What is Ethical investing?
The UN climate change summit started this week in Egypt, with more than 120 world leaders due to arrive to discuss the growing issues with the sustainability of our planet. Now in its 27th iteration, the 2022 United Nations Climate Change Conference, more commonly known as COP27, will last for two weeks where world leaders will negotiate how collectively we can tackle climate change.
Investing sustainably is nothing new, however recent years have seen a surge in interest from investors looking to ‘do their bit’. There are many different ways you can invest ethically although ethics are subjective, so it’s important to understand the difference before you look to take the next step. So, what is ethical investing and how does it work?
Ethical investing is the practice of filtering your investment selections to suit certain ethical principles. It gives you the opportunity to make a non-financial assessment of a company and make a positive impact on our world, whilst still creating returns. As more and more people become conscious of the issues that face our world, ethical investing has become increasingly popular. There are now several strategies that investment funds adopt to select or ‘screen’ the stocks that they include in their portfolios. So, what are the different options, and how can you tell what’s best for you?
ESG stands for Environmental, Social, and Governance and these core principles are often used by ethical investors to screen companies for potential investment opportunities. The ‘Environmental’ aspect of ESG evaluates a company’s approach to safeguarding the environment, for example, corporate policies relating to cutting carbon emissions. The ‘Social’ aspect relates to how the company manages its own people and the people it deals with. For example, this could include the diversity of employees, the company’s approach to working environments, or the wellbeing of their customers, clients, or wider stakeholder groups. The ‘Governance’ in ESG deals with how the company is run by examining aspects of the company such as leadership, combatting corruption, executive pay, and shareholder rights.
As ESG has grown in popularity in recent years, many managers apply ESG criteria to their fund selection and some have even adopted specific investment portfolios for ethical investors. When looking at Ethical or ESG portfolios, managers specifically select certain companies based on their ESG criteria. However, by its nature, this assessment can be subjective as good practice means different things to different people.
ESG investing also helps investors avoid companies that have a larger financial risk due to their negative ESG practices. Investing in companies who engage in unethical practices often holds a higher risk of making a loss because they may be held accountable for those practices in the future.
Impact investing is another form of ethical investment that has gained popularity in recent years. This strategy aims to generate an actively beneficial ‘impact’, as the name suggests on the environment or society. One simple way to distinguish between impact investing and other ethical investment strategies is this: most ethical investment strategies can stop at ‘do not harm’ whereas impact strategies seek to proactively ‘do good’.
Positive and Negative Screening
There are two different types of screening that ethical funds use to decide which companies should be allowed into a portfolio. Positive screening and negative screening. Positive screening aims to include companies that take positive steps for the environment or the community in which they operate. This type of screening often uses ESG criteria to compare investments, hence ESG-focused funds usually include positive screening processes. Within these strategies you might still find sectors which are considered ‘unethical’, for example, oil and gas. Positive screening is focussed on improving industry standards and finding the best-in-class companies within a sector, so this could mean including a gas company which has pledged to reduce their emissions markedly.
Negative screening, on the other hand, actively excludes certain products and sectors, for example alcohol, tobacco, or fossil fuels. This approach is particularly relevant for tailored or bespoke portfolios as advisers can negatively screen investments to suit the needs and values of the client. Therefore, this method can be beneficial to investors who have a set view of what they want to invest in. Other strategies adopt a joint approach to screening, for example impact funds which invest specifically in companies that make a positive impact and ‘do good’ and avoid any sectors which clients may be averse to.
ESG criteria was originally introduced to encourage companies to act responsibly, and portfolios which adopt this strategy attract many ethically conscious investors. As a result, many companies have upped their ESG game in recent years and boosted their ESG credentials. Therefore, it is important to make sure that the companies hold out on their promises. The rapid growth of ESG funds has led to claims that some companies have been misleading investors about their ESG accomplishments. Many companies have manipulated their marketing to support their ESG claims, for example, exaggerating their environmentally conscious business practices. This has since been coined as ‘greenwashing’.
So, how can you tell what is ethical and what is ‘greenwashing’? This is where research is key, whether you are investing directly into a company or into a portfolio, you or your adviser can do a deep dive into companies’ practices. Many ESG funds publish impact reports to outline the real-world influence that their investments are making. Many companies also publish Corporate Social Responsibility (CSR) reports which are used to communicate their ethical efforts to investors. It is worth noting that because the company itself produces this report, some aspects might be biased. Therefore, to back up a company’s ethical claims, and get an unbiased view, investors can use third party audit sources. Providers such as Morningstar offer company and fund ESG scoring so investors can compare their efforts.
A key objective here at The Private Office (TPO) is to have a positive impact on our world, and as such, we have committed to gifting 25% of our future value to environmental charities ‘Restore Our Planet’. The charities aim to protect and restore Britain’s natural habitat and deal with environmental and bio-diversity related issues globally.
If you are interested in investing ethically it is important to find a strategy that aligns with your values, whether it is through positive screening or negatively screening particular investment areas, there is something out there for everyone. The best way to protect your wealth is to invest in a combination of different types of investments. Therefore, investing in an ethical investment portfolio increases the diversification of asset types compared to investing directly into an ethical company. It is worth remembering, however, that as with all forms of investments, values can both rise and fall and you may not get back what you originally invested.
If you’d like to learn more about how ethical investing could be incorporated into your own investment strategy, why not get in touch and speak to one our expects for a free initial consultation.
Note: The value of investments can fall as well as rise, you may not get back what you originally invested. This article is for information purposes only and is not intended as specific or individual advice and should not be taken as such.