microcaps are often younger companies whose processes and policies are not yet carved in stone. Smart management may recognize the value responsibility can provide to products or industries that are otherwise benign.
· Less bureaucracy: More access to decision makers increases the ability to successfully influence the company’s activities through shareholder proposals.
Now, before you place sell orders for all your “irresponsible” investments, consider the following potential downsides to ethical investment.
· Socially responsible investment is more labor-intensive. It requires extra research, which, in a market where information is already hard to find, can be intimidating. To maximize profits, investors must be willing to commit time and energy to ensure social responsibility and financial benchmarks are met and maintained.
· It can be tempting to over-emphasize your values. Whether you screen for social responsibility before or after you’ve narrowed down your investment options, the particularly risky nature of microcap investment necessitates satisfying yourself of the company’s viability before proceeding with the investment.
· Another risk is that, under pressure from interest groups, companies could de-prioritize the immediate interests of the shareholders.
If this doesn’t discourage
you, it’s time to examine the three primary methods of socially responsible
investment.
1.) Screening involves filtering for specific criteria to determine an equity’s appropriateness for a portfolio.
· Using Exclusionary Screening, an investor rejects companies whose policies, products or practices meet undesirable criteria, such as operating in weapons production, violating human rights, or distributing tobacco products.
· Inclusionary screening is becoming a more popular method of screening, as it involves selecting companies whose policies, actions or products benefit society, such as solar power development, employment equity, or sponsoring community education programs.
· Best of sector is an approach which does not automatically exclude companies based on their participation in undesirable industries but, rather, selects the best performing companies in terms of their CSR practices. An example would be a weapons manufacturer supporting the safe removal of landmines from previously war-torn countries.
One point worth noting: it is not always practicable to apply the same standards to operations in developing countries as to those in industrialized countries. Investors need to use personal discretion to determine CSR in such cases.
2.) Shareholder Activism puts the onus of responsibility on the investor to enact corporate change through communication with management, filing shareholder proposals, exercising voting rights, and, as a last resort, divesting the shares to prove a point.
3.) Community
Investment provides equity to local
agencies in disadvantaged areas to promote community development and services
through micro-business loans, public housing, etc. Community investment is
generally understood to offer a lower financial return in exchange for a higher
social yield.
Should you choose to add socially responsible investments to your microcap portfolio, the following guidelines may help you get started and increase your profitability.
Rank your values. List all issues of importance to you, prioritize them, and concentrate on pursuing the top few.
Broaden your mind. When evaluating investment opportunities, open your mind to how companies might fit your criteria. It’s not always as obvious as eliminating sweatshop labor. Socially responsible practices include perks and programs investors in progressive, industrialized countries may take for granted, such as pay and employment equity regardless of gender, religion, race or sexual orientation, encouraging employee education, and sponsoring breakfast programs for hungry children in the community.
Separate emotion from logic. This is easier said than done but, ultimately, you must remember this is not a charitable donation. No matter how attractive a company may be from an ethical standpoint, let it go if it does not pass a rigorous financial assessment.
Diversify. As with any portfolio, diversification is key in protecting your portfolio from industry downturns. Avoid investing in too many companies with common industries, products or services. Likewise, if your portfolio becomes heavily weighted with responsible investments, diversify your criteria to avoid exposure to adverse events.
Determining a microcap’s compliance with socially responsible criteria involves an even deeper level of research in an industry where information is scarce. This is hindered by the lack of legislation and reporting requirements for corporate social responsibility. You might easily find one of the following scenarios:
· Companies using a CSR label to “greenwash” themselves, when in reality they practice little or no such responsibility;
· Companies with good intentions who do not practice systematic or thorough checks to ensure their actions comply with their policies; and
· Companies with sound corporate responsibility who are unable to provide empirical evidence in their reports.
Don’t be afraid to contact the
company directly for information on its corporate social responsibility. Ask
for detail of its reporting practices, the frequency and methods of evaluation
and copies of any reports, such as CSR, environmental responsibility or
sustainability reports it may produce. Also request the company’s code of
conduct, and proof of responsible product certification. Inquire about
membership in industry associations that support CSR and follow up with those
organizations. If the company is committed to environmental protection, check
if it adheres to CERES Principles. Sustainability reports for member companies
are published on the CERES site (www.ceres.org). You may also find CSR
information in the company’s annual report.
A search of the Internet may turn up news articles or press releases. As with any other information found on the Internet, beware its validity until confirmed. Don’t forget to alert your investment advisor to your goals – he or she may be able to provide information from financial industry associations dedicated to promoting social investment.
In today’s global business
world, where companies can have operations and suppliers in many countries,
investors can definitely make a difference in human rights conditions, poverty
reduction, the creation of fair jobs, environmental conservation, and more.
You may never find a company that meets all possible SRI criteria but that’s not the aim of responsible investing. The goal of SRI is to recognize the issues that have the most personal meaning to you and pursue opportunities that support those values. It may take more effort to incorporate your principles into a profitable microcap portfolio, but perhaps that’s just the price to pay for a good night’s sleep.
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Sidebar: The Criteria
There may be as many
combinations of socially responsible criteria as there are responsible
investors. Although the selection is very personal, the following is a list of
some common screens.
Exclusionary:
Producers of tobacco, alcohol, gambling products, weapons, genetically modified foods, pornography, and possibly nuclear power.
Manufacturing processes that pollute the environment, damage or deplete natural resources and ecosystems, include harmful chemicals, employ sweatshops or child labor, and practice animal testing.
Companies that discriminate based on age, race, gender, religion, sexual orientation or income; practice predatory lending; discourage fair labor practices; operate in countries that practice human rights abuses or have corrupt governments; and neglect the communities in which they operate.
Inclusionary:
Producers of
environmentally or socially beneficial products, such as alternative power,
fuel-efficient technologies, educational toys, biomedical research, organic
foods and recycled products.
Manufacturing processes that are toxin-free, reduce greenhouse gas emissions, use renewable resources, promote recycling, protect ecosystems, promote biodiversity, use fuel efficiencies, and do not employ sweatshop conditions or child labor.
Companies that offer pay equity, practice affirmative action, incorporate a no-tolerance policy for discrimination in their codes of conduct, contribute to the development of the communities in which they operate, provide health and educational benefits to its employees, and practice corporate philanthropy.
In socially responsible
investment, you invest with your heart.
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