The evolution of ethical investing

Ethical investors need to be pragmatic and patient and work closely with an experienced investment manager to reflect their ethical views in their portfolios. It can be a long, but ultimately rewarding journey.

There are many different ways of expressing an ethical position in investments. Traditionally this has been achieved by negative screening, such as excluding tobacco manufacturers, which reflect the individual investor’s views. But in the last few years ‘ethical investors’ have started to embrace the idea of positive screening where only the companies that score the highest marks for specific attributes are eligible for inclusion in their portfolio.

More recently we have seen the emergence of ‘impact investing’. Originally this was about the use of shareholder power to influence how companies behave and invest. However, it now includes investing in companies and projects that actively promote a desired outcome. Examples of this include investing in companies developing battery technology for those concerned about carbon emissions, or in social projects that aim to reduce convict re-offender rates through a social justice agenda.

Bespoke active management solutions

Every ethical investor will have different ethical requirements, requiring a bespoke ethical portfolio. Vigeo Eiris, one of the leading ethical screening services, considers more than 3,000 companies using 110 different criteria. There are many grey areas in ethical investing and the challenge is to find the right balance or trade-off.

If you’re an ethical investor, it’s likely that there are some investment areas you won’t even go near, some where you will only consider the best-in-class companies from an ethical perspective and others where you are prepared to actively engage with the companies concerned.

You may therefore want to use a series of negative screens for ‘will not touch’ investments and positive screens for ‘best-in-class’ investments in your portfolio. This will determine how much of the investment universe is excluded and the impact this will have on the ability of your portfolio to meet your objectives and achieve the diversification required to match your risk profile.

It’s important to look at the number of companies excluded from your potential investment universe and their market capitalisation. This will help determine how your ethical preferences will affect your ability to construct a portfolio that meets your objectives and risk profile.

Meeting your objectives

There are a number of ways that the impact of restrictions on your portfolio can be mitigated.

Global investing
Look at global investments to increase opportunities.

Finding substitutes
If tobacco companies are restricted, investments in consumer durables may be good substitutes with close correlations. Similarly, if pharmaceuticals are restricted, then a mix of consumer durables, services and technology companies can act as substitutes, and so on.

Positive screening
Positive screening can help maintain diversification. For example, an investor might be very concerned by the damage done to the environment and local communities by mining, but accept that mineral resources will always be mined by someone. It may therefore be best to support companies that use the very best practices to protect local communities, ground water and limit damage, rather than excluding mining companies altogether.

Active engagement
Some ethical investors adopt a policy of engaging with companies to encourage change, only excluding them if they fail to deliver the required change.

Ethical investing vs return

The longer-term studies show a mix of results. But more recently, the evidence suggests that ethical investing over shorter time periods may be enhancing returns. This perhaps reflects the increasing amount of money being invested in this way. Whatever the reason, there are certainly many ‘ethical’ themes with attractive growth prospects that you’d expect to see even in portfolios not subject to screening. Ethical investors need to be pragmatic and patient and work closely with an experienced investment manager to reflect their ethical views in their portfolios. It can be a long, but ultimately rewarding journey.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.