Backing the most progressive companies can be good financial strategyby Iona Bain / December 8, 2019 / Leave a comment
Ethical investment funds have been around since the 1980s. The recent growth of environmental consciousness has stoked awareness, and the past two years have seen a big rise in funds that target our consciences. Traditionally these avoid so-called “sin sectors” such as tobacco, alcohol, weapons, gambling, and these days they increasingly abhor oil. More fashionable now are funds that claim to cherry-pick the companies with the most positive impacts on society or the environment.
Research has consistently found that a conscience need not damage your returns; in fact, backing the most progressive companies can be a good financial strategy too. The problem is there are as many opinions about what constitutes “ethical investing” as there are investors. Is an oil company good because it has the best employment practices in the industry, or just bad per se? Should an otherwise cuddly firm fall out of favour when it trips up on an accounting scandal? Is a defence company off limits though weapons may only be a tiny percentage of its business?
Tesla, the electric carmaker, ranks top of the ethical league in the MSCI global index for the greenness of its products, and bottom in the Financial Times index, which only rates the emissions from its factories. It depends what you are measuring. And funds may not do what they say on the tin. They may badge themselves as sustainable, SRI (socially responsible investment) or ESG (environmental, social and governance), yet the working parts can vary wildly.
The area is prone to jargon, alphabet soup, and “greenwashing” of funds that have a low ethical threshold but high charges. Some managers, however, have clear strategies and past performance worth paying for.
At lowest cost, there is a growing choice of “passive” funds—run by algorithms—which select shares from an index using “ESG” criteria. Caution is still needed. Vanguard SRI European Stock Fund for instance has 5.7 per cent of the fund invested in alcohol, gaming and defence stocks while L&G Future World ESG UK Index has twice as much and includes tobacco too. Their promise is only to have less exposure to these areas than standard funds. Vanguard only excludes companies deemed to violate the principles of the UN Global Compact initiative. That may be good enough for you. Some active funds, by contrast, seek out companies whose businesses have the most positive impact, sometimes excluding swathes of large companies in favour of smaller specialists. But such funds may also manage risk by including big companies in “safe” sectors that not everyone loves—like banks or internet giants.
Julia Dreblow of SRI Services, a specialist consultant, says “A tobacco, oil, bank or pharmaceutical company can have excellent ESG strategies but that does not make them ‘ethical.’ Having a high ESG rating typically means a company documents and manages their environmental, social and governance risks well—but this may rightly be of no interest to individual investors.” Rebecca O’Keeffe, head of investment at the UK’s second biggest fund platform, interactive investor, says “Ethical investing is, by its very nature, hugely subjective. However, far from compromising investment performance, there is a growing body of evidence that suggests that companies with good environmental, social and governance practices should be expected to outperform their less ethical counterparts, especially as interest in sustainability and environmental issues grows.”
Interactive has devised a jargon-free listing of funds according to what they avoid, consider or embrace. Whatever your ethical priorities, homework is needed to establish just how strong a fund is in its professed strategy. That long list may be a good place to start your research.