Ethical investing — is it right for you?

13 Nov 2017

By Shadforth Financial Group

There is an increasing recognition of the importance of ethical investing and its effect on the environment, society and the economy. But what is ethical investing and why would you get involved?

What is ethical investing?
‘Ethical’ or ‘socially responsible investing’ (SRI) is an investment strategy that incorporates investment return with social responsibility. That is, ethical investment management focuses on identifying companies and investments that not only have the potential for strong returns but also contribute positively to the world.

When deciding if a company or investment is socially responsible the three main areas that are considered are their environmental and social impact as well as how they are governed. Also known as the environmental, social and governance (ESG) criteria.

When thinking about the environment, ethical investing addresses issues such as resource efficiency and the impact on the environment whether it be through ‘green policies’, the company’s carbon footprint or the use of resources like water to create revenue. Ultimately, one of the goals is to finance energy transition towards a greener energy mix and lower the use of natural resources.

In terms of social impact, ethical investing addresses how the business behaves — especially around ‘human capital’. It’s not just what they pay their workers but also how they help in areas, such as, health and demographics, working conditions, education and the overall labour practices of the company.

In a world of arguably various ethical standards, assessing governance or the quality of management and the board is paramount. How are they incentivised? What controls and oversights are in place? And, it extends further into the political policies of the country where the company is based as well as considering gender diversity and fairness issues.

There are different ways companies are judged when deciding on their level of social responsibility. The two most well-known ways are through:

Negative screening — this excludes companies, behaviours, industries or countries that are perceived to be engaging in unethical behaviour.

When it comes to negative screening some investment managers take a ‘zero tolerance’ approach. They will exclude a company from their investment list if they have even a single dollar of revenue from an industry they deem unethical. Others display a level of tolerance towards certain industries. For example, companies are permitted up to 10 per cent of total revenue to come from what is deemed unethical. Beyond this level the revenue source is considered significant and the stock is excluded from their investment list.

Positive screening — this involves selecting companies based on their socially responsible and positive ethical behaviours. It can cover many forms depending on the investment manager and can include:

  • investing in companies that sell positive products that contribute to future economic and environmental sustainability
  • thematic investing such as investing in specific areas like environmental technology
  • a best-in-class approach by choosing to favour companies that demonstrate best practice within its industry.

So, why get involved?
There’s no doubt that ethical investing is taking off in Australia. The ‘Responsible investment benchmark report 2017 Australia’ found that responsible investments more than quadrupled over the past three years to $622 billion in assets under management in 2016, with nearly half (44%) of Australia’s assets under management now being invested through some form of responsible investment strategy.

The reason for the rise is clear. Many investors wish to balance their investment return with a ‘moral’ return. They want to feel that the money they are investing isn’t doing any harm and is actually giving back to society or the environment. And it seems that the perception that ethical investments significantly underperform against traditional investments is being challenged. A recent study by the Australian Centre for Financial Studies found that ‘Socially responsible investing does not come at a detriment to financial returns. On average there is no statistically significant cost — and in fact there is often a benefit1.

For instance, providing good working conditions will be more favourable to consumers compared to a ‘sweatshop’ with underage workers and is more likely to succeed in the long term. So, long term sustainability becomes increasingly important in driving long term returns.

Every time you spend money, you’re casting a vote for the kind of world you want...
Anna Lappé, Small Planet Institute

However, there are still no hard and fast rules around which practices are considered ethical. For example one individual may view mining uranium as unethical due to both the mining as well as the fact that it is used in the production of nuclear weapons, however, it is also used for nuclear power plants, which reduces the need for polluting coal power plants.

Increasing demand for ethical investments
Not only has demand increased but the requirements or filters have also become increasingly selective and a broader spectrum of measurements is evolving. Previously, investors typically only screened out negative issues by avoiding exposures like tobacco or alcohol. Now, much more can be involved.

There is a real belief that responsible investing needs to be applied not only across all asset classes but ESG factors need to become increasingly mainstream, become a part of the investment decision-making process and make a positive difference to returns, the environment and society.

Everyone is different and what’s acceptable investing to one person may not be acceptable to the next.

Your individual ethical views will determine the best investment for you. Your Private Client Adviser can help you assess your unique requirements in order to find an appropriate investment.

1 A review of socially responsible investing in Australia — the Australian Centre for Financial Studies (ACFS) at Monash Business School May 2017

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