Reading the above offers interesting viewpoints and part of the dilemma faced by investors and investment fund managers alike in how to proceed in this area.
So, for what it’s worth, I’d like to throw my two pence worth into the pot too.
For starters let’s state the obvious - in the current climate it would be foolish and extremely damaging for a financial institution or individual to come out and deny that ethical impacts are not part of their overall consideration in the investment industry. But what is the truth behind such words?
The questions are, as has been hinted already, how does this actually manifest itself in real terms? Is it feasible to offer such an investment opportunity to clients? Or is there just too much latitude for obfuscation by the investment target companies and/or by the fund managers?
Historically, the conventional view propounded has always been that ethical investments are more likely to offer below par returns as they have been perceived as niche investment markets - inevitably by their very nature - and you would have to eliminate specific mainstream sectors of a ‘normal’ portfolio thereby arguably increasing unnecessary risk and tracking errors.
The views of Warren Buffet and Milton Friedman on the subject from even further back, as quoted here, are interesting to say the least and seem fully supportive of a traditional investment programme.
Much of this type of argument is classically supported by fund performance tables which show a basket of ethical funds under performing benchmarks or sectoral averages. However, there are a number of studies that show ethical funds produce returns at least in line with mainstream investments.
In fact there are numerous publications and theories dating back 20 years or more to support SRI and ESG investment inclusion can be highly successful and profitable and perform on a par with their non-ethical equivalents.
One such example is the oft quoted “More gain than pain-SRI: Sustainability pays off” commissioned by the Dusseldorf based West LB Panmore in 2002 and co-written by Garz, Volk and Gilles as here.
So, putting that argument to one side for a moment, why is there a rise in Socially Responsible Investing (SRI) and Environmental, Social and Governance (ESG) funds?
Possibly an over-simplification, but the answer is just that we are increasingly seeing the demand in the investment community by young (and old!) people who want to be able to have more of a say in where their money goes, what their savings invest in and the type of future this builds for them.
They are actively seeking investment funds that support their own specific values with a wide range of selection criteria from climate change to workers’ rights.
So how does the process work to determine that the companies to be invested in are meeting the SRI and ESG criteria?
Initially you would need to establish a specifically described matrix through which you would then register all the various prospective company’s data to determine their ‘suitability’ to be included in an ethical portfolio.
In the simplest (did I just write simplest?) form and in order to satisfy customer demand prior to any investment a meticulous analytical study would have to be undertaken to ensure that environmental, moral and social core values are applied to portfolios and investment strategies.
You, or the investment vehicle you propose using, would need to calculate and create a ‘league table’ of the considered companies based on their ESG impact.
To determine the environmental criteria there would need to be a quantification of each company’s impact on the environment, such as their energy efficiency, emissions and waste.
For the social criteria you would need to track various performance measures ranging from a company’s policies and record on human rights, right through to responsible employment practices.
With the final aspect, the governance criteria would be assessed and measured on how a company is managed by considering all their internal controls of leadership, including their executive pay and shareholder rights.
So far so good, but then the detail gets even more complicated as you, by using a on a pre-determined scale, start to eliminate companies that you identify as having been involved in any environmental, social, or governance issues which have influenced their operations and/or products and services.
Understandably companies involved in such activities as alcohol, gambling, tobacco, nuclear power, conventional weapons and nuclear weapons would fall at the first fence.
Then you would have to assess and score through a second set of criteria based on the company’s ESG risks, ranging from how they respond to climate change, treat their workers and manage their supply chains.
Imagine having to drill down into the data, as above, all the while, knowing that there is just too much latitude for obfuscation by the investment target companies in their determination to be accepted into ethical investment proposals.
Not so simple after all it seems, in fact one might observe that it is well-nigh impossible to satisfy all of the above and then hand on heart present an investment portfolio that is ethical in the full and true sense of the word.
Last but not least, one shouldn’t forget for one moment that when socially responsible investing becomes the primary objective, in my humble opinion the financial side of the equation will likely suffer - at least part of the time.
So yes, I am fully supportive of ethical investing but I think we need to stop kidding ourselves (and our investors) that it is a straightforward process - there is still a large proportion of unethical landscape to unearth first.