From SRI to ESG: The Origins of Socially Responsible and Sustainable Investing

Introduction

Socially responsible investing. SRI. It is a well-worn term that grew in prominence during the 1980’s and 1990’s, but its roots trace back two millennia. In fact, SRI reflects a set of values that migrated from religious doctrine at the edge of the historical record to a modern landscape challenged by social justice issues, climate change and concerns about corporate governance. At its inception in North America, civil rights-era thinkers, faith-based organizations and women were SRI’s most strident evangelists; specifically, women investors, women entrepreneurs and orders of Catholic Sisters. Today its proponents range from millennial analysts at Wall Street firms, to financial engineers, pension trustees, heads of family offices, sovereign wealth funds and retail investors. From a virtual novelty run out of a few dedicated shops, modern SRI is now a global phenomenon affecting the debate on fossil fuels, fundamental stock research, required disclosures for stock exchanges, credit ratings, global accounting standards and multinational cooperation with stakeholders.


SRI has always been rich in nomenclature, and the modern process is no exception. “Sin stocks,” “best in class,” “community investing,” “values-based in-vesting” and “green investing” are now joined in the lexicon by “environmental, social and governance (ESG),” “impact,” “gender lens,” “fossil fuel-free” and a host of other terms. Today, SRI can aptly be described as sustainable, responsible and impact investing, and is a legitimate influence on the capital markets and financial services. In the traditionally more liquid markets (stocks and bonds), modern SRI falls into two camps: values-based investing along the lines of traditional socially responsible investing; and more forward-looking ESG analysis, which strives to assess the materiality of non-traditional data to determine which companies are best prepared to compete in a world with dwindling natural resources, higher regulatory burdens, a growing human population and climate change. According to the 2016 trends report by the United States Social Investment Fo-rum (USSIF), sustainable, responsible and impact investing now accounts for $8.72 trillion invested in North America, up 33% from 2014. Much of this growth is driven by large asset owners who now consider ESG criteria across $8.10 trillion in assets, up 69% from $4.8 trillion in 2014. [1] As the USSIF data shows, it is the growth in ESG investing that makes modern SRI more than just a trickle in the market. ESG has done what traditional socially responsible investing could not: ESG has breached the wall that isolated mainstream investing from socially responsible investing. The modern SRI process stands on three pillars incorporating the old and new:

  1. Values-based avoidance screens – akin to traditional North American socially responsible investing;

  2. Proactive sustainability-focused analytics – “ESG investing”; and

  3. Corporate engagement and impact investing.

In this piece, we will focus on the origins and evolution of the first two pillars, the traditional North American model for responsible investing and ESG – which first took hold in Europe.


Socially Responsible Investing

Do no harm. That is the central concept of traditional faith-based investing and to some degree the central concept of traditional socially responsible investing: avoiding products or industries that conflict with a set of moral values. These prescriptive screens, however, don’t quite capture the aspirational spirit behind the birth of socially responsible investing in America. Traditional SRI was heavily influenced by the transformative 1960s and 1970s, which saw the rise of the anti-war movement and the maturity of movements on racial equality, women’s rights, consumer protection and the environment. These social and cultural influences are sometimes undersold in the narrative of traditional socially responsible investing. In fact, it was a fusion of the faith-based values with these distinct American progressive values that created the recipe for “socially” responsible investing in North America. By the early 1970s, this led to the creation of the first mutual funds reflecting faith-based values, civil rights-era sensibilities and environmental concerns.


Of course, by 1970, using any “social” criteria in in-vesting went against conventional wisdom, and traditional socially responsible investing had many more critics than investment vehicles. Famed University of Chicago Economist Milton Friedman offered the most famous soundbite of the era, telling the New York Times Magazine in 1970 that “the social responsibility of business is to increase profits.”[2] Friedman’s comments dovetailed with the Nobel Prize-winning work of fellow University of Chicago economist Harry Markowitz. It was Markowitz’s 1952 Journal of Finance paper, “Portfolio Selection,” that introduced “Modern Portfolio Theory” (MPT) to the world. MPT had as a basic tenet the notion that restricting an investment universe (for any reason) should be anathema in the world of investing. [3] Critics came from outside the financial world as well. Kennedy Administration National Security Advisor and future Ford Foundation President, McGeorge Bundy, was succinct in expressing his thoughts on the subject when he said, “we don’t believe only the virtuous make money.” [4]


Nevertheless, in the 1970s the socially responsible investing industry established a pattern that would become very familiar in the decades to come. Despite its “conservative” biblical influences, socially responsible investing proved nimble with respect to changing cultural mores and “progressive” views in society. As society reacted to nuclear energy, sweatshops, Apartheid, GMOs, climate change, human trafficking, the gender wage gap, the LGBTQ movement and a host of other policy or cultural issues, socially responsible investors followed suit. It has been this way since John Wesley steered the Methodists away from the slave trade.


