Ethical Investing: It is no longer about sacrificing returns for principles

Posted by Adrian Lowcock in Portfolio management category on 01 Oct 18

This weekend saw the start of Good Money Week (29th September to 6th October) which looks to promote sustainable, responsible and ethical investing. The campaign is in its’ 11th year and this area of investing has evolved significantly. 

Ethical investing has been around since 1984 but according to the Investment Association ethical funds account for just 1.3% of total investments, around £16.7billion. The sector has consistently failed to garner interest amongst investors over the years. 

What is ethical investing? 

Initially ethical investing arose from the desire of some individuals who wanted to invest in line with their ethics and principles. The initial view was to avoid companies that were perceived to be unethical such as Tobacco or Defence companies or avoid those that were environmentally unfriendly such as Miners or Oil Producers. 

This lead to the perception that ethical investing offered lower returns and for good reason. In the 1980’s through to the turn of the millennium the sectors which performed well were exactly those areas avoided by ethical and environmental investors so ethical was seen as a choice between investment returns and principles, you couldn’t have both. 

But ethical investing has evolved and where previously it was about avoiding companies or excluding sectors, managers have adopted a more proactive and inclusive approach. There are now approaches which look to support companies to make positive change in their behaviour and invest in companies which look to make a positive change to our environment and society.  This has led to a wave of new funds and definitions being applied to the sector.

More and more fund managers are looking to incorporate Environmental, Social and Governance (ESG) factors when they analyse companies they are considering to invest in. These principles can apply to any company in any industry; it’s less about what your business does and more about how the company goes about doing it. The reason is the evidence is growing that companies which act responsibly deliver better returns for investors in the long run.  As such we are seeing that it is not just ethically focused funds which are adopting these factors but it is being incorporated by fund managers across the all markets. 

3 different approaches to ethical investing

There are a variety of approaches you can take with ethical investing, and as the philosophy has evolved so too have the terms we use to describe them. The terms ethical and environmental which have long been associated with underperformance are being replaced. Three of the main terms are outlined below although, unfortunately, they remain open to different interpretations:  

Socially Responsible Investing (SRI) - This refers to the practice of integrating social and environmental factors within the investment process to avoid companies which have a negative impact on the environment and companies. This type of investing applies a negative screen, filtering out companies which are seen as unethical or not environmentally friendly. Once the filter is applied the investment objective is to maximise returns.

Impact Investing - Impact investing integrates social and environmental factors in investment analysis, similarly to SRI, but goes further by making investments in companies whose objective is to produce social and/or environmental benefits alongside financial return. This approach applies a positive screen looking for companies which aim to generate a positive social and/or environmental impact. Investment returns are ultimately secondary to the investment social theme or impact. 

Responsible / Sustainable Investing - Is an approach which aims to incorporate ESG factors into investment decisions in order to better manage the risks and generate sustainable long term returns.  Unlike SRI and Impact investing, these approaches look at the corporate behaviour and governance of a company.  Responsible investing can be incorporated by investors whose sole purpose is financial return. Responsible investing doesn’t exclude any companies from its investment universe but incorporates ESG information when making an investment decision. 

For more on ethical investing you can review our shortlist of featured ethical funds here.

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