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Adopting an ethical investment strategy takes into account the wider impact of investing on society when seeking financial returns. Also referred to as responsible investing, its rise in popularity means money invested in the UK’s green and ethical retail investment funds has reached a record high of £11.3 billion, according to the latest research by ethical investment research organisation, EIRIS.
These latest figures also come shortly after the Investment Management Association (IMA) confirmed that gross retail sales into UK ethical funds were up by 25 per cent in the second quarter of 2011, compared with the same quarter in 2010. Such impressive growth clearly reflects an investor-base brimming with good intent and wanting to put their money where their ethics are; acknowledgement indeed that the financial choices we make can shape the world we live in for the better.
Asset owners, such as companies, pension funds and charities are increasingly using their financial might to adopt an investment strategy that not only focuses on financial requirements, but addresses wider social and environmental criteria as well.
This increase in interest in ethical, or responsible, investing is down to how the sector is increasingly viewed, according to Kade Sow, Head of Africa Desk at Mazars, who is also involved in sustainability and human rights. Sow believes that it’s a subject now firmly on the table and no longer the ‘soft’ option it once was: “Charities and companies increasingly have to respond to global economic pressures, as well as pressure from shareholders and stakeholders who want to know that their money is being invested responsibly. Companies who ignore these issues not only run the risk of losing out financially, but also risk damaging their reputation in the future,” she says.
It's a view shared by the National Employment Savings Scheme (NEST) that recently become a signatory to the UN-backed Principles for Responsible Investment (PRI), a framework for responsible investment.
Commenting on the move, Mark Fawcett, NEST Chief Investment Officer (CIO), said: "NEST believes that to protect and enhance the value of investments over the long term, it must act as a responsible asset owner and market participant. We also believe that investing responsibly enhances long-term value and reduces risk, and we have therefore embodied this view within our investment beliefs." As a major investment option for workplace pension schemes following auto-enrolment, the announcement by NEST is set to increase awareness of ethical and responsible investment issues even further.
For organisations such as charities, an ethical investment strategy helps avoid any conflict with the charity’s objectives. It can also help avoid alienating supporters, staff or beneficiaries.
For companies, an ethical investment strategy can be applied to a range of assets that need investing such as company pension schemes. Even smaller companies can play their part by applying ethical criteria when deciding who to bank with.
In all cases, the first step is to actually define what you would class as ‘ethical’. Sow says a good starting point is to build awareness within the company and involve as many people as possible. “If a responsible investment strategy is to work in the long term, it’s important that everyone on the investment board agrees on the objectives and expected results,” she says.
For charities, the investment choice is often used as a way of aligning with the charity’s stated aims. So, a charity supporting the homeless might, for example, consider investing in a community housing project.
If, as a company, you are not sure where you stand on the ethical investment front, a useful exercise is to reverse the question and try answering, 'What counts as unethical to me?’ For example, many persuaded by an ethical stance will opt to avoid the arms industry. Cigarette manufacturers are frequently given a wide berth, too. Likewise, petroleum industries can raise the hackles of many.
Creating a ‘blacklist’ of companies you wish to avoid is one approach. Alternatively, you can apply positive criteria and include companies or industries that are working towards environmental sustainability or upholding and supporting human rights, for example.
But choices are never clear-cut, and ethical investing is no exception. Whilst it’s perfectly possible to avoid investing directly in mining and refining stocks, for example, it’s harder to find ‘clean’ petrol to put in your car. Human rights is another issue likely to raise as many questions as there are answers.
Alternatively, you can apply positive criteria and include companies or industries that are working towards environmental sustainability or upholding and supporting human rights.
For example, what is your position when it comes to investing in countries with a poor human rights record? Do you avoid investing in any company or bank operating in that country, which potentially cuts off much-needed investment in the region? Or do you invest in companies that have achieved a good human rights’ record wherever they do business?
For many, the decision comes down to a question of doing some good, rather than no good. “It’s important to understand that issues such as human rights are ongoing processes. A country doesn’t suddenly become 'good'. They evolve and that often requires a more proactive approach by investors,” explains Sow.
Increasingly, environmental issues are also being added to the mix of choices investors need to take when taking an ethical approach. Particularly as deforestation and water pollution not only have an environmental impact, but also affect human health and safety. This is an important issue in developing countries such as Brazil, Russia, India and China who are going through their own ‘industrial’ revolutions, at a time when we are all being urged to reduce our carbon footprint. So will avoiding such economic growth hotspots mean you have to forgo performance to stand by your ethical principles?
Not necessarily. As ethical fund choices increase and investment products become more mainstream, it is becoming much easier to measure performance. Plus there are a number of benchmarks, such as the FTSE4Good Index, now on offer to assess performance. According to independent financial data provider MoneyFacts, ethical funds marginally out-performed non-ethical funds in the first half of this year. With ethical funds achieving 14.91 per cent return in the first half of 2011, compared with 13.65 per cent for non-ethical funds over the same time period.
Looking at performance over a longer time period, the outlook is more challenging. Over a three year time period to 1 October 2011, the average UK ethical fund produced a return of 11.14 per cent compared with 20.37 per cent from the average non-ethical fund equivalent, according to financial performance analysts, Lipper. On a more positive note, a return of 11.14 per cent compares very well with a benchmark return of 4.61 per cent from the Footsie 100 (FTSE100) Index. In addition, ethical funds fare extremely well when comparing corporate bond funds. The average ethical Sterling corporate bond fund has delivered returns of 22 per cent compared with the average non-ethical UK corporate bond producing a return of just over 23 per cent in the three year period to 1 October 2011, according to Lipper statistics.
But perhaps the most important issue to bear in mind when embarking on an ethical strategy is to take a mirror to your own company policies. If an investor wanted to invest in your company would you pass an ethical screening test? Look at your own attitude on issues such as anti-bribery. Do you operate fair employment practices? What is your record on workplace safety?
Sow sums it up: “Ask yourself, what is at the heart of your business? We put a lot of emphasis on our clients, but the main value to any business are the people in it.”
Where companies may be excluded or ‘screened out’ from investments because of their involvement in certain activities deemed to be negative, such as heavy polluters, arms companies or animal testers. Or ‘screening in’ companies based on their their positive contributions to society and the environment such as those providing better healthcare or organic farming.
Similar to ‘screening in’ a company. For example, an ethical fund might have criteria which enable it to invest in the oil and gas sector, but only in those oil companies which are ‘best in their class’ as they have a better record on the environment and human rights than others in their sector.
Does not necessarily exclude, include or prefer companies but works by actively encouraging companies to adopt social and environmental best practices. This can involve meetings with senior management and voting at relevant annual general meetings.