SRI investors push the industry. They are not pulled. Over time, their stances have seldom been judged harshly in the eyes of history. Whether on slavery, Apartheid, tobacco, private prisons, conflict minerals or coal, these early investors did not require quantitative

validation before making their choices. The decision was a matter of principle and very much reflected the aspirational Zeitgeist of the 1960s and 1970s. In the same way, Warren Buffett inspired investors with the simple mantra: don’t invest in a company you don’t understand. Socially responsible investors have been just as inspirational: don’t invest in a company that conflicts with your values. The birth of the industry coincided with a time when many Americans were challenging which values were most important.


There is usually a catalyst for innovation within the SRI market – Apartheid and climate change are the most recent examples. At the birth of the SRI industry in the 1970s, the most prominent catalyst was the Vietnam war.


Orange is the New Green

By the end of the 1960s, the Vietnam war had grown more complicated for the general population and social-minded investors. The volume of dissent was increasing around the country, and the realization that portfolios may be profiting from the war effort forced the hand of many religious investors. By the 1970s, some in North America began searching for ways to avoid “war profiteering” in their portfolios. The low hanging fruit was Agent Orange – what became identified as a “controversial weapon” in the parlance of SRI.


Over a five-year period, Agent Orange was sprayed over 10% of South Vietnam in a technique called “herbicidal warfare” developed by the British in the 1950s. This combination of toxins was developed for the United States Department of Defense by Dow Chemical and Monsanto, and has been described as the “most toxic molecule

designed by man.” [5] Agent Orange was designed to defoliate forests and terrorize populations. In 1971, the Pax World Balanced Fund was launched in large part to provide an option for largely religious investors looking to avoid direct investments in the supply chains for Agent Orange on moral principles.


The launching of Pax also corresponded with the general awakening of the environmental movement in this country. It occurred less than ten years after Rachel Carson’s seminal book, The Silent Spring, gave birth to the modern environmental movement and the idea that toxics, pollution, water, air, plants, people and animals were all connected. She probably couldn’t have imagined how correct she was. In 2016, scientists found tiny crustaceans in some of the deepest, most remote crevices of the ocean – six miles below the surface – contaminated with PCBs and even flame retardant at levels 50 times heavier than crabs living in China’s most polluted waters. [6] The era also saw protests over nuclear disarmament evolve into concerns over nuclear energy. Friends of the Earth was created in 1969 to carry that mantle. By April 22, 1970, Wisconsin Senator Gaylord Nelson and a Harvard-educated organizer named Denis Hayes mobilized 20 million Americans for the first Earth Day celebration. That same year, the Environmental Protection Agency was created and the Clean Air Act was passed. A cascade of environmental and consumer protection legislation followed, including the Clean Water Act in 1972 followed by the Endangered Species act in 1973, both with bipartisan support. North American socially responsible investing was born against this backdrop. Pax soon had company, and the mission of the other new socially responsible funds reflected this groundswell of aspirational progressive values. The Dreyfus Third Century Fund was launched in 1972 with serious capital for the time ($25 million) and

had some heavy hitters behind it (presidents of the League of Women Voters and Rockefeller Foundation, the executive director of the Urban League, a Nobel Prize winner, and president of Princeton University). The Fund’s prospectus stated it was looking for companies that “show evidence in the conduct of their business, relative to other companies in the same industry or industries, of contributing to the enhancement of quality of life in America.” [7] Novel at the time, this type of analysis would essentially be called “Best in Class” in socially responsible investing by the 1990s.


Another entry to the fledgling SRI business was the First Spectrum Fund, which started in 1971. Its process also foreshadowed modern SRI techniques, promising no investment

would be made before it analyzed companies’ performance in “the environment, civil rights and the protection of consumers.” There was important work being done on specific issues as well – like workplace practices and companies’ roles in society. The early champion of

this work was journalist Milton Moskowitz, a tenacious business-minded thinker who believed that treating employees well, being transparent and being a good corporate citizen was a pretty fair investment thesis for a long-term holding. Moskowitz wrote in the Sunday New York Times in February of 1973, “I do harbor the suspicion that a socially insensitive management will eventually make enough mistakes to play havoc with the bottom

line.” Moskowitz wrote a nationally syndicated column three times a week from 1968-1986 and published seven books. In 1968, Moskowitz also launched Business & Society, the first business newsletter focusing on the role companies played in the lives of their employees, in their communities and society at large. “Its constant drumbeat,” wrote Moskowitz, “was to encourage corporations to become engaged in tackling social problems.” In 1982, Moskowitz served as senior editor for Business and Society Review, a serious academic journal covering the same subject matter. It survives today as an arm of the Center for Business Ethics at Bentley University in Waltham, MA.


