Friday Q & A – What do I need to know about investing ethically?
What do I need to know about investing ethically?
Ethical investing is a growing area of investment management as more and more people are becoming conscious that they invest inline with their values.
Unfortunately this a particularly confusing subject and I don’t think the industry helps itself with there being so much jargon, acronyms and terms.
Responsible investing, ethical investing, socially responsible investing (SRI), sustainable investing, impact investing and Environment, Social and Governance (ESG) integration. So what do they all mean?
Responsible investing – a general term used to describe a range of investment strategies where the investor takes into account certain factors that are ‘responsible’.
Ethical investing – a concept of investing alongside a set of values by excluding these companies e.g. avoiding certain companies that profit from weapons, gambling or tobacco as well as potentially excluding companies that harm the environment.
Socially responsible investing (SRI) – another term for responsible investing. You’ll also sometimes hear SRI referring to Sustainable, Responsible and Impact investing….Ahh!
Sustainable investing – this is a term sometimes used interchangeably with responsible investing. Although it is often used as a broad term like responsible investing some investment managers may use it as a term describing a strategy where they invest in companies that are sustainable to the environment e.g. clean energy.
Impact investing – this refers to targeting an investment aimed at addressing social or environmental issues whilst achieving positive financial returns. Many other responsible strategies buy shares from other shareholders (not affecting the capital to the company) whereas impact investors provide capital to an initiative to achieve a defined purpose.
Environment, Social and Governance (ESG) integration – this is an investment strategy where the investment manager considers Environmental, Social and Governance factors as part of the decision making process. This could include the company effects on the environment, the companies effects on human rights, employee and management diversity plus many many more.
Not all responsible strategies are created equal
Some may just consider the effects, some may explicitly exclude companies (negative screen), some may have less exposure to these companies, some may specifically target companies or industries (positive screen), some may have a specific theme e.g. clean energy whereas others will actively target specific outcomes (impact investing).
There’s no right way to go about it rather I’d try and get clear on what’s important to you, narrow your options down to a few investments and then read how they go about their strategy. The devil’s in the detail and not all ethical options are created equal so it’s important you do your research.
Where do I find information on the specific investment options?
Below are some resources that could help you get the information you need to achieve the result you’re after:
Will I sacrifice returns?
Not necessarily. Returns will be different and the difference will depend on how ethical/responsible the investment is and how big the remaining universe of investable companies is e.g. an Australian responsible share fund is likely to differ more from its benchmark than an International responsible share fund. Like any asset class, no one really knows how responsible share funds will perform and they could outperform, underperform or do similar to the market. The key, like with all investments, is to have a diversified portfolio and try and keep costs low.
Costs in responsible options are higher because there’s an additional layer of investment analysis required and because the market is less competitive and there being fewer options. With all investments, fees are a drag on returns so I’m hopeful as responsible investing becomes more mainstream, cheaper options will continue to become available.
A lot of peoples investable assets are in their super and most super funds now address the topic by either providing commentary on how they go about it or offer specific responsible options. In super, the biggest driver of your returns is the asset allocation and in particular the split between growth (shares and property) and defensive (cash and bonds) assets and as most funds only offer 1 option, this option may not be in line with your “risk profile”. It’s therefore important to consider that the investment option is appropriate for you whilst being in line with your values.
I’ve mainly referred to shares however it also applies to fixed interest where you are buying companies debt. If investing through super, it’s likely there will be some fixed interest in your portfolio so check with the fund that they also consider the same effects on this side of the portfolio.
You may hear the argument from sceptics that “when you invest you’re not giving the company money rather you’re buying a share from someone else and the company doesn’t care who owns the share so you’re not making much of a difference.” This is true however this argument is similar to saying “don’t bother recycling because your efforts won’t make much of a difference.”
As more assets are invested responsibly these fund managers will own more and more of company shares and hopefully get to the point where they’re big enough to put pressure on these companies to be responsible.
Lastly, as most investment options pool money from many investors, these investment managers aim to provide the best outcome for all investors. Depending on your values, available options may address more or less of your values. As such, try not to chase perfection as it’s currently unlikely to be achieved with the options available rather try and find an option that most aligns with your values and investment objectives and if in doubt chat to an independent financial adviser, but I would say that ;)