Why investment funds are increasingly taking the high road

Ethical investing, where socially responsible investing objectives are incorporated with financial objectives, is a rapidly growing area and one that more people are becoming aware of, and demanding from their investments.

It refers to the practice of using one’s moral principles as the initial filter for the selection of investible securities, says Peter Smith, investment director, Aviva Investors. “Ethical investing gives the individual the power to allocate capital toward companies whose practices and values align with their personal beliefs, which may be rooted in environmental, religious, or political precepts,” says Smith.

“In Ireland the term ethical investing was historically linked to the provision of investment products that were in line with the ethos of the Catholic Church and involved excluding companies that were involved in alcohol production and distribution, gambling, pornography, stem-cell research and weapons manufacturing. This type of investing involved the exclusion of certain companies, a practice referred to as ‘negative screening’.”

Ethical investing is sometimes used as a catch-all phrase for investors looking to invest responsibly, says Smith. “Other types of investing that seem to be caught under this umbrella are terms like ESG investing, impact investing and thematic investing which, although quite similar, all have their own distinct meanings.”

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Ethical investing is an investment process where an investor chooses based on ethical code and financial return, says Marc Aboud, director focused on sustainability risk and regulation at Deloitte. “It looks to support industries making a positive impact. The way I think about it is like an umbrella term for a range of strategies – for example, socially responsible; exclusionary; environmental, social and governance (ESG); and impact investing,” says Aboud.

Why invest ethically?

While it may seem like a no-brainer to invest ethically, historically ESG investments were seen as lower-performing and more expensive. However, John Cotter, professor of finance at UCD Smurfit Graduate Business School, says that according to a recent report, 20 per cent of all investment funds in the EU will be green by 2026, rising from 15 per cent or less. While the United States lags behind, it is showing similar growth, as is Asia.

“The one thing that seems to be happening is that if you were to look at the performance of funds, stocks and portfolios over time, the tide seems to be turning in terms of performance,” says Cotter. “The feeling early on was that ESG stock performance was not as good, not as strong – but that’s not the case. The growth potential is phenomenal.”

What many people don’t appreciate is the scale of the real-world difference they can have through their saving or pension investments

—  Sandra Rockett

Sandra Rockett, director, retail and wealth distribution, at Irish Life Investment Managers, says its research indicates that customers really care about their personal impact on the world. “After cost-of-living concerns, customer awareness around issues like climate change is becoming more acute. Only a minority of people feel that the Government are doing enough to act on the climate change crisis and, more so than ever, people are looking for companies and governments to take more action.

“What many people don’t appreciate is the scale of the real-world difference they can have through their saving or pension investments. Our research tells us that nearly half the population (49 per cent) don’t understand that investing responsibly is the most impactful way they can help the planet.”

Who benefits from ethical investing?

The increase in focus on ESG factors by investors is set to benefit a large number of stakeholders, says Smith. “Although much of the focus currently is on the ‘E’ of ESG and how companies can reduce their carbon footprint by setting carbon net-zero targets in line with the Paris Climate Agreement – which aims to limit the global temperature rise this century well below two degrees Celsius and ideally at 1.5 degrees – focusing on the ‘S’ and the ‘G’ can also play a pivotal role to society and also to investors.

“Some of the world’s historically large oil-producing companies are transitioning to a low-carbon world, aiming to become carbon net zero by 2050. It will not be an easy journey and there will be ups and down but, as a result of the increased focus on ESG, shareholders in many of the world’s biggest companies are now encouraging these companies to address E, S and G concerns.”

When it comes to the ‘S ‘and the social element, there are strong links that you can point to that illustrate companies that look after their staff and suppliers may provide better returns in the long term, says Smith. “A study on winners of the annual Glassdoor best companies to work for in the US found that these companies significantly outperformed the Standard and Poor’s 500 over a 10-year period,” he notes.

“Similarly, when it comes to governance, Bank of America Merrill Lynch conducted a study on the S&P 500 over a 10-year period that identified 17 companies that filed for bankruptcy; of the 17 companies, 15 scored poorly from an ESG perspective.”

Investment strategies

In terms of investment strategies, there are many to choose from, says Aboud. “Thematic investing, where you’re investing in companies within a specific industry – for example, energy efficiency or clean water; corporate engagement – when you’re investing in a company and you have shareholder leverage and you use that leverage to influence; integration investing, which is incorporating material ESG issues into the investment philosophy and process; and impact investing, which is targeting particular social objectives with measurable financial returns to produce a tangible social and environmental good. These can include education, health, agriculture, diversity, and environment but also infrastructure and affordable housing.”

Negative screening or exclusion investing is another strategy, says Rockett. “This is where individual companies are excluded from investment portfolios based on their ESG criteria. “Typical examples in a responsibly managed fund would be business activities that are deemed harmful to the environment, like Arctic oil sands; harmful to society, like tobacco or controversial weapons manufacturers; or in breach of human rights laws or regulations like the UN Global Compact.”

Similarly, investments can be made through the lens of positive screening or inclusion investing. Smith says positive screening is the process of finding companies that score highly on ESG factors relative to their peers and investing more in these companies.