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Point of View

What is Ethical Investing? 

Duncan Burden, Senior Equity Analyst

We are finding more and more people are asking about how to invest ethically, so much so that it is entirely possible that in the next 15 to 20 years it will become the new mainstream.
 
Ethical investing in the UK dates back to the late 1960s. Originally associated with the Methodist Church, and latterly the Quakers, it became an investment philosophy that was closely associated with the church, charities and ethical individuals.
 
Today, ethical investing is commonplace within most investment strategies. Indeed, some elements of ethical investing are standard within all funds, not just those with an ethical ‘badge’.
 
As a sector, ethical investing is surprisingly complex, probably because it’s having to adapt to rapidly changing investor attitudes, and government policy. In essence, though, there are two key approaches:

Negative screening

Negative screening means not investing in companies that are involved in activities believed to be harmful, such as having a negative environmental impact, or benefiting from questionable human rights. Such businesses include those that are involved with:

  • Addictive products such as tobacco, alcohol and gambling

  • Pornography

  • Poor environmental practice, for example some energy companies

  • Countries that have a poor human rights record and/ or oppressive regimes

  • Weapons and armaments

  • Animal exploitation

  • Poor employment practices such as unfair remuneration, and discrimination

Positive screening for social impact

A more sophisticated, and increasingly popular, approach to ethical investing is where investors actively seek out firms that make a positive social impact. Ethical and socially responsible investors look for businesses that pass muster across certain corporate practises, such as environmental, human rights, consumer protection, diversity and sustainability – whether they’re investing directly with that company, or through a fund. These are usually known as Environmental, Social and Governance (ESG) factors.

Environmental, Social and Governance (ESG) factors

Most ethical or socially responsible funds will find companies that exhibit strong, and preferably improving ESG factor scores. The financial materiality of these factors – which are often mistaken for ‘soft’ subjective criteria – results in a genuine economic impact on the company, hence they are integrated into the investment process. This is done by assigning ESG ‘scores’ to the businesses approach according to some of the following criteria:

Environmental factors

A company must be actively managing their environmental impact by reducing carbon emissions, waste generation and use of resources such as energy. Environmental factors also look at a company’s long-term impact and sustainability, including use of raw materials.

Social factors

Social factors focus on:

  • Ensuring companies are not limiting themselves in the way they recruit and develop their people, offering a diverse and inclusive working environment, plus fair remuneration.

  • The longer term impact on the community and economy within which the company operates, such as creating jobs and opportunities for local people, and using local suppliers with a sustainable supply chain.

  • A company’s attitude to human rights and consumer protection, such as creating quality products and services that meet customers’ needs, while being transparent, ethically sound, and looking after customer information securely.

  • The importance of paying tax on profits that are earned in those jurisdictions.

Governance factors

How a company manages itself is of great importance. This includes the management structure within the business, how the business manages risk, and how the executives are compensated.

Sustainable factors – the UN’s Sustainable Development Goals (SDGs)

Another way of assessing the behaviour of a particular firm is to measure it against one or more of the UN’s sustainable development goals (SDGs). These are goals, targets and indicators that all UN member states are expected to use to frame their agendas and political policies over the next 13 years. There are 17 goals, and each goal has specific targets that must be reached by 2030.

UN’s Sustainable Development Goals (SDGs)

The goals are:

 

1) End poverty in all its forms everywhere
2) End hunger, achieve food security and improved nutrition, and promote sustainable agriculture
3) Ensure healthy lives and promote wellbeing for all at all ages
4) Ensure inclusive and equitable quality education and promote lifelong learning opportunities for all
5) Achieve gender equality and empower all women and girls
6) Ensure availability and sustainable management of water and sanitation for all
7) Ensure access to affordable, reliable, sustainable and modern energy for all
8) Promote sustained, inclusive and sustainable economic growth, full and productive employment, and decent work for all
9) Build resilient infrastructure, promote inclusive and sustainable industrialisation, and foster innovation
10) Reduce inequality within and among countries
11) Make cities and human settlements inclusive, safe, resilient and sustainable
12) Ensure sustainable consumption and production patterns
13) Take urgent action to combat climate change and its impacts
14) Conserve and sustainably use the oceans, seas and marine resources for sustainable development
15) Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification and halt and reverse land degradation, and halt biodiversity loss
16) Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels
17) Strengthen the means of implementation and revitalise the global partnership for sustainable development

The concept of measuring and reporting on portfolio companies’ impact on the 17 SDGs is a new and exciting field.  One approach is to screen for companies whose revenues are derived from impactful sources, and which make a material contribution to the resolution of one of the SDGs. We are currently working on a proprietary SDG impact assessment model that will help with our decision making.

Outcomes of ethical investment

No investor wants to lose money, and socially conscious investors are no different. Indeed, the integration of ESG factors within the investment process can often mean investing in businesses that have less inherent risk, and better longer-term financials. That, in turn, can equal better performance.

The future for ethical and socially responsible investing

As demographics change, and people become more socially and environmentally aware, ethical and socially responsible investing is increasing in prominence, and is constantly adapting.
 
As ethical investing becomes more and more popular, we are now seeing a move towards ‘impact investing’. This is where investors actively seek opportunities that mean their money can make a measurable positive environmental or social difference, while also generating a return.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.