Ethical Investing - What It Is, How To Do It, And Does It Actually Makes A Difference
How to choose ethical investing funds and my thoughts on socially responsible investing are some of the most frequent questions I get when it comes to designing an equity portfolio and choosing funds.
Ethical investing, also known as socially responsible investing (SRI) is an investment strategy aimed at generating financial returns while also having a positive impact on society and the environment.
It is an attempt to “Put your money where your month (and heart) is” when it comes to your equity investing.
This video is from a micro training I did recently for The Wealth Chef’s Wealth Builder Club and I thought I’d share it with you too.
In theory, ethical investing allows investors to align their investment choices with their personal values and beliefs, and to avoid investing in companies that engage in practices that are harmful or unethical or are just not aligned to a specific set of values that you might hold as important.
Categories of Ethical Investing
There are several categories of ethical investing, each with its own focus and set of criteria.
Some of the most common categories are:
Socially Responsible Investing Funds (SRI Funds)
SRI funds avoid investing in controversial areas such as gambling, firearms, tobacco, alcohol, and oil. Here, the investor’s moral value is given critical importance in investment selection. SRI funds focus on investing in companies that demonstrate ethical and socially responsible practices.
Environmental, Social and Governance Funds (ESG Funds)
Unlike SRI funds, ESG funds consider how environmental, social, and governance risks and opportunities can cause material impacts on a company's performance. ESG funds invest in companies that prioritise sustainability and environmental responsibility while still maintaining the same level of returns as they would with a standard approach.
Impact Funds
Impact funds place equal importance on fund performance. Hence, they aggressively look at creating ethical changes supporting companies that provide certain products and services. Impact funds are suitable for investors who are socially responsible but also want good returns.
Faith-based Funds
Faith-based funds only invest in stocks that follow religious values and ideals and strictly exclude investments that don’t fit the category. These funds are designed for investors who want to align their investments with their faith and values.
Pros and Cons of Ethical Investing
As with any investment strategy, ethical investing has its own set of advantages and disadvantages.
Let's take a look at some of the key pros and cons:
Advantages of Ethical Investing:
- Enables an investor to align their investments with their personal values
- Provides an incentive for companies to align their business practices with sustainable and ethical practices
- Promotes social and environmental responsibility
- Gives a feel good factor to investing which can help people follow through on their own wealth plans and get investing happening in their lives.
Disadvantages of Ethical Investing:
- SRI / ESG and Ethical funds typically have higher ongoing charges compared to index tracker passive investing (hyperlink to what is an index tracker blog) and as you know keeping costs low are one of the important criteria costs
- There are fewer funds to choose from
- To select a fund that actually aligns with your values means more work and digging on your part - don’t just trust the label
- Ethical investing may not provide the best return on your money meaning you could end up taking longer to achieve your financial freedom or end up with less than you could.
One of the biggest issues for me is that as it has become trendy to do “ethical Investing” it has just become an opportunity for great marketing and not real change. See the issues below.
There’s a Lot of “Woke-Washing” Going On in Ethical Investing
With its growing popularity comes some confusion and obstacles in achieving its goals.
If you really want your ethical investing to do more than just make you feel good, you need to be prepared to dig deeper and spend some considered time on selecting your criteria and ensuring the funds and their selection criteria actually align.
Here are some of the issues.
Industry Label Confusion
A survey by Which? News revealed that the ESG investing industry uses labels that most investors don’t truly understand and there is no industry wide standard for labelling.
Green fund, dark green fund, light green fund, socially responsible fund, Impact investing, ethical investing, ESG, SRI…
… lots of fancy names and TLA’s (three letter acronyms) but no consistent definition of what these mean, the criteria that the fund house uses to screen and select companies to go in a fund and even when those are included in the fund prospectus or fund fact sheet - the data to measure companies on these metrics are also not consistent.
Currently, there is no regulation on using these labels, so they can vary by a fund manager and allow for a wealth of approaches.
By its very nature, ethical investing is subjective, so labels and funds vary by each fund house.
For example, take the automobile industry. You could argue that this is a negative-impact industry since most cars run on fossil fuels and contribute to pollution. However, some companies, like Tesla, are famous for their electric vehicles and thus could be considered ethical investments.
What about Audi or VW?
They both manufacture electric and fossil-fuel powered cars. You could argue that Audi and VW should be included in a light green investing portfolio for its electric vehicles (companies that do good) or excluded from an ethical portfolio and put on the dark green list for their fossil fuel powered cars.
Unreliable Data
The vagueness of data also makes for difficulty in truly understanding the market’s performance, since these interchanging labels and standards can lead to varying research. Furthermore, companies’ activities cannot always be proven, and often, it may take months or even years for ethical or sustainable behaviour to be proven.
While it is well-known that industries like clean energy are growing and carry great importance, they are still relatively young. Their fullest potential is yet to be realised and it is therefore difficult to estimate their future performance accurately.
Greenwashing
A common issue in ESG investing is companies ‘greenwashing’: misrepresenting an investment to appear more sustainable than it is.
Think of eggs labelled “farm fresh”, where the laying hens are kept in terrible battery conditions but the battery is on a farm. Grain Fed, does not mean the hens are wandering around pecking the ground.
It’s like the emergence of “organic” in the 70’s. Everyone was slapping the “organic” label on everything but there was no standardised criteria for what that meant. Then it swung to the other extreme and many local, ethical, and sustainable farmers get penalised because they don’t fit a now bureaucratic criteria of organic.
