Once marginalized by the broader investment community and considered at odds with the goal of achieving optimized risk adjusted returns, socially responsible investing (SRI) is now at the forefront of the investment decisions made by an increasing number of institutions and families. 

A growing canon of academic work, in addition to better defined and more rigorous methodologies, has demonstrated that SRI not only can produce similar returns to traditional investment frameworks, but also can, in many cases, achieve higher returns than these strategies over a long period of time. In fact, it’s increasingly accepted that not only may a fiduciary consider a given beneficiary’s ethical considerations, but also actually should consider them as a matter of fiduciary responsibility.



Over the history of modern finance, the methods and goals of socially conscious investors have developed from an ethical focus inspired by various religions into its modern form (see “Evolution Timeline,” p. 50). The earliest form of SRI, also known as “ethical investing” (now known as “negative screening”) was the deliberate avoidance of certain companies and industries that didn’t adhere to an individual’s or organization’s values and ethics. This approach was typically in line with a group’s religious beliefs, such as the Quakers, who, since the 1500s, have avoided investments in companies that profit from gambling, alcohol and tobacco.1 John Wesley (1703-1791), a founder of the Methodist Church, described an early ethos for environmentally aware investing: one’s business practices shouldn’t harm one’s neighbor, and industries that can have a negative impact on the health of one’s laborers should be avoided.2

During the 1960s, the term “socially responsible investing” came to describe the values-based and exclusionary investment approach that had been born out of the earlier religion-based ethical approach to investing, but had evolved with the political environment of the era and an increasing awareness of the impact that companies and investors could have on the public good.3 An example of this evolution is the recognition by trade unions that their pension assets could be directed towards investments that increased the overall well being of society in general, such as the increased investment by the United Mine Worker’s pension in health care facilities during the 1950s and 1960s.4

Perhaps one of the most notable examples of the impact of this earlier form of SRI is the fall of apartheid in South Africa. In 1975, Rev. Leon H. Sullivan, then a member of the Board of Directors of General Motors Corporation, drafted an ethical framework for companies operating in South Africa, which was then still under apartheid law. This framework, which became known as the “Sullivan Principles,” called for companies to maintain fair employment practices, regardless of race, and the active pursuit of improved living conditions for people of non-European descent. The growing anti-apartheid movement used the Sullivan Principles as a focal point, as it pressured American companies to pursue anti-apartheid practices.5 

Later, in the 1980s, the movement led to a disinvestment campaign in which anti-apartheid activists lobbied for institutions, such as university endowments and public pension funds, to remove investments in companies that didn’t adhere to the principles. 

Specifically, student protests caused the number of universities participating in the disinvestment campaign to rise from 53 in 1985 to 155 by August 1988. Overall, the Sullivan Principles and the accompanying disinvestment campaign contributed to a reduction of U.S. direct investment in South Africa from $2.28 billion in 1982 to $1.27 billion in 1988 and are considered to have played a meaningful role in ending the apartheid system.6

The 1990s brought the incorporation of an investor’s broader social and environmental goals into the investment process with the addition of positive screens, in which an investor’s criteria are used to identify those companies that specifically seek to achieve certain goals or take certain measures in adherence with an investor’s personal goals.7 

It’s positive screening, in addition to shareholder activism, that’s been the most important factor in the development of modern SRI, which seeks to express an investor’s goals and values in a manner that doesn’t reduce diversification or sacrifice performance in the long run. 

Until the earlier part of the last decade, the majority of SRI was focused on social and environmental concerns. Since then, however, there’s been an increasing emphasis by both academics and investors on the importance of corporate governance to sustainable investment returns. 

It’s been suggested that this shift was initially inspired by Robert Levering and Milton Moskowitz’s book, based on the “100 Best Companies to Work For” list, which brought to light the importance of corporate governance to financial performance. It was this work, in addition to the passage of the Sarbanes Oxley Act in 2002, that led to the inclusion of corporate governance in the three pillars of SRI that exist today: environmental, social and corporate governance factors (ESG).8


Financial Performance

During SRI’s developmental years, much of the investment profession, supported, in part, by earlier academic work by Milton Friedman, took the view that SRI was essentially philanthropy. This view was supported by the misconception that, in general, corporate social responsibility and robust governance were costly for the firms that engaged in them; thus, these activities detracted from the firms’ bottom lines.9 In addition, it was widely assumed that SRI mutual funds in general underperformed their peers in various asset classes.9

