Is SRI Right For Pension Plans?

pollutionSocially responsible investing (SRI) has been around since the 1700s but it only started to become mainstream in the 1960s and 1990s. Global investments increased from $639 billion in 1995 to over $3 trillion in 2010 while the number of SRI investment vehicles  increased from 55 to about 500.[1]

Socially responsible investing (SRI) is an investment approach which takes into account returns and seeks out activities which do no “‘social harm,”  i.e. avoiding investments in companies involved in alcohol, tobacco, gambling, weapons, the nuclear and mining industries or poor environmental practices, etc. SRI is also commonly referred to as environmental, social and corporate governance (ESG) or corporate social responsibility (CSR) investing.

Deciding what constitutes “social harm” is a challenge in itself.  In adopting a SRI approach a plan sponsor may have a specific “social harm” in mind. For example, SRI investments that specifically avoid alcohol, tobacco or armaments companies may appear to be easy to identify. Avoiding offending companies, given the multitude of other investment opportunities, isn’t likely to have a major impact on overall portfolio performance. Sponsors or fund managers could however take a more general view of social harm resulting in many good investments being excluded. The more general the definition of social harm the greater the investment excluded.


There is no standard or coherent definition of what constitutes SRI: SRI can include an unlimited number of activities and causes. Are companies supplying machinery, vehicles, software, computers, supplies or, accounting firms, banks, etc. which enable the operation of offending companies not equally guilty of perpetuating the problem? Taken to an extreme a substantial number of excellent investment opportunities could be excluded under SRI. Obviously It’s a question of degree – where do you draw the line and why.

A specific definition of social harm is needed to select and monitor the companies for compliance. If the investment is in a single company and there is a specific defined social harm, the selection and monitoring tasks may be easier; however, many companies are involved in a variety of activities in many locations. In the case of pooled or mutual funds with broad social harm mandates and investments in many companies in many locations, it may not feasible or practical to select then monitor the fund to ensure compliance with the SRI mandate.

From a legal perspective if you are screening out certain types of industries, companies, activities etc., a specific authority should be included in the trust agreement. From a fiduciary perspective, return, style or risk expectations included in the Statement of Investment Policies and Procedures (SIPP) for other types of investments and the specific SRI conditions and expectations should be outlined monitored for compliance.

The concept of SRI is not without critics. Some argue against SRI on the grounds that a) it encroaches on what should be the role of government; b) companies do more social good than bad in the form of jobs, innovation than explicit SRI firms do; and c) SRI involves playing with other peoples’ (shareholders or pensioners) money in pursuit of goodness vs. profits.

Robert Reich, a former U.S. Labour Secretary in the Clinton administration, argued that the social responsibility of business is to create profits.[2] Others argue that those seeking profit do so at the expense of others, i.e. a social harm.

SRI is a relatively new special case pension investment. From a governance and fiduciary perspective it is therefore important to clearly define the purpose, nature and expectations in the SIPP: is the objective of the SRI investment clear and is it achieving its mandate and return expectations? Documentation supporting the reason for and selection of a SRI investment and, ongoing monitoring is important because of the additional scrutiny SRI investments may receive.


One of the traditional arguments against SRI has been that it underperforms other types of investing because of the limitations on certain companies or industries. The research that has been done however does not support this perception.

An academic review of 35 years of studies found there was a positive but weak link between SRI companies and financial performance.[3]

A joint Harvard and London Business School study found that in the 18 years prior to 2011 a valued-weighted portfolio of high sustainability organizations that adopted a number of environmental and social policies outperformed a similar portfolio that didn’t. This could include companies not otherwise considered SRI candidates — e.g. a tobacco or alcohol company. In other words, this criteria isn’t much of an indicator of SRI performance but it does highlight the difficulty in identifying and monitoring SRI companies.[4]

Research by Goldman Sachs analysts concluded that SRI investing, in itself, added no value but an SRI perspective in viewing the market over the long term be advantageous: SRI analysis is a good proxy for evaluating management. A 2007 study undertaken by Phillips Hager & North found that SRI does not result in lower investment returns. They also cited a 2005 study by Schroders which confirmed that SRI indices had higher risk(volatility).  Phillips Hager & North concluded the question of whether  SRI negatively impacts returns would not be answered soon due to the “fuzziness’ over what is considered a SRI investment and research-related concerns about the methodologies used and quality of the data.[5]

SRI in DBs vs. CAPs

SRI is should be viewed differently for large defined benefit (DB) plans vs. capital accumulation plans.

