Must you pay a price for ethical investment?
ESG fund reporting relies on self-disclosure by constituent companies to measure the impact it generates
Investing for some is no longer as simple as making money. It’s about saving the planet and maybe your soul too. Do it right and the financial returns can add up. Photograph: Getty Images
Guns, tobacco, gambling, pornography, fossil fuels, fast fashion – do you know where your savings or pension fund is invested?
It’s all very well to recycle, give to charity or swear off buying more stuff, but if your hard-earned cash is fuelling industries that clash with your principles you might be missing a trick.
“Ireland has a young, tech-focused, outward looking workforce who are asking more searching questions about this stuff,” says Ralph Benson, head of financial advice at Moneycube. “We are now seeing a number of people refusing to invest if the product isn’t governed by some ethical guidelines.”
Investing for some is no longer as simple as making money. For the woke it’s about saving the planet and maybe your soul too. Do it right, and the financial returns can add up.
As if the investment world needed more jargon, there are now more terms to contend with – “ethical”, “sustainable” and “impact” investing. They mean different things apparently, though agreed definitions, even among fund managers, are hard to come by.
When it comes to ethical investing, it’s personal. Sticking to your personal ethics may entail excluding whole industries from your investment portfolio. The United States Conference of Catholic Bishops, for example, won’t invest its coffers in companies that make or sell contraceptives. For others such an investment might be a good. What’s ethical and what’s not is highly subjective.
“I had a customer who was perfectly happy investing in tobacco,” says Benson. “He had spent years working with NGOs in Malawi, where planting tobacco was people’s livelihood.”
Matching your investment to your ethics is a starting point, but there are other considerations too.
Benson cites the Stewardship Ethical fund from Aviva/Friends First as a good performer. It comprises companies that benefit from or substantially contribute to sustainable development, avoiding companies with damaging or unsustainable practices. The fund has been fossil fuel-free since 2017. “Arguably a fund that is heavily exposed to fossil fuel investments now represents a pretty material risk,” he says.
The fund’s manager engages with participating companies, nudging them towards better environmental, social and governance (ESG) practices by giving a greater weighting to the stocks of those that show improvements. It has achieved a 10-year return of 12.72 per cent.
“Anyone would have been happy to be invested in that. Over time it has performed exceptionally well,” says Benson.
Returns rival the big equity funds where most people’s pensions are invested during mid-career, he says.
However, Benson warns those seeking an ESG-focused fund to be aware of sometimes-higher annual charges that can eat into returns. “An ethically-focused fund should be available to people on the same terms as any other fund – there is no huge additional cost in providing these funds.”
If your ethics are leading you to a quagmire you could try “impact” investing.
“With ethical investing we send out a survey to our investors and ask questions around their ethics and morals, and what they want us to avoid investing in,” says Sarah Norris, fund manager with Aberdeen Standard Investments. “With impact investing we don’t ask our clients, we take the UN’s definition.”
The UN has 17 sustainable developmental goals ranging from things like ending poverty and hunger to gender equality, clean water and energy, responsible production, decent work and climate action.
Standard Life’s Global Equity Impact fund invests in equities that aim to have a positive environmental and social impact aligned to these goals. Investors in the fund include individuals who want their money to do some good and pension trustees switching to more sustainable products. Norris says they get “a double bottom line” of social and environmental impact and financial return.
The company is a signatory of the UN’s Principles of Responsible Investing and the fund is managed along ESG criteria. Investors receive an annual report with metrics that they can examine to ensure the environmental and social impacts stack up.
“There are metrics such as carbon off-set or avoided, or how a company you are investing in is helping a country achieve its sustainable development goals,” says Norris.
Like other ESG funds, reporting relies on self-disclosure by the company in which it is invested to measure the impact it generates.
Despite the fund eschewing some stalwart stocks, Norris says clients choosing it don’t have to sacrifice returns.
“The average investor has to be aware that you are not going to be investing in certain sectors like oil, gas, tobacco, alcohol and mining, and sometimes when those sectors are doing quite well there might be a bit of lag in performance,” she says. “But over the medium term we aim to outperform the indices.”
Last year the fund outperformed the MSCI ACWI Index, an index or measuring device for investments maintained by Morgan Stanley and used to gauge overall global stock market strength or weakness. “That index was up about 25 per cent and we were able to outperform it by about 90 basis points.”
For some fund managers and investors adhering to environmental, social and governance principles is just about following the money. It might be good for the planet, but it must be good for the pocket.
“A lot of fund managers would look at ESG investing solely as a risk management tool: they are not on a values crusade,” says Patrick McLaughlin, ESG multiasset portfolio manager at Davy.
“What companies are going to be exposed to environmental considerations or social considerations? How are they treating their employees; how are people being treated in their supply chain; what is the company’s governance like; is the board independent; what’s diversity like? Monitoring elements like that should ultimately lead to you making a better investment.”
Davy’s asset management arm runs three ESG funds where the investment managers are also signatories of the UN’s Principles of Responsible Investing. McLaughlin says fund performance is “comparable” to other funds, with their ESG bias not impacting on returns.
In the past conversations with private clients might have been around screening out “sin stocks” like gambling, tobacco, civilian firearms or alcohol, says McLaughlin. While some screening continues, now companies are evaluated on their exposure to environmental, social and governance risks.
“Positive screening” happens too. That means investing in companies for positive ESG performance relative to their industry peers.
“You could still end up with an oil company, but they are actually the oil company with the best ESG credentials in the oil sector, and the fund manager is engaging with them to enhance their ESG credentials further.”
And it’s not just environmental polluters that come under the microscope.
“With a bank you are not going to be measuring them on how they use water or natural resources, but you might look at their interaction with society and see things you would take a dim view of.”
McLaughlin agrees the area of ethical, sustainable or impact investing lacks standardised terminology and measurement.
“People can find a way of justifying a holding based on their interpretation of ESG. It’s important to understand your manager’s interpretation of ESG, and what are the likely holdings in your portfolio.”
Whether you are driven by your values or value, you don’t have to sacrifice one for the other. A study by Morgan Stanley comparing the performance of sustainable funds and traditional funds from 2004 to 2018 found returns were comparable. In fact, in this particularly volatile period sustainable funds were more stable.
Asking your broker to incorporate environmental, social and governance criteria into your investments may help to limit your risk. You don’t have to choose between your conscience and profits anymore.