In the years since, however, a series of academic studies have been published that demonstrate the opposite. Many have made the argument that ESG screens don’t hinder a portfolio by reducing diversification, but instead result in better financial performance.10 

This effect is predicted by stakeholder theory, which puts forth that firms that consider all parties that have a vested interest in the company, or “stakeholders” (such as the community, customers and labor force), versus those firms that only focus on parties with ownership interest “shareholders,” would demonstrate better financial performance over time.11 

It’s also supported by empirical evidence, such as the Samuel B. Graves and Sandra A. Waddock study in 2000, which found that companies with strong stakeholder management polices led to above average performance over the previous eight years.12 

A simple comparison of SRI and traditional indices demonstrates the point well. Since its inception in May 1990, an SRI index (the MSCI KLD 400) that includes U.S. large- and mid-cap companies based on their adherence to common ESG criteria and excludes any companies that are involved with specific industries, such as gambling, tobacco and nuclear power, has had an average annual performance of 7.71 percent. In comparison, the S&P 500 has exhibited an average annual performance of 6.77 percent over the same time period.13 (See Simple Comparison,” this page.) Generally speaking, long-term investors of all stripes would seek out a strategy that delivers nearly 1 percent of outperformance on average over a long period of time.

Further, a report published by the United Nations Environment Programme Finance Initiative in 2007 aggregated the conclusions of 20 academic papers and 10 studies by financial institutions and found that investment strategies with an SRI focus performed at least as well as traditional strategies.14 And, in 2012, Deutsche Bank Asset Management (a recognized global leader in ESG investing) issued a report analyzing over 100 academic studies and concluded that individual security selection that incorporated ESG criteria led to higher risk-adjusted returns and that SRI funds performed as well as their peers (see “Performance Levels,” p. 53).15


Studies such as these have supported the emerging view among institutional investors and family offices alike that investors needn’t sacrifice performance in pursuit of a portfolio that’s aligned with their ESG views. And, the discipline and selection involved with SRI using ESG criteria often leads to outperformance versus non-SRI investment strategies. 

In fact, a survey of 195 fund managers by Mercer Investment Consulting in 2005 revealed not only that positive screens for ESG factors are a method used in SRI investing, but also that traditional investment managers are increasingly employing these screens to target companies whose strong ESG practices limit various risks and liabilities and can be expected to generate superior financial performance.16



Notwithstanding more widespread adoption of ESG investing, trustees and other fiduciaries often express concerns about whether employing socially responsible criteria is at odds with their fiduciary duty. The most common concerns expressed are: 1) an ESG focus may produce worse risk-adjusted returns; thus, failing to adhere to the prudent investor standard; and (2) incorporating the ESG goals of each beneficiary and/or remainderman of a trust is difficult, since their goals may differ. It’s become increasingly evident, however, that these concerns are unfounded and that fiduciaries may even be obliged to include ESG criteria in their portfolios.

As the body of research described earlier suggests, an ESG-aligned portfolio is likely to financially outperform traditional portfolios over a long period of time. In 2005, the weight of this evidence led the United Nations to commission the international law firm Freshfields to survey the law of fiduciary duty in a number of developed jurisdictions including the United States. They concluded that “ESG considerations may be taken into account as long as they are motivated by proper purposes and do not adversely affect the financial purpose of the portfolio.” Moreover, they found that in many jurisdictions, the duty of prudence could even require that fiduciaries take ESG factors into account when making investment decisions.17

In the United States, trustees in 44 states are governed by the Uniform Prudent Investor Act. Its terms require trustees to make investment decisions for the sole purpose of providing benefits to the beneficiaries with the care, skill and prudence exercised by similar fiduciaries. As Freshfields concluded, a trustee certainly could give expression to the beneficiaries’ ESG goals, consistent with its duty of care. But, as the weight of the data suggests, a trustee should probably consider even basic ESG goals in selecting certain asset classes when there’s evidence of superior risk-adjusted return.18 

Fiduciaries shouldn’t be discouraged by a fear that it’s difficult to incorporate ESG factors with multiple beneficiaries. We’ve worked successfully with trustees who have identified the individual ESG goals of each beneficiary and created a comprehensive ESG matrix of issues representing the common views among the beneficial owners. 

