WEEKLY E-MAIL

19 February 2020

THE RISE OF ETHICAL INVESTING

By Patrick Malcolm

Investors are increasingly aware of the link between a company’s long-term success and profitability and its sustainability focus. Regarding environmental screening, a growing body of research suggests that superior environmental management usually correlates with high standards of corporate governance which requires attention to more than just short-term financials. There is also increasing evidence that shows a strong link between good sustainability performance and corporate profitability.

According to Investopedia, the earliest recorded instance of ethical investing in America was made by Quakers in the eighteenth century, which restricted members from investing their time or money in the slave trade.

In the 20th century, ethical investing gained traction based more on people’s social views rather than their religious ones. Ethical investments tend to mirror the politics and trends of the time. In 1960s and 1970s America, ethical investors focused on those companies and organisations that promoted equality and rights for workers, and avoided those that supported the Vietnam War or benefited from it. Starting in the 1990s, ethical investments began to focus heavily on environmental issues, with ethical investors moving away from coal and fossil fuel companies toward those that supported clean and sustainable energy. That trend continues today.

When constructing an ethical investment portfolio, the framework around which it is built is often based on the concepts of environmental, social and corporate governance (ESG). The diagram below represents the different approaches to screening for ESG issues.

Positive screens

Companies that make a positive contribution to society, the environment and governance issues are actively sought under this approach.

‘Best-of-the-best’ companies are those whose activities align with ESG principles. A drawback of this approach is that it may not always result in a diversified portfolio, sometimes excluding entire sectors.

A ‘best-of-sector’ approach is where the best companies within each sector are ranked against ESG principles. Investment choices are made from the top-ranked companies within each segment and better diversification is provided with this approach.

Negative screens

Originating with the Quakers and the Methodists in the US, negative screening is called ’ethical’ investment, as opposed to socially responsible investment. Companies whose business activities or products are deemed to be morally unacceptable are screened out.

Thematic overlay

This approach looks for outperformance from companies which address society’s needs and are working towards environmental sustainability, e.g. “industries of the future”.

Examples of ESG screens

Until recently, the problem with ethical investment was that many funds failed to deliver comparable returns, and too many investors believed that ethical funds were compromised. However, a substantial body of research has emerged to disprove this idea.

Back in 2012, the Royal Bank of Canada conducted a study that collated the results of the most comprehensive pieces of ethical investment research into a single document. The chief finding was that socially responsible investing did not result in lower investment returns.

Demand is rising for responsible or ethical investment, as funds flow into the sector, and the product offerings grow with more investment managers joining the trend. We see no reason why this trend won’t continue.

Patrick Malcolm
Senior Partner
Certified Financial Planner®
SMSF Specialist Advisor™
Authorised Representative No. 278061

If you have any questions or comments, please email me at patrick@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution. The information here is of a generic nature, and does not take into account your investment objectives or financial needs. No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

Copyright: © This publication is copyright. Subject to the conditions prescribed under the Copyright Act, no part of it may, in any form, or by any means (electronic, mechanical, microcopying, photocopying, recording or otherwise) be reproduced or transmitted without permission. Enquiries should be addressed to GFM Wealth Advisory.