Good Money Week - Ethical investing has outperformed the market

Posted by Adrian Lowcock in Weekly musings category on 11 Oct 19


Good Money Week (5th - 11th October) looks to promote sustainable, responsible and ethical investing. It is now in its 12th year and the performance of ethical investment strategies is being taken more seriously than ever.

Ethical investing arose from the desire of some individuals to invest in line with their ethical beliefs and principles. The initial approach was to avoid companies that were perceived to be unethical (e.g. tobacco, defence) or those that were environmentally unfriendly (e.g. mining, oil explorers).

There are different ways to invest ethically and the principles behind it have been evolving. While, initially, it was used as a means of avoiding companies seen as environmentally damaging or unethical, the approach has shifted in recent years to supporting companies that are making positive changes in their behaviour in order to have an impact on our environment and society. This has led to a wave of new funds and terminology being applied to the sector.

Nonetheless, while the UK’s retail ethical investment industry has been around since 1984, statistics from the Investment Association show funds with ‘ethical’ mandates total just £20 billion. This represents 1.6% of total industry assets, but whilst it is still a small proportion of the whole, the value has risen 17% in a year.

Leading Ethical indices beat their non-ethical peers over 10 years

In the past, ethical investing was thought of as a lower-return strategy, aimed at people who wanted to put their morals above profits. But new analysis suggests that the opposite is true. Ethical equity indices have beaten their mainstream peers in the UK and US over 1, 3, 5 and 10 years.

To 3rd October 2019 the ethical FTSE4GOOD index was up around 1%, whilst the main FTSE All Share index was actually down the same amount. Over ten years the gap has widened with the ethical index returning 125% compared to 118% for the FTSE All Share.

The picture is the same in US, not a country renowned for its ethical approach. The S&P 500 has returned 321% over the same 10 year period (to 3rd October 2019) whilst the comparable FTSE4Good US delivered a 373% return.

Much of the outperformance has been a result of poor performance in the oil and mining sectors in the UK. Both suffered amid falls in the oil price and the effects of the global financial crisis. More recently the tobacco sector, which for many years had been a large contributor to investment returns, has also under-performed. As many ethical funds have little or no exposure to these areas, many have been able to offer investors some protection from these negative effects.

The picture is similar in the US, the energy sector there has also been a poor performer. The larger gap for the US market can also be explained by a strong performance in the technology sector in recent years. Technology is often considered a sector where investors can proactively support ethical changes – such as climate control.

However, it does depend on your perspective. Until recently Facebook was seen as largely ethical as it connected people, however the Cambridge Analytica scandal have changed peoples’ perspectives on how they view giant technology companies.

Tesla is another excellent example. The shift to electric cars, which Elon Musk’s company has championed, is frequently cited as an example of how technology is helping the environment. However, what is less well known is that the production of the cars is producing lots of waste whilst the mining of lithium used in their car batteries results in environmental damage.

In today’s world, it is not enough to only look at the company producing the goods to determine if it is ethical. You have to consider the whole supply chain, and the companies involved, to understand whether it could be considered ethical.

Ethical is becoming mainstream

The finance sector is taking ethical investing more seriously. It is no longer just about avoiding certain types of companies or accepting a lower rate of return because of your morals. In fact, several studies have shown that employing prudent sustainability practices and incorporating Environmental, Social and Governance (ESG) principles, can have a positive influence on long-term investment performance.

Investors can now choose how they engage with ethical criteria, deciding whether to avoid certain areas of the market, through traditional negative ethical screens, or proactively invest in businesses looking to initiate change. Other investors’ top priority may still be investment performance, but many understand that how a company behaves will have an impact on the sustainability of the business and its future profits, and this approach is increasingly being catered for as well.

Ethical investing can be treated like any other investment style, in the same way that you might invest in a growth or value fund, or have exposure to equity income or Asian equities, you could also consider getting exposure to ethical strategies.

Three tips on how to do good for your portfolio and the planet’s future

1)  Start small – If you’re interested in ethical investing, you don’t need to switch your entire portfolio into ethical funds in one go, you could instead consider putting a small proportion into areas which you are most interested in
2)  Look for funds with a high sustainability rating – Sustainability themes are about looking at companies that operate in a sustainable fashion. This makes good business sense as well as having that feel-good factor. You can check if a fund has a sustainability rating here
3)  Look for fund groups that incorporate ESG principles into their investment process. Different groups approach this differently but the more resources a fund group has committed to ESG the more seriously they take it.


Greenwashing

Because ethical investing is becoming more popular there are many funds being launched with an ethical or sustainable tag, as well as existing funds which have put an ESG focus on their process. Some of these funds do not do the hard work and just pay lip service to the whole ethical approach. This is known as greenwashing and is something you should look out for.

You can visit our website to find ethical investment ideas, using Willis Owen :explore tool to filter to the Morningstar Sustainability rating or Socially Responsible funds. We also have a shortlist of ethical funds which are highly regarded by our research team, which you can check out here.

This list includes Morningstar Bronze rated Kames Ethical Cautious Managed, which invests in UK shares and bonds. It applies a strict ethical filter to its investment process which excludes mining and energy stocks, tobacco and banks with investment banking operations. The fund also excludes government gilts on the bond side which results in a very different fund to many peers.

For a global fund the list also includes the Silver rated Stewart Investors Worldwide Sustainability fund. The investment process will take account of sustainability themes and issues and requires positive engagement with companies. Manager David Gait focuses on stock selection and conducts thorough fundamental analysis, with a heavy focus on the sustainability of earnings and business models.

In summary, Ethical funds have different guidelines about what is acceptable and what is not, so it is important to identify one that matches your personal philosophy.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.

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