Ethical Investment

 

 

The terms ethical investment and socially responsible investment are often used interchangeably to mean an approach to selecting investments whereby the usual investment criteria are overlaid with an additional set of ethical or socially responsible criteria. Another investment type which comes under the category of "ethical investment " would be ecolological or green investments.

 

Ethical Investment Approaches

The Ethical Investment Research Service (EIRIS) defines an ethical fund as “any fund which decides that shares are acceptable, or not, according to positive or negative ethical criteria (including environmental criteria)”.

One could apply that definition to a general ethical investment philosophy by saying:

“Ethical investing is the process of making decisions about buying, holding and selling investments, based on whether they are perceived as acceptable according to both positive and negative criteria.”

In addition, this process may also involve making judgements regarding to what extent such investments are perceived to be acceptable, and on the potential for improving through engagement the ethical performance of the party offering the investment.

The inherent difficulty is that this is a subjective area. It is therefore unlikely that fund managers and investment advisers will always be able to offer an accurate match between the exact criteria of the investor, and what is available at reasonable cost in the marketplace.

It is also true to say that there has to be an element of compromise – very few, if any, companies run their business in such a way as to be wholly ethical or environmentally aware in absolutely every aspect.

So far, the ethical investment process has developed into four broad strategies. These cover the different approaches of traditional ethical investment and the more recent SRI (Socially Responsible Investment) methodology:

Four Ethical Investment Approaches

  1. Ethical Screening:
    The inclusion, or exclusion, of companies in an investment portfolio on ethical, social or environmental grounds. Ethical screening is usually divided into negative screening to exclude unacceptable companies, and positive screening to select companies with superior social or environmental performance.
  2. Thematic Investment:
    Where key themes are used to identify companies operating in “industries of the future” which are trying to improve the world environmentally and socially.
  3. Best of Class or Preference:
    Where companies within the same industry or sector are rated according to a variety of social and environmental issues, and fund managers bias their investment decisions toward the “best of class.”
  4. Positive Engagement:
    Identifying companies which could improve their ethical, social and environmental behaviour and encouraging them to do so by means of dialogue, pressure, support for responsible management and voting at AGMs.

Types of Ethical Investment

An investor can apply an ethical strategy to almost every part of a savings and investment portfolio:

  • Bank Accounts - (e.g. Co-op Bank and Triodos Bank) which have a policy of ethically screening the loans they make to companies
  • Shares - in socially-responsible companies
  • Corporate Bonds - fixed-term loans to socially responsible companies
  • Investment funds - directly or via ISAs, PEPs, Pensions, Life Policies etc.
  • Community Investor Accounts - Limited availability UK investments designed to benefit communities (e.g. those offered by Triodos Bank)
  • Micro-credit accounts - (e.g. Shared Interest accounts) designed to provide a fair source of finance to people in developing countries
  • Specialist managed portfolios - For trustees, pension funds or individuals with greater sums to invest (typically more than £200,000) - these are invested using ethical criteria agreed by the investor. (Our parent company Flowers McEwan Ltd has considerable experience in arranging this type of investment)

Ethical Funds

There are over 40 fund managers offering some sort of ethical fund. Around 30 of these are readily accessible to the private investor. However, they all operate in a different way using one or more of the 4 general strategies identified previously.

Ethical investors will believe that they should not (or need not) sacrifice their life principles in exchange for chasing the best financial returns. Indeed, many ethical specialists argue that, in the long term, ethical and SRI funds have good prospects for out-performing the general investment sectors.

Performance

Ethical funds are usually expected to be more volatile than their mainstream equivalents . At times they can out-perform well: then again, at other times they can fall further behind than their peers. There are periods in the investment cycle when certain non-ethical shares do particularly well – tobacco, alcohol and armaments being the obvious ones. Then again, there are periods when the more speculative and forward-looking funds come good. Over the long term, many ethical funds have produced very good returns.

The performance of ethical funds is often benchmarked against either the FTSE 4Good indeces or against their non-ethical peer group.

Risk

Since ethical investment, by definition, reduces the number of shares, securities or funds in which you can invest, it tends to increase the volatility of your portfolio and therefore the risk profile. This can be mitigated by diversifying between funds, and between different styles of funds and fund managers. Like their non-ethical equivalents, some ethical funds are much higher risk than others.

Charges

It costs more to run an ethical fund since, in addition to the usual investment disciplines of selecting stocks and shares, the management team have to apply additional expertise (and systems etc) in order to perform the necessary ethical screening. This is usually reflected in a small additional charge, which can erode slightly investment performance.

Conclusion

We believe that the case for ethical investment stacks up from an investment perspective as well as for those wishing to align their savings and investments with their values, For more information on whether it might be for you, see our article Is it for me?

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