The idea of corporate social responsibility (CSR), much less a dedication to reporting on it, was nearly nonexistent in 1968 when Moskowitz began his career. To be sure, focusing on CSR was not a target-rich environment for a journalist in 1968. As Moskowitz pointed out at the time, Major League Baseball was integrated in 1947, but it took twenty years before there was a single black board member at a Fortune 500 Company. There were few sources of CSR information readily at hand. In many ways, Moskowitz built a strawman for CSR on which decades of researchers and journalists could build. There is now a cottage industry on CSR that spans consulting, journalism and publishing. The 500 largest companies in the world now spend over $15 billion per year on CSR efforts. [8]


Although it would be decades before the academic studies caught up with the growth of the socially responsible investing industry, Moskowitz published a list of “responsible” stocks in Business & Society in order to track them against broad market indices and the first socially responsible mutual funds in 1972. His original list included the following “responsible” companies:

  • Chase Manhattan

  • Dayton Hudson

  • First Pennsylvania

  • Jewel Companies

  • Johnson Products

  • Levi Strauss

  • M-REIT

  • New York Times

  • Rouse Company

  • - Standard Oil (Indiana)

  • Syntex

  • Weyerhauser

  • Whirlpool

  • Xerox

In 1973, Moskowitz added new names:

  • CNA Financial

  • Cummins Engine

  • Lowe’s

  • Quaker Oats

  • McGraw-Hill

Moskowitz tracked these “responsible” companies against the broad stock market and went as far as compiling an “irresponsible” list as a further data point to explore the investment thesis of picking the “good guys.” These early efforts to evaluate performance started the clock on the academic research dealing with SRI performance. Moskowitz’s insights shed additional light on the civil rights-era sensibilities that influenced early SRI offerings.


For example, Moskowitz included Johnson Products because it was the only black-owned business listed on the NYSE exchange. And M-REIT, which was a real estate investment trust looking to acquire residential properties and racially integrate them. M-REIT sought to make a statement that might still resonate today with millennial investors seeking to avoid for-profit prisons and concerns about growing wealth disparities in this country. M-REIT founder Morris Milgram said at the time, “Life is too short to do anything but build the kind of world one believes in.” [9]


A prominent name on the list was Levi Strauss & Co., a company at the forefront of the early CSR movement with a suite of business practices that would set the early standard. Levi Strauss was a featured company in the first edition of the best-selling 100 Best Companies to Work for in America, published by Addison Wesley in 1984 by Moskowitz, Robert Levering and Michael Katz. The “100 Best” list eventually became an anticipated annual release in Fortune Magazine beginning in 1998, and its methodology has spawned numerous other endeavors to rate companies.


The “100 Best” methodology was also applied in real-time as part of the investment thesis for the Parnassus Management’s Endeavor Fund (formerly called the Workplace Fund). Launched in 2005, the Endeavor Fund has crested $2 billion in assets under management by 2017 and has received rating service Morningstar’s highest ratings for its category.


In 1996, the Moskowitz Prize was established to recognize peer-tested academic research in the area of socially responsible investing. Given annually, the Prize is administered by the Haas School of Business, University of California Berkeley Center for Responsible Business – one of the hundreds of graduate programs that now focus on CSR and sustainability issues. In fact, today over 88% of students looking for a business school MBA believe learning about social and environmental business impact is critical. [10] Many of the companies on Moskowitz’s original list (or their successors) still maintain some of the CSR attributes they espoused at the time. Johnson Products was sold to consumer giant Procter and Gamble in 2004 but was then spun out to a group of African American investors in 2009 to re-establish its position as a black-owned business. And in Ursala Burns, Xerox today has one of only five African American CEOs among the Fortune 500 companies. Burns was also the first black woman CEO of a Fortune 500 company and the first woman to succeed another woman as CEO of a Fortune 500 company. In January 2017, Levi Strauss was a lead signatory of a letter to the new Trump administration to support the low carbon economy.


To read full paper, click here to download the PDF.


1. http://www.ussif.org/blog_home.asp?Display=75

2. http://link.springer.com/chapter/10.1007%2F978-3-540-70818-6_14#page-1

3. http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1952

4. Business and Society Review, July 18th, 1972

5. The Invention of Ecocide: Agent Orange, Vietnam, and the Scientists Who Changed the Way We Think about the Environment. By David Zierler. Athens: University of Georgia Press, 2011

6. https://www.theguardian.com/environment/2017/feb/13/extraordinary-levels-of-toxic-pollution-found-in-10km-deep-mariana-trench

7. New York Times Sunday, February 11th 1973, Why ‘Good Guy’ Funds have Flopped, Milton Moskowitz

8. https://www.ft.com/content/95239a6e-4fe0-11e4-a0a4-00144feab7de

9. http://archives.chicagotribune.com/1969/12/04/page/31/article/bob-cromie#text

10. https://www.netimpact.org/sites/default/files/documents/2014BAU_expanded_0.pdf