You don’t have to give up returns to invest ethically.
Climate change, nuclear proliferation and labour exploitation are some of the greatest challenges of our time. Concerned investors have been able to find a voice by investing ethically, but there has been a nagging doubt that they may forego investment returns. Today, ethical investing is supported by new investment research that recognises that there is not a financial trade-off when investing ethically.
What is ethical investing?
Ethical Investing or Socially Responsible Investing (SRI) is the process of aligning the personal values of investors with their investment portfolios.
Ethical investing gained traction alongside the 1970s anti-war protests and the 1980s anti-apartheid movement. It began with negative screening, a strategy that seeks to divest companies that involve themselves in activities detrimental to society. Excluded businesses may include gambling, tobacco, weaponry and factory farming. It remains a dominant strategy today and was recently demonstrated by large funds such as the Rockefeller Brothers Fund and the Norwegian Sovereign
Wealth Fund divesting from the fossil fuel industry. This approach is often blended with other strategies, such as corporate engagement and shareholder action.
Another approach to ethical investing is ESG integration. This is a strategy that scrutinises companies according to three pillars: environmental, social and corporate governance. It covers a broad range of issues including remediation of mining sites, water scarcity, labour exploitation, supply chain management, board composition and executive remuneration.
Too good to be true?
A common argument against ethical investing is that it decreases the investment universe and places additional constraints on investors’ portfolios. Another argument is that it is economically wasteful. This rationale suggests SRI undermines the ability of firms to maximise shareholder wealth by redirecting resources otherwise allocated for profit maximisation.
These arguments fail to recognise the substantial upside of ethical investing.
1. SRI is a powerful risk-reduction tool; it provides a holistic, long-term view of the context in which businesses operate. This can lead to a better judgement of future investments. For example, prior to the catastrophic BP Mexican Gulf oil spill, shareholders were unaware the company made 760 ‘egregiously wilful’ safety violations at its oil refineries.
2. The profit motive is actually enhanced by societal good. Decent working conditions, adequate executive compensation and happy communities, are indicative of strong stakeholder management. The most effective way to improve shareholder wealth is by nurturing the interests of all stakeholders.
3. Ethical investing provides a wider analysis of a company’s financial health such as earnings potential and the ability to repay debt, by focusing on non-financial factors.
The numbers don’t lie
In one of the most sweeping reviews to date, in 2012 Deutsche Bank published their paper titled Sustainable investing: Establishing long-term value and performance. Over 60 academic studies were reviewed to establish the efficacy of responsible investing and the findings were overwhelming. 77 per cent of the studies revealed responsible investing had a positive impact on financial returns. 22 per cent of studies were cost neutral or mixed, and a mere 1 per cent found a negative outcome.
In a similar study conducted by the Harvard Business School in 2011, 180 companies were reviewed over an 18-year period. The results were significant:
High Sustainability firms dramatically outperformed the Low Sustainability ones in terms of both stock market and accounting measures.
For the serious ethical investor, this is no surprise. The data is compelling. It’s saying if you have a bias towards companies that have a higher ESG score, your returns will be higher and your risks will be lower in your portfolio. Even if you adopt the traditional approach of negative screening, studies are showing you are better off or, at the very minimum, no worse off. Hunter Hall’s flagship fund, the Value Growth Trust, which has applied ethical screens since 1994, has delivered compound average returns of 13.2 per cent a year over 20 years to 31 October 2016. That result puts it on top of the list of all investment funds in Australia over that period.
Here come the Millennials
There is no question that the global financial system will be reinvigorated as the Millennial generation approach their great wealth transfer. In the US alone, it has been recorded that Millennials are set to inherit approximately $40 trillion over the next 50 years.
This coming of age will see a shift in money management to accommodate the values and needs of this generation. Millennials are, fortunately, dedicated to the idea of investing not only for financial gain, but also for ethical considerations.
So what does this mean for current investors?
The Millennial interest in SRI is already causing a ripple effect in the financial system. Demand is penetrating family offices, university endowments, sovereign funds and many large institutions. Product offerings for SRI investments are widening; financial advisors and asset managers are building their expertise and becoming more literate in the ethical space. Furthermore, the quality of ESG data is evolving as research tools become more sophisticated.
Now, more than ever, there is a greater opportunity for investors to select stocks that are compatible with their personal values and beliefs. Most importantly, ethical investing is no longer a fringe solution for gaining good rates of financial return. It can be just as lucrative, if not more, so that you can “do well and do good”.
Christina Christopherson, ethical analyst, Hunter Hall
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