By Nicholas Stotz, Investment Research Analyst
Socially conscious investing, whereby companies are evaluated not only by their investment potential but also by their environmental and social impact, is one of the fastest growing investment strategies in the world as investors strive to align their portfolios with their conscience.
The investment community generally identifies ethical investments by evaluating companies on environmental, social, and governance (ESG) factors. Examples of ESG issues include:
- Impact of the business on the Environment – Environmental degradation, pollution, climate change, sustainability, water/energy efficiency, animal testing, clean energy.
- Impact of the business on Society – Human rights violations in supply chain, exploitation of cheap labour in developing countries, supply of armaments to military, poor labour relations, provision of socially undesirable goods such as tobacco and gambling.
- Management structure and Behavior – Undue political influence, lack of diversity on the board, large gender pay gap, lack of board independence, abuse of market share, corruption, use of tax havens.
Different ethical funds focus on different ethical issues. Whilst this means that socially conscious investors have a wide range of options to choose from, it also increases the chances of an investor choosing a fund with ethical principles incongruent to their own.
Many of the top performing ethical funds invest heavily in big banks and miners, but won’t invest in industries such as tobacco, alcohol, and gambling. Is it more unethical to invest in a wine distributor than a big bank or miner?
Would someone wanting to invest in an ethical fund expect it to include banks and miners? It depends on what their ethical beliefs are.
What is ethical?
“The beginning of wisdom is the definition of terms” – Socrates
Before we can delve into the world of ethical investing, we need to define what is ethical in order to differentiate between ethical and non-ethical investments. This presents a challenge, since every individual has their own beliefs about what is right and wrong, and often what one thinks is perfectly ethical may be seen as morally reprehensible by someone else.
Ethics refers to the discipline dealing with what is good and bad, and with moral duty and obligation. However, what constitutes ethical behaviour is often ambiguous. For example, take the following thought experiment:
You are walking over a bridge when you notice a train hurtling towards
five people tied onto the train tracks. As it happens, there is an overweight
bystander on the bridge. The only way you can stop the train is by pushing
the bystander over the bridge. What is the ethical decision?
What if there were only two people at risk?
What if there was only one person, but they were a member of your family?
The various justifications for each decision illustrate that what is considered to be ethical can vary wildly, especially in situations where what constitutes moral behaviour is unclear. Therefore, it is essential for socially conscious investors to understand the ethical framework underpinning the investment strategies of ethical funds. One environmentally conscious fund may invest in nuclear energy as a clean alternative to fossil fuels, whilst another environmentally conscious fund may deem nuclear energy unethical due to the environmental effects of nuclear waste.
There may be no right or wrong answer, only the preferences of the investor.
As our society continues to grow wealthier, investors are increasingly foregoing the pursuit of maximising returns, aiming instead on constructing portfolios consisting of companies that are aligned with their core values. Major corporations are responding to this demand by creating large divisions dedicated to corporate social responsibility and sustainability, with the conventional management wisdom of ‘the only business of business is business’ rapidly being replaced by Triple Bottom Line accounting, which places an emphasis on societal and environmental performance as well as economic performance.
Shifts towards corporate social responsibility, plus the potential of sustainable products such as solar energy, should serve as a tailwind for the ethical investors of today as other investors begin to incorporate ESG principles into their portfolios. The ascent of ethical investing is likely to be a great force for good in the world, as hundreds of millions of dollars will flow from unethical and unsustainable companies to their ethical and sustainable counterparts. A hurdle many ethically inclined investors fail to overcome is the belief that excluding unethical investments is likely to result in underperformance. As detailed in this paper, the consensus from academia is that portfolios constructed with ESG screens have no significant difference in performance or volatility than conventional portfolios.
As more ethical investment products are released, investors will have to be increasingly diligent to ensure that funds marketed as ethical are indeed so. We hope that after reading this paper you are better equipped to make that judgement, and hope that ongoing investor education will help spur the sustainable growth of the ethical investment industry for many years to come.