Ethical investing is changing. With more investors now concerned about the long-term negative impacts of corporate activities, the once niche approach is going mainstream.
Driving the trend is a fast developing ethical investment style that is different from what many might think of when they hear the words ‘ethical investing’. It is an approach that appeals to younger clients in particular.
Let us first consider traditional ethical investing, which really started to establish itself in the late 1980s and early 1990s.
Darren Lloyd Thomas, director of Pembrokeshire-based advice firm Thomas and Thomas Finance, said this approach was based on negative screening. ‘It involved trying to avoid certain areas, such as tobacco, alcohol and arms dealing,’ he said.
Chris Welsford, director of Isle of Wight-based firm Ayres Punchard Investment Management, said: ‘In the early days, only three or four funds marketed themselves as green or ethical.’ These included Friends Provident Stewardship, NPI Global Care (now run by Henderson) and Jupiter Ecology.
This approach came at a cost, according to Ryan Smith, head of corporate governance and ethical research at Kames Capital. ‘Broadly speaking, all ethical funds have been successful in the long term. But when you restrict sectors you reduce the opportunity set, so they are more volatile. But long-term returns should be comparable to unconstrained peers,’ Smith said.
Today we have a new approach. This comprises positive screening for environmental, social and corporate governance (ESG) factors, where fund managers seek out companies with positive
Amanda Young, head of responsible investment at Standard Life Investments, said: ‘We’ve seen a shift away from “thou shalt not invest in X”. We are moving from negative to positive. Investors want to know companies are contributing positively to the environment and their employees, and have products that make the world a better place.
‘This is a focus on positive corporate behaviour and away from the negative. It is actively seeking investments that do good. So it is moving away from sector avoidance to sustainability matters.’
There are broadly three sets of factors that are used in ESG:
- corporate governance
Environmental factors include the need to ensure companies do not negatively impact the environment. Smith said Kames had recently launched a global sustainable equity fund that met this need by investing in companies in areas such as renewables and water technology.
Meanwhile, social factors include the need to ensure firms treat staff and society fairly. ‘Social impacts refer to such things as employee welfare, customer relations and safety with regard to engineering, mining, and oil and gas companies,’ said Smith.
Finally, corporate governance factors include the need to ensure groups have, for example, positive managerial conduct. Smith said: ‘Corporate governance involves how companies are run, who runs them and how they are incentivised. From an investor’s point of view, you need to ensure the company is run in an appropriate way, and that the rights and interests of minority shareholders are being respected. After all, we are one of them.’
According to Young, the ESG approach is becoming increasingly popular with the under-40s. Consequently, several fund houses have recently launched funds to cater for these investors, and the new Kames offering is one such fund.
However, Thomas said: ‘The usual response of financial advisers to ethical investing is: “I can’t guarantee it is ethical, so invest normally and give to charity.”
‘But I don’t agree. You can develop ethical funds using positive screening. I want to see sustainable climate change awareness and good treatment of humans. The younger generation is more concerned about the environment.’
Like the younger investment generation, ESG is the new kid on the ethical investment block, and financial advisers would do well to familiarise themselves with it. ‘Ethical investment is not dead, but we have moved the positives further upwards,’ said Young.
A failure to meet broad ethical and environmental standards can itself damage a company’s reputation, and its share price. Just ask the management at Volkswagen.