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Ethical investing isn’t what you think

Daniel Lane

Daniel Lane - Fidelity Personal Investing

It's Good Money Week and that means the ethical investment debate has come up again, as we are reminded to make sure our portfolios are backing the causes we want them to.

And it seems like investors have fairly staunch views on this niche side of the industry; while a few will invest in nothing but ethical strategies, quite a number of voices stick to the opinion that morals have no place in the markets. I’m just not convinced it’s as black and white as that.

In fact, the more I speak to investors the more I’m likely to equate the entrenched views (either way) with a rather antiquated perception of what ethical investing is all about. Millennials in particular are leading the pack in wanting to know how the sausages are made and, as this generation is the most in favour of tying their beliefs to their money, it’s worth seeing if we’ve got it right.

Green: the only colour that matters

Star fund managers like Neil Woodford have been known to make clear they are not paid to make moral judgements on behalf of their investors, only to aim to provide returns for them. This, along with investors refusing to give up gains to satisfy personal beliefs, forms the crux of most concerns surrounding the space. Worthy points but there are a few things to say here.

First, while personal investors often join the sector with morals in mind, ethical investing shouldn’t be confused with philanthropy. With such subjectivity in the term ‘ethical’ it is more useful to look at the commitment to sustainability and responsibility found in these funds, as well as strict controls around environmental, social and corporate governance (ESG) standards.

The only way is ethics

The whole fund industry is being pushed to raise ESG standards because, regardless of societal well-being, we now know that those companies doing good, or at least not doing bad, are the most sustainable. There’s no moral judgement here, just a focus on long-term sustainable business models.

Ethical fund managers use screening processes to sort those companies deemed to be harmful to society from those benefiting it but lift up the bonnet and it can all look remarkably familiar - analyst teams poring over accounts and quizzing company management. Arguably investors get the same fundamental processes as with other funds, with a dollop of extra due diligence thrown in.

Money or morality

And second, do investors give up returns by investing in the sector?

No, says David Osfield, co-manager of the EdenTree Amity International Fund: “There’s been an enormous amount of academic and commercial investment bank-led research about these strategies and they’ve found a positive approach has led to superior risk-adjusted returns over the long term.”

While many will point to the opportunity cost of missing out on big gains in the likes of tobacco and alcohol stocks over the years, ironically what investors think they would be giving up to use ethical strategies is often what the funds’ managers are trying to achieve - sustainability.

Fund bosses heavily invested in the likes of big tobacco like to talk about repeat and dependable customers, and a lot of the time those in the ethical space are looking for the same thing. However, to these managers the best way to make sure that’s a strong probability is to look at responsible companies in sectors that either don’t do damage to the world around us, or do a lot of good. For them, it’s more likely that they will survive and prosper than companies that risk running out of resources, face further regulation and possible fines, and are susceptible to public backlash.

The extra leg-work ethical teams conduct to clarify just how sustainable a business is, and how liable it would be to fines etc. if its operations went wrong, is designed to prevent shareholders being exposed to unnecessary risk. While each individual strategy will make judgement calls on which business sectors to include and exclude, many investors in the space seeking reliability of cashflow with a long-term view simply see a fund’s overall social aims as a happy bonus.

If sustainability and good corporate governance are top of your priority list, ethical funds might help, whatever ‘ethical’ means.

More on ethical fund investing

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