Ethical Investing: ESG, Sustainable Investing and Impact Investing.
In this video, I explain what Ethical investing is, the various labels like SRI and Impact investing, Ethical investing v/s conventional investing, what to look for in a financial adviser when picking ethical investing and how to look for information to decide which funds to invest in - if you choose not go with a financial adviser.
Note: ESG factors are incorporated into an investment process employed by conventional funds too and having ESG in the label does not mean that the fund is an ethical fund or indeed a sustainable, responsible investment (SRI).
Transcript:
If you want to invest in line with your values and make good returns, focused on long term sustainable earnings, not just short-term profit maximization, it sounds like you want to invest sustainably, ethically.
Investing is not just rational
As Professor Meir Statman argues in his book, Finance For Normal People, the assumption that investing is a purely rational pursuit of a utilitarian benefit (greater wealth) is simply not true. Investing is done by normal people who want utilitarian, expressive and emotional benefits from all of the products and services they purchase and consume, including their investments. In other words, it is perfectly normal for investors to apply “non-economic filters”.
Ethics
Ethics can be a grey area; plastic is a very useful substance and we can’t stop consuming goods; the question is how do we use this sustainably and what does that even mean? At times, all these decisions can just feel overwhelming.
Sustainable means maintaining a certain level: A path to meet the needs of the present without compromising future generations ability to meet their own.
“In every deliberation, one must consider the impact on the 7th generation.”- The Great Law of Peace by the Iroquois Nation
Data also shows that sustainable funds have the potential to perform better .Also, sustainable funds have shown higher survivor-ship rates than traditional funds over the past 10 years, meaning fewer sustainable funds have closed down. Asset inflows in sustainable funds are growing fast. Two factors: the real risk of global warming both for society and investments and a shift from looking at just profits for shareholders to true value for all stakeholders which ultimately does benefit both shareholders and society.
On average, 77.3% of sustainable funds available to investors 10 years ago have survived, compared with less than half (46.4%) of traditional funds. Source: Morningstar UK
Ethical investing has many names : some include green investing, socially responsible investing, ESG focused, impact investing, thematic investing, purpose-driven investing …I wouldn’t worry too much about these labels. all it is.. is filtering what to invest in, based on what is important to you.
The evolution of Socially Responsible Investing really started with a focus on what investors didn’t want. This is called negative screening. For example: controversial weapons, tobacco or thermal coal. We also have positive screening like support for health or education in the local community.
Impact investing started with philanthropists and investors wanting to invest money and do social good while also holding on to their capital and receiving financial returns. Impact investing funds focus on the 17 UN sustainable development goals such as no hunger and responsible consumption. These funds support positive initiatives like renewable energy or affordable housing and focus on benefiting stakeholders and the community.
A good example of a business that focuses on corporate social responsibility (CSR) in local communities is Danone which helps distribute nutritional yogurt to fight against malnutrition in Bangladesh; while also helping farmers and local women earn a living. CSR is about how a company relates to its stakeholders & the world around them, over and above just profits.
ESG
ESG refers to an investment process used more and more even by conventional funds and investment firms to filter out criteria for issues with financial, material risk. ESG stands for environmental social and governance.
The E criteria for the environment could include how the company’s operations look at waste or energy or carbon emissions.
The S is for social and therefore it looks at the human aspects which are quite important in the whole of the ESG and you would look at things like supply chain, how employees are treated, employee well-being and so on. There is also significant reputational damage when an employer gets this wrong; we have seen during this time of Covid19, some employees being paid fairly during the shutdown like Patagonia and other companies reacting in not so kind a way receiving a backlash.
Recently, Boohoo, a UK apparel company was in the headlines for allegations of sweatshop factories, modern slavery and poor working conditions.
And the G refers to corporate governance so things like board pay, gender diversity and so forth.
Companies that score high on ESG tend to be well-run businesses that treat their stakeholders well, address their environmental challenges, enjoy more conservative balance sheets, and have lower levels of controversies. They tend to be more resilient during market downturns.
Another way that you can engage is as a shareholder or as an AGM (Annual General Meeting) activist. You can find out more about this in the UK at Shareaction.org.
Check your pensions
If you have a pension in the UK and it ‘s not ethically invested, more than likely you have about 5–10% invested in fossil-fuel companies; which may or may not align with your values. So, do login to your work pensions and have a look at the top 10 holdings of the funds you are invested in. You have power to influence your organization at work and you can use that to ask to invest in companies that you want to.
