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What is ethical investing and why you should care | bestbrokers.co.uk

What is ethical investing and why you should care

A large number of ethical investing opportunities have emerged in recent years as investors seek ways to use their money more consciously and responsibly.


This is a companion discussion topic for the original entry at https://www.bestbrokers.co.uk/blog/2020/06/04/what-is-ethical-investing-and-why-you-should-care/

The original post says that -

Ethical investing involves avoiding companies that engage in unethical operations, such as tobacco, defence/weapons, alcohol, gambling and adult entertainment.

Some, at the extreme end of the pedantic scale, might even consider any form of investment for gain to be a type of ‘gambling’ and therefore fall fully within these definitions offered and so ‘forbidden’. Hopefully, that sentence will be taken in the spirit written as it is not meant to cause any offence to professional investors, myself included - note to readers: see the words ‘some’, ‘pedantic’ and ‘might’ - none of which include this author!

In a totally altruistic sense ethical investing would therefore only exist if it were for the benefit of others rather than self-gain whilst also being for the betterment of a sustainable, socially and environmentally cause too.

In some mitigation the third paragraph does go on to expand on the first and explores criteria that I would consider to be more aligned with ‘ethical investing’ in the more generally accepted interpretation of the phrase.

So let’s look at some ways of allegedly investing ethically, but before that we need to define ‘ethical’ more clearly. the word ethical itself comes from the Greek word ‘ethos’ meaning moral character and by extension is a description applied to a person or practice that is considered right in the moral sense, i.e. truthful, fair and honest.

Moving on from here it then makes sense to examine the codes of ethics normally held up by banks, finance houses and brokerages. They all normally, have a set of internal guidelines committing to operate legally and to promote honesty, accountability and ethical conduct.

All well and good it would seem - or not? Certainly not in today’s more socially aware environment, no that’s not good enough - just because a person or institution has a so-called internal code of ethics doesn’t place them in a position of infallibility - you need to take a deeper dive into their background to see if that ‘commitment’ is being followed through with.

Many institutions might scrape by on the ethical ‘litmus test’ yet if you were to carry just some basic further diligence you might well find they fail alarmingly on their environmental awareness and a whole plethora of other ‘ethical issues’. For instance it has been reported that 33 of the world’s biggest banks have funnelled $1.9 trillion (£1.5 trillion) into fossil fuels in the past three years alone.

These same major (and many minor, too) institutions each spend a small fortune on advertising - millions of pounds each year - to convince the general public that they are ‘green’, ‘socially aware’, ‘transparently ethical’ and ‘morally responsible’ when their actions quite clearly say otherwise.

Would you really consider yourself to be even vaguely close to being an ethical investor if your money was helping fund nuclear weapon manufacturing, tar sand mining or fracking?

Before you get the impression that I’m off on an old hippy rant about this let me assure that I’m not. I seriously do agree with and advocate the use of ethical investment vehicles whenever possible ( and that is the underlying get out clause you will say ).

But, yes here comes the BUT, in order to ensure that you really are investing ethically you need to dig deep and then dig even deeper into the background of the vehicle that you are proposing to use as the corporate smoke and mirrors brigade are ahead of the game on this one to safeguard their profits.

Let me demonstrate by use of a short personal anecdote which, although embarrassing to relive, has remained a lesson hard-learned and fully etched in my memory banks.

Twenty years ago when new to this game of being a freelance day trader, and unfettered by my previous corporate city desk shackles, I briefly and ‘innocently’ wandered into the world of what I then considered to be an ethical trade.

Cutting a long story short, it involved third world, fair trade and sustainable agriculture crops with a reasonable percentage of profits and harvest being ‘donated’ back to the front line farmer communities.

It was being ‘fronted’ by a fairly reputable Swiss financial services body, so although it was taking place on the far side of the world my diligence was not as in-depth as it might (should!) have been. Inevitably, with the benefit of 20/20 hindsight of course, everything turned sour.

The crops never materialised (blamed on a combination of reasons from climatic to political to local mismanagement impacts) there was no investment return (in fact nil return of anything!). Ha ha - more fool me!

Whether there was ever any reality at all for the investment on the ground, so to speak, it was hard to determine - suffice to say, the intermediary had carefully worded all legal jurisdictional bindings in such a way to make further investigation impossibly impractical.

So whilst I applaud those wanting to participate in more consciously responsible investments, the theory offers a far easier option than the reality of doing it.

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.