With the help of experienced advisors, fiduciaries can use the results of this questionnaire to assess where the ESG views of the beneficiaries might overlap, in which case the views can be implemented in the portfolio, and where the views might specifically conflict, in which case the views are excluded from investment decisions. 

In cases in which a beneficiary has a specific ESG view that neither conflicts nor overlaps with the views of the other beneficiaries, the 2005 Freshfields study also suggests that the ESG consideration may guide an investment decision between alternatives that are equally attractive on a fundamental and risk/return basis.19 

On balance, we believe that every fiduciary should at least understand beneficiaries’ ESG goals (if any) and consider an ESG approach to certain asset classes where there’s evidence of consistent outperformance over time. 


Implementing an ESG Strategy

If a client has decided to consider an ESG strategy, the next question is, “How do I do that?” Many sophisticated ESG clients have described two challenges to pursuing an ESG mandate in their portfolio. 

First, most managers who describe themselves as pursuing ESG strategies have a very definitive ESG agenda that doesn’t necessarily match a client’s. Our clients have told us that they have trouble identifying that agenda upfront and feel “stuck” with it after investing. 

More established ESG managers will offer to customize their strategy, but clients should beware. Investors should always strive to choose best-in-class managers, and it’s difficult to evaluate whether a top manager with an environmental agenda will necessarily be a top manager when customizing her approach with the client’s governance or social objectives.  

Second, many clients profess confusion about navigating the plethora of ESG mutual funds and building an appropriate portfolio out of them. Their confusion is well-justified: It’s nearly impossible to weight ESG concerns and asset allocation when building a portfolio solely with mutual funds. The result is usually a misallocated fundamental portfolio or a misallocated ESG portfolio. 

We’ve found that the better approach is to build asset allocation strategies tailored to the client’s risk/return objective and to use ESG criteria to drive security and/or manager selection. We are by no means alone in following this approach and think it’s the best way to manage wealth consistent with all of a client’s objectives. 

This approach typically begins with the development of a rich matrix of a client’s ESG goals. This matrix is created through both a detailed discussion with the client and a questionnaire to assess specific areas of concern. The matrix is incorporated into the client’s Investment Policy Statement, used to design the specific asset allocation, guide security selection by managers, evaluate mutual fund/index investments and monitor both financial and ESG performance.  

In the majority of asset classes (for example, U.S. equities, EAFE equities, U.S. taxable bonds, U.S. tax-exempt bonds and cash management), when the allocation is large enough to warrant it, an investment advisor following this approach will employ active management and strive to use a separately managed account with specific security selection. Incorporated into the fundamental analysis involved with their security selection, such managers can employ both a positive screening process to select companies that best reflect their client’s specific ESG criteria and a negative screen to ensure that none of the companies in the portfolio engage in activities that directly conflict with their client’s goals.

When a strategic asset class has too small an investment universe to pursue a customized portfolio consistent with the client’s mission, an advisor following this approach might employ ESG/impact mutual funds and indices that can give expression to the desired asset allocation and the client’s mission. 

Manager research and selection are critical here for two reasons: (1) there’s significant dispersion in performance among SRI managers;20 and (2) to ensure that the funds selected are aligned with a client’s specific ESG goals. In addition, for asset classes in which active management might not be warranted, an advisor could employ an index fund that’s consistent with broad SRI principles.

Certain hedge fund strategies can form an important part of a diversified portfolio, given their historic outperformance of traditional asset classes and lower volatility. However, for many ESG-focused clients, hedge funds are unacceptable as an asset class, and in those cases, an advisor might not use them (instead increasing a client’s allocation to other higher-risk asset classes, including direct equity investments). 

For those whose ESG objectives don’t exclude them as an asset class, hedge fund strategies, such as long-short equity, merger arbitrage, relative value and distressed equity or debt can offer the possibility to invest in an interesting asset class with an ESG/impact focus. The challenge in hedge funds, except for the very largest clients, is finding a top manager executing an ESG objective similar to the client’s.

Currency exposure can also play a role in an SRI portfolio. Look for nations whose social and fiscal policies reflect a client’s ESG goals, as well as issuers whose activities and mission are consistent with a client’s beliefs. 