Defined Benefit (DB) Plans

CPPIB, AIMco, BCIMC or OMERS, Teachers or government heritage funds are a few of the government pension or investment organizations that could effectively undertake SRI. These types of organizations have professional staff and resources and have a better chance of clearly defining SRI objectives, selecting appropriate direct or fund investments, establishing unique benchmarks and monitoring them on an ongoing basis. Few DB plans or investment organizations however are 100% SRI. In most cases a small portion of a portfolio is allocated to SRI investments.

Most small DB plans don’t have the time, resources or desire to try to effect socially responsible changes in another company.  In addition, return and risk performance are unlikely to present a strong case for adding one or two SRI investments to a DB plan.

Do smaller DB plan administrators or committees who are considering adding one or two SRIs understand or want the additional administrative and fiduciary responsibilities? Probably not.

Some argue that large DB plans or Investment organizations should make a significant investment in a company and then take on a shareholder activist role to try to influence behavior. This likely to be more effective than simply not investing in the company.

Capital Accumulation Plans (CAPs)

Adding SRI funds in a CAP requires careful consideration given that CAP administrator must act in the best interest of the members. A critical question: is a CAP sponsor’s desire to be socially responsible and imposing their values through SRI in fact acting in the best interest of the CAP members? If the sponsor is aware that some CAP members are keen on SRI, is it prudent to offer only one or two SRI options? In the future, could the members argue that there were insufficient diversification opportunities or that they were effectively forced to into using one or two investments? Would it be prudent to be 100% SRI in a CAP? Sponsors need to address these issues in their governance documents.

Generally, CAP members are unsophisticated, reluctant investors. CAP sponsors should therefore try to keep the investment structure and member learning curve as straightforward as possible. Having numerous investment options, with different objectives, asset classes, styles, risk profiles, time horizons and benchmarks tends to intimidate and confuse the average CAP member. For example, adding a SRI equity fund is unlikely to improve risk or return performance vs. similar non-SRI funds. In addition, communicating with and educating CAP members becomes more challenging and costly the greater the number of investment options.

There may be a feel good factor resulting from investing a bit in a SRI option, but it will not likely result in any meaningful reduction in social harm. Rather, CAP members’ investments will mostly be in non-SRI Investments. In addition, neither the sponsor nor the members will likely know what social harm is being targeted or whether the fund is in compliance with its mandate. From a fiduciary and member perspective and given the extra administration, communication, education, monitoring,  risk and cost involved, is there really a good argument for having SRI funds in CAPs?


Where demand and significant profits exist from the tobacco, alcohol or armaments industries etc. it is unlikely that the companies accused of social harm will disappear or change their business because of SRI.

Large investment organizations and DB plans are more likely to have the capacity to effectively undertake SRI but need to be open and vocal about their SRI policies. Alternatively they may be more effective investing in all types of companies and becoming activist shareholders encouraging practices that improve behaviors even in companies that are generally considered to inflict social harm.

In the case of CAPs, the feel good factor is likely the strongest argument for having SRI investment options but, it is not likely to result in any effective or meaningful reduction in social harm. SRI investments also complicate the CAP investment structure from a fiduciary and member perspective. SRI is a noble idea but it would appear that the main beneficiary of having a SRI option(s) in a CAP is the SRI fund manager.

[1] Seeking Alpha – Oct 2012 SRI: From Fringe to Mainstream

[2] The Economist, Does CSR work? Jan 17, 2008

[3] Economist, Does CSR Work, Jan 17, 2008

[4] Seeking Alpha, Socially  Responsible Investing: From Fringe to Mainstream, Oct 2012.

[5] Phillips Hager & North, Does Socially Responsible Investing Hurt Investment Returns, Oct , 2007