The last decade has marked a period of significant growth in Socially Responsible Investing (SRI), both domestically and abroad. From 2012 to 2014, American SRI assets hit the so-called "hockey stick curve" -- growing by 76 percent to $6.57 trillion in value. Today, investors are increasingly concerned that their investment portfolios reflect their  personal values. This is particularly true for Millenials, notes Daniel Kern, CFA, chief investment strategist at Boston-based TFC Financial.

"Millennials are among the  most passionate about pursuing SRI strategies, and are likely to have a major influence as SRI enters the mainstream in coming years," Kern notes. He expects some major changes to the SRI landscape. These changes will make tomorrow's approaches to SRI very different than those of recent years. Here are five SRI trends Kern says to look out for:

1.     Personal choice: Investors will demand portfolios that reflect their preferences, and will be less satisfied with "generic" approaches to SRI. 
"SRI today is like the television industry before the rise of cable, satellite and internet streaming," Kern says. "The first few decades of television were dominated by three networks.  Today, cable, satellite and Internet-based options offer hundreds of programming choices ranging from broadcast networks that attempt to appeal to the mass market to niche-focused cable networks that cater  to specific demographics or interest groups.  The SRI industry is experiencing the same type of transition today, in that first-generation 'generic' SRI products with a common set of exclusions are giving way to targeted approaches that more tightly align with specific issues investors are passionate about."  On this list are investments that focus on fossil fuel free, low carbon, and women-oriented products. "Ultimately, I expect a dramatic expansion of personalized options in SRI mutual funds, ETFs (Exchange Traded Funds), indices, and separately managed accounts," Kern concludes.  

2.     Party crashers: The SRI "club" will be crashed by large, well-funded investment firms.
"Pioneering SRI firms such as Calvert, Parnassus, and Pax World were friendly competitors who shared foundational beliefs and often collaborated on issues of mutual interest," Kern explains. "The SRI club is now being invaded by major investment firms that will offer new and more competitive SRI products." New entrants include BlackRock, which created a dedicated division focused on SRI; Goldman Sachs, which acquired an SRI-focused firm; and Merrill Lynch and UBS, which are among the retail broker-dealers that have launched or plan to launch SRI platforms. "These new entrants will change the competitive environment, with both positive and negative implications for investors and providers," Kern predicts.

3.     Fee compression: "Party crashers" will be catalysts for an era of increased price competition among SRI products.
"ETFs and robo-advisors are creating what appears to be a 'race to the bottom' in fees for traditional investment products," Kern warns. "Increased competition for SRI assets will lead to lower fees across the board." This is good for consumers but may not be so good for the product providers unless they can grow assets under management fast enough to offset shrinking profit margins.

4.     Performance matters: Performance will be more than just an after-thought for the next generation of SRI investors, as expectations will be higher.  

"Some firms excel at evaluating Environmental, Social and Governance (ESG) considerations and acting as shareholder advocates; others shine at evaluating traditional financial metrics.  It's rare to find investment managers who are outstanding at both ESG evaluation and traditional financial analysis," Kern notes.

"The CEO of a leading SRI firm was recently quoted saying, 'If you invest sustainably, you've got just as good a chance of beating the market as not.'  I think that statement misses the point for the next generation of investors, who may be reluctant to pay mutual fund fees of 1% or more to invest in strategies that have just a 50/50 chance of outperforming the S & P," he continues. "Index-fund proponents would argue that high fees and taxes undercut returns, and that index-based solutions will have a performance advantage over most actively-managed SRI strategies." The bottom line is that Millennial SRI investors are savvy, and will expect a lot from the people they hire to manage their money.

5.   Social priorities change as the generational torch is passed: Our children and grandchildren have different social priorities than the earliest proponents of SRI.
"Nuclear power, the aftermath of the Vietnam War, and polluted rust belt communities framed my generation's perspective about social issues," Kern explains. "My children know little about protests at the Seabrook nuclear power plant or about toxic pollution at Love Canal, but they are very familiar with the fossil fuel divestment movement, Occupy Wall Street, same-sex marriage, and LGBT equality issues. Younger investors often give me a blank look when I mention the faith-based exclusions of alcohol, gambling and adult entertainment that are found in many of the largest socially-screened mutual funds. Different generations may have some very different social priorities, with those differences implying a need for fresh approaches to SRI." By interviewing your target market, you can help craft specific investment strategies that will appeal to their values and philosophy.

Because the next wave of SRI will need to be more custom-tailored to investors, Kern offers some guidance as a starting point for those who have both social and financial objectives:

·      Define what you want to accomplish:  Defining the investment objective, social considerations and time horizon are critical steps in the process. 

·      Decide whether you want absolute or directional alignment with your values:  If directional alignment is enough, a mutual fund or ETF may satisfy your needs.  If absolute alignment is important, a separately managed account may be more suitable.  However, absolute alignment comes with a cost: potentially in higher fees, complexity, or personal involvement in the design process.

·      Understand the investment implications:  There may be financial trade-offs associated with the SRI strategy.  Understand the investment risks associated with different values-driven investment strategies, so that you're fully informed about the environments in which those strategies will thrive or struggle.

By following his approach, you can offer your SRI clients better service - or ask for better service yourself as you put your money where your heart is.



Disclaimer: Historical performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss of income and/or principal to the investor. Nothing in this communication is intended to be or should be construed as individualized investment advice. Unless otherwise stated, neither Kern nor I endorse or recommend any vendors or investment managers mentioned in this post.