You might believe that pay day loan sharks…these are lenders that charge an exorbitant rate of interest to often vulnerable groups are morally wrong and you might discover that you have an accidental investment exposure to them. For example, the Church of England who have a moral stand against loan sharks discovered they had a small stake in Wonga a few years ago; Wonga, a payday lender, charged an Annual Percentage Rate (APR) of 1,509% and had questionable debt collection practices. Wonga is no more.
So, ethical investing is a way to walk your talk, to have financial integrity, to vote with your wallet and to exercise some of your own personal power in asking for a world that you want.
Screening
Negative screenings now include a high number of criteria and this is rapidly evolving. Environmental damage, human rights violations, animal testing medical and non-medical, manipulative advertising and so on and so forth. So the focus on negative screening is on avoiding creating harm.
Positive screening criteria looks at what is the business doing operationally to help the local community, education or health care and things like that.
So what are the big differences between ethical v/s not:
You have a smaller investment universe to choose from (although a rapidly expanding one with even some conventional funds re purposing to SRI ). Not all companies report equally; smaller companies for example may not keep up with larger ones so that may introduce a bias. And the other big one is fees. However, active sustainable funds charge about the same as conventional active funds so, not a big deal. You do need good old fashioned HI (human intelligence) and a research team to sift through companies. The research team would look to avoid green-washing — which is the process of conveying a false impression or providing misleading information about how a company’s products are more environmentally sound.
Overall, OCF or ongoing charges figure for my ethical client portfolios in the UK are around 0.7% to 0.8% per annum. If a client tells me, she is fee-sensitive then I ensure we have a thorough conversation and accommodate criteria for lower fund fees too. For some reason, fund charges seem a lot higher in the US however sustainable and activities even in the US seem about the same.
You have a great choice of passive investing too with lower fees with big players like Vanguard and Blackrock getting involved in the ESG world… However, if you want higher quality filtering based on your criteria, the devil is in the detail. ESG passive funds cost a bit more than conventional passive funds but the differential is minor. Passive funds can hold from 100 to a 1,000 companies so effective engagement is difficult.
Smaller companies find it much more difficult to provide the information that the research houses want. This means that British American Tobacco can often score better than the smaller businesses whose operations focus on curing cancer caused by cigarette smoke.
So, if you are an investor and you want to start investing ethically yourself, without an adviser, where do you start?
Tips on finding a financial adviser
By the way, If you need an adviser, because you have decided you don’t have the willingness or capacity or interest to do this research yourself, my top tip is to go to a specialist ;I will list resources for a directory in the UK so you can find one more easily. You want to find an adviser who is independent, has an active understanding of sustainable investing, is well read on the latest research, and is open to creating a solution based on what is important to you. If they say that sustainable investing is not profitable, or have negative views on it, find a different adviser.
Tips on doing your own research
Actually we could do a lot more in the industry to have standardized processes and practices for retail investors to do their research. There is no easy rule book or process to follow; however I will give you a few tips. Remember, this is not financial advice in any way: my content is for educational purposes only. Therefore, I don’t have any fund names in my video today as I am a regulated financial adviser, I have to be careful.
You can use FundEcomarket to filter through based on the criteria you want; it is free to use.
After this, the best website to go through is a website called Trustnet, also free to use — and you would have to read the details of the fund factsheet, look at the investment objectives and ethical criteria, past performance, performance in relation to benchmark, UK regulation and any other information important to you, to satisfy yourself that it meets the criteria that you have in mind. Also, you can read through the fund prospectus, KIID (key investors information document) for more information. Don’t rely on just the fund name — the fund name may contain ethical, responsible, green, sustainable…but the lines are getting blurred between traditional funds looking to incorporate some ESG and sustainable investments.
Don’t forget cash
You can also look at cash savings and look at banks and building societies in which you believe in. I have no specific recommendations but there’s a lot of information online if you look for it.
Policy action
Remember, we also have to demand policy action and systemic change. Individuals can’t provide subsidies for clean energy or put a price on carbon or deter people from using plastic unnecessarily -but governments can. We need politicians who will support climate-friendly policies.
Happy investing
Meanwhile, go easy on yourself… if at times, like me, you feel like a hypocrite; we simply aren’t in control of everything that happens in the Universe to make perfectly ethical decisions at all times; at times, inadvertently or otherwise, our actions & buying decisions cause harm…and we have to invest how the world is, not how we want it to be — whilst also working towards the world we want.
ESG investing has had massive, massive interest with greater choice being added at rapid speed. My hope is that companies will adapt to thrive in a world that values a safer, happier, healthier quality of life: A world that works for everyone including beautiful creatures like birds, bees and fish in the ocean.
That’s it from me on ethical investing. Happy investing!