As the investment fund market realised that the public was becoming increasingly socially conscious, the “green” label suddenly appeared on everything.
Critics have called sustainable investing a marketing ploy or scam for this exact reason, noting that companies are merely trying to capitalise on the trend. Greenwashing can cause companies to be incorrectly included in ESG funds and contribute to the problem of unreliable industry data.
I do believe that any commitment toward sustainability is better than nothing, but we have to be vigilant and prepared to do the work to see what is actually “in the tin”.
The Whole Life Impact and Unintended Consequences
It is very easy to take one isolated criteria and deem it as good or bad based on our own value set. BUT life is never that simple.
Take tobacco. It’s BAD right! Is it really?
What about the role it plays in providing sustainable crop demand for small farmers in emerging markets?
An independent research was done in three contrasting tobacco-growing countries – Bangladesh, Brazil and Kenya - involving different types of farmers who cultivate tobacco and other crops. The study found “ Tobacco is grown as part of a cropping system and contributes to a diverse income portfolio; it is an important and reliable income source that enhances food security rather than reducing it and has contributed to increasing farmers’ welfare. The ability of households to move in and out of tobacco cultivation does not support a picture of entrapment. There is no evidence to suggest that tobacco cultivation poses a greater hazard to the welfare of poor farmers in comparison with other available crop alternatives .
What about battery operated cars? Good right? Are they? What is the ultimate environmental impact of disposing of the batteries? How are the batteries charged? If the course of the battery charge is fossil fuel then what's the point?
And Palm Oil? The devastation of the forests and the orangutans in SouthEast Asia and Indonesia due to the indiscriminate monocropping of palm oil as a replacement for fossil fuels is heartbreaking, yet…
Palm oil farming in West Africa is a healthy traditional crop mostly produced by small holder farmers, who suffer from the stigmatisation of palm oil. It got this bad reputation when big companies e.g. in Indonesia started cutting down the forests for monocropping of palm oil as a replacement for fossil fuels.
These are not easy questions to answer or resolve.
The point is - don’t just take a label at face value and believe you’ve done your bit for improving the world.
Does Ethical Investing Work?
One key aim of ethical investors is to avoid investing in companies that produce products that are against the social, moral, and religious values of the investor.
However, boycotting an “evil company” by not investing in it doesn’t mean that money is not going to the company.
When an investor purchases a share in a company, the money goes to the seller of the share not the company. The company only makes money when it issues new shares like an initial public offering (IPO).
Hence, ethical investors are not punishing the “evil” companies by withholding their investment dollars.
By boycotting a company, ethical investors are reducing the pool of potential shareholders which may reduce the price of the shares in a set of companies, making those even better investments for investors who are not using these criteria.
Ultimately, it’s up to the investor to decide whether this is the case.
In-depth research is the key to reducing the harmful effects of greenwashing, throwing the baby out with the bathwater and the unintended consequences of impacting the full supply chain.
Often, with a bit of digging, investors can make more informed decisions about whether their investments truly fit their own personal ethical values and standards.
Criteria for Selecting Ethical Funds
When selecting ethical funds, investors should consider several key criteria to ensure that they are investing in companies that align with their values and beliefs.
Here are some of the most important criteria:
Investment strategy: Consider the investment strategy of the fund and ensure that it aligns with your ethical criteria.
Fees and expenses: Consider the fees and expenses associated with the fund, as higher fees will impact your investment returns over time.
Transparency and disclosure: Look for funds that are transparent about their screening process and provide regular updates on their holdings. The fund fact sheet should state their screening criteria and list the companies they hold in the fund.
Fund Screening Platforms
There are several fund screening platforms available for ethical investors, depending on their location.
Here are some examples:
Europe: Ethical Screening, Eiris, and Vigeo Eiris are popular platforms for ethical investing in Europe.
Australia: The Responsible Investment Association Australasia (RIAA) database provides information on ethical investment options in Australia.
United States: The ImpactAssets 50 database features funds that focus on impact investing in the United States.
United Kingdom: Ethical Investment Research Services (EIRIS) and Good Money are popular platforms for ethical investing in the UK.
South Africa: The JSE Socially Responsible Investment (SRI) Index tracks companies that meet certain ethical criteria in South Africa.
Investing Better Means Paying a Little Bit of Attention
There’s an old maxim in investing attributed to Andrew Carnegie and Mark Twain that says…
… you should put all your eggs in one basket, and then watch the basket.
If you want to invest ethically, you have to watch the basket and the eggs closely.
Ethical investing allows investors to feel they are aligning their investing with their values and can provide a great feel good factor.
The feel good factor is often a good enough reason to do it especially if it makes you get on and actually invest.
My worry is the “placebo” effect of “ethical investing” that makes people think they’re accomplishing something when they’re really not.
We have a far greater impact on our world by how we choose to spend our money, time and energy than the indirect impact we can make through our investing. Making these sort of direct choices are hard, yet that is what we are called to do.
I also know that ultimately having more money to direct to the things that matter to us has a far greater impact - which is why I choose to follow an index tracker investing strategy and then direct the proceeds to the areas that align to my value directly.
If you really care about social change, the environment, conservation, social justice and so forth - get your money working hard to get the best returns it can and then use the power of your financial resources to make the changes you want to see in the world.
ALL of this is covered in more depth in the Savvy Investor Programme.