Through this lens, a client’s ethics are aligned with his investment interests in currencies of countries with sound governance, as they typically provide an environment more hospitable to growth, which may generate an increase in demand for their currency and thus, appreciation. 

For some, like us, that gets expressed in making specific international investments (for example, equities or bonds). For others, it can be expressed in a specific currency allocation and/or supranational bonds issued in specific currencies.

When a portfolio demands an allocation to private investments, many advisors will consider an allocation to impact-focused private equity and venture capital. These are varied and require careful consideration of non-ESG factors. For example, is the private investment focused on frontier markets and, if so, is that consistent with the overall asset allocation? The strategies selected are determined by the client’s specific impact goals, the correlation of the strategy’s specific risk to other components of the portfolio and the client’s desired level of impact. 

A private debt allocation can be expressed through a microfinance fund or other community lending activities. Again, one should carefully consider non-ESG factors. For example, is the infrastructure fund largely focused on philanthropic goals (to the exclusion of profit)? 

The result of this approach is a fully diversified portfolio that’s been tailored to a client’s given risk and return requirement and the client’s impact and ESG goals.


Growing Trend

Supported by academic research, empirical evidence and an increasing number of investment options, SRI is being adopted by an ever-growing number of investors. Many, working with mutual funds and boutique ESG managers, have built good portfolios. However, the evolution of ESG investing has developed a new process to construct a complete and diversified portfolio, which considers the fiduciary responsibility not only to balance a client’s risk tolerance and return requirements, but also to incorporate a client or beneficiary’s ESG goals. 

The trick is making sure that the client’s advisor is first and foremost building a good fundamental portfolio and knows how to employ ESG goals.                 


—Offers and sales of alternative investments are subject to regulatory requirements and such investments may be available only to “Qualified Purchasers” as defined by the U.S. Investment Company Act of 1940 and “Accredited Investors,” as defined in Regulation D of the 1933 Securities Act. This article is meant to serve as an overview, and is provided for informational purposes only. It does not take into consideration the recipient’s specific circumstance and is not intended to be an offer or solicitation, or the basis for any contract to purchase or sell any security, or other instrument, or for Deutsche Bank to enter into or arrange any type of transaction as a consequence of any information contained herein. Deutsche Bank does not provide tax, legal or accounting advice.



1. Mark Fulton, Bruce Kahn and Camilla Sharples, “Sustainable Investing: Establishing Long-Term Value and Performance,” Deutsche Bank Climate Change Advisors, June 2012.

2. John Wesley, “Sermon 50: The Use of Money,” Feb. 17, 1744.

3. Supra note 1.

4. Hillel Gray, New Directions in the Investment and Control of Pension Funds (Investor Responsibility Research Center, Washington, D.C. 1983), at pp. 36-37.

5. James B. Stewart, “Amandla! The Sullivan Principles and the Battle to End Apartheid in South Africa,” The Journal of African American History, Vol. 96 (Winter 2011), at pp. 62-89.

6. Richard Knight, “Sanctions, Disinvestment, and U.S. Corporations in South Africa,” Sanctioning Apartheid, Robert E. Edgar, ed. (Africa World Press 1990).

7. Supra note 1.

8. Ibid.

9. Michael L. Barnett and Robert M. Salomon, “Beyond Dichotomy: The Curvilinear Relationship Between Social Responsibility and Financial Performance,” Strategic Management Journal, Vol. 27, (August 2005), at pp. 1101-1122.

10. Supra note 1.

11. Ibid

12. Supra note 9. See also Samuel B. Graves and Sandra A. Waddock, “Beyond Built to Last … Stakeholder Relations in ‘Built-to-Last’ Companies.” Business and Society Review, Vol. 105(4) (2000), at pp. 393-418. 

13. Performance is of S&P 500 and MSCI KLD 400 from May 31, 1990 through May 31, 2013, based on Bloomberg, LP.

14. “Demystifying Responsible Investment Performance.” United Nations Environment Programme Finance Initiative, and Mercer, http://www.unepfi.org/fileadmin/documents/Demystifying_Responsible_Inves... (October 2007).

15. Supra note 1.

16. “A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment.” United Nations Environment Programme Finance Initiative, and Freshfields Bruckhaus Deringer, LLP, http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf (October 2005).

17. Ibid.

18. Ibid.

19. Ibid.

20. See Barnett and Salomon, supra note 9.