Why ethical investing may be harder than you think
By: Tim Bennett
16.05.2018

Why ethical investing may be harder than you think

An increasing number of investors want to follow some sort of ethical, or socially responsible, mandate. Here I explain that, whilst this is a potentially great aim and there are certainly plenty of products on offer designed to achieve it, it can be harder to execute in practice than many perhaps first realise. With funds in particular, investors need to make sure that they are getting what they pay for.

The numbers

Ethical investing, which goes by several other names such as “ESG” (ethical, social and governance), is growing fast, according to data from Boston Consulting Group;
It is particularly popular amongst the Millennial age group, according to Morgan Stanley;

What is it?

One of the first challenges with the concept is actually defining it. Once you start to look under the bonnet of what is often called “ESG” investing, it clearly means different things to different investors;
In particular, your approach will be heavily influenced by how you answer the three questions on the right of the slide above. We’ll take a quick look at each of them in turn.

Investing criteria

At the moment, mandates that seeks to invest in firms that meet specific low-carbon criteria are popular. However, there are many ways to define and shape an ethical investing strategy, as you can see here below. Your choice of portfolio constituent, or fund, will be driven in the first instance by which of these matters most to you.

Investment approach

The next potential decision is about how you put your money to work. Like other areas of investing, there are active and passive approaches available, each with their pros and cons. For example, whilst a passive approach will usually be cheaper, you may have to sacrifice something in terms of the ESG purity of a resulting portfolio. Active solutions will be more expensive but will also allow you to direct your money more precisely towards your chosen strategy.

Performance

There is a well-worn cliché in investing that vice pays. The reason is that firms associated with activities such a smoking, drinking, gambling and even defence can be some of the market’s more reliable performers, especially when it comes to dividends. The good news is that recent history, at least, suggests that a more ethical mandate needn’t necessarily give up too much in performance terms. Below you can see, for example, that the FTSE4Good index has managed more or less the same performance as the FTSE 100 over the past five years.
That said, ethical investing does have some challenges on the right of the next slide. These are not unique to this sort of approach but they need to be borne in mind. A skew in favour of ESG firms can have unintended consequences for a wider portfolio. These can be addressed but should not be overlooked.

A radical suggestion?

Clearly, there is increasing choice available to investors who want to follow an ethical, or ESG, approach and this is to be welcomed. However, as in all areas of investing where this is the case, care is needed to ensure that you choose the right strategy. Screening funds for example is vital if you want to ensure you are getting the right balance between the investment strategy and your expected returns.
For anyone daunted by this, here is food for thought to finish – if you are struggling to find a standard investment product that suits your ethical criteria and objectives, you could take another approach altogether. Invest following a more traditional mandate and then use any gains to separately fund the causes you support (adding the associated gift-aid, in the case of charitable ones). This isn’t a “pure” solution to the ESG challenge in investing terms but it does mean you have more control over where your money is put to work.
To find out more about how you can add ESG objectives into a wider strategy, please contact an Investment Manager.