The history of ethical investing goes back centuries to the mid-1700s when Quakers and Methodists made moral choices regarding where they invested their funds. For instance, these groups chose to avoid investing in the slave trade and industries such as tanning and chemical production.
Religious restrictions on investing
Indeed, religious orientated investments have, and still do, follow defined ethical principles in line with the related creed, laid down by specific religions.
Consider Epworth Investment Management, which together with its parent organisation, the Central Finance Board of the Methodist Church, manages equity, bond and cash portfolios in excess of £1.3bn. It is named after the Lincolnshire village where Methodists founder John Wesley was born.
While boycotting the worst offenders, Epworth also looks to engage with firms in which it invests. It tackles them on a wide range of issues including human rights, child exploitation and welfare, climate change, corporate governance and medical safety.
Similarly, Ava Maria Mutual Funds follow responsible, faith-based investing principles laid down by the Catholic Advisory Board.
There are also many Sharia compliant funds that invest following principles set out in the Koran. Alcohol, gambling and interest paying investments are all outlawed under Islamic law. This means investment products have to structured so that growth does not come from prohibited sources.
CIMB Principal, Amana Funds and Al Ameen Fund are just three such providers.
The arrival of ethical funds
While faith-based funds could be classed as the first ‘ethically’ motivated investment products, mainstream, non-denominational, ethical investments did not really appear before the early 1970s when the first ethical fund was launched in the US.
It was a product of its time as the mandate was to avoid any investments associated with, or benefiting from, the Vietnam War.
In terms of the UK market, it took much longer – 1984 to be exact – when Friends Provident launched the UK’s first ethical unit trust.
Boobs, booze, baccy, betting and bombs
Since then ethical investing has moved on at quite a pace. Until recent years it used to centre around the Five B’s boobs, booze, baccy, betting and bombs. Or using slightly better grammar – an investment fund that screened out companies linked to pornography, alcohol, tobacco, gambling and arms manufacture.
But things have evolved somewhat. Now companies linked to mining and mineral extraction, blood diamonds, sweatshops, child labour (the list goes on) frequently find themselves on an ethical blacklist.
And ‘ethical funds’ are no longer just about negatively screening out companies either. Many funds now adopt positive screening.
This means identifying companies that make a worthwhile contribution to society or the environment. This could mean the company satisfies criteria relating to, for instance, equal opportunities, sustainability, clean energy or recycling.
The bottom line is that with ‘ethical funds’ these days, you are seldom comparing like with like. There are funds categories including:
· Light green
· Dark green
· Climate change
· Corporate Social Responsibility (CSR)
Then there’s impact investing which is a variation on the same theme.
What do all the labels mean and how does performance stack up?
Light green funds
For some investors, an ethical stance may be simply the exclusion of one or two sectors from their portfolio – for instance arms manufacturers or tobacco companies.
For these investors, a ‘light green’ fund would suit their needs – the choice of stocks that can be included remains very broad. In theory, the wider the investment universe, the better potential returns.
How green you want to be is down to personal choice but the important factor is to find the fund that best suits your ethical position.
It is important to look under the bonnet of the fund to see the companies held within the portfolio and be clear on the fund manager’s investment remit. How aligned is the fund to your principles?
Dark green funds
A ‘dark green’ fund would have far stricter criteria on stock selection than a light green funds. For instance, tobacco, gambling, alcohol, animal testing, fur trade, intensive farming, fossil fuels and arms manufacture could all be sectors that are immediately filtered.
The universe of stocks to choose from is therefore significantly reduced. Oil and pharmaceutical companies which account for a large percentage of the FTSE 100 would be red carded.
Banks financially supporting logging companies in the developing world may be out of bounds from an ethical standpoint.
Companies that actively trade with repressive regimes such as Saudi Arabia may be excluded too.
Socially Responsible Investment (SRI) funds
A typical ethical fund will screen out sectors entirely, while Socially Responsible Investment (SRI) funds (sometimes referred to as Sustainable and Responsible Investing) are more focused on improving practices of the companies they invest in.
As shareholders in a business, investors/fund managers have the right to vote and voice their opinion on how things are run. The onus is on changing and improving things from within rather than excluding companies altogether.
An ethical fund manager can challenge senior management and exert a positive influence on their policy direction. By working with companies, and in some cases regulators and politicians, they can also help develop best practice standards and improve corporate responsibility.
Each fund will have its own ethical criteria. For some, fair trade will be a prerequisite. Simply put, Fair Trade means paying a fairer – for that read above market – price to the producers. It is a fairly broad definition that permits companies to have one Fair Trade product among many market-priced alternatives.
Kitkat and Divine Chocolate
Nestle introduced a KitKat using Fair Trade Cocoa. While this may have satisfied some investors, at the other end of the market are companies such as Divine Chocolate, which is cooperatively owned by its cocoa growers. Both carry the Fair-Trade mark.
Others refuse to invest in Nestlé due to the company’s consistent marketing of baby food against World Health Organisation advice in favour of breastfeeding and despite widespread condemnation.
That reputation may be out of date. Epworth has recently decided to hold Nestlé stock, though admits it “remains a controversial issue” that Epworth’s clients continue to ask about.
“For a long time we avoided investment in Nestlé, but over the years felt that there had been sufficient change in the company's business practices that it was no longer appropriate to avoid, and that we should start a holding.
“When compared with the starting point of the 1970s/early 1980s there has been a sizable transformation in the business practices of the company in developing countries.
“Nestlé was, for many years, the only company breast milk substitute manufacturer that was included in the FTSE4Good Index. This involved a verification process including in-country audits in developing countries. In addition the Access to Nutrition Index ranked Nestlé as the best company among those involved in breast milk substitutes.
On a broader level, ‘ethical funds’ may insist that UK firms they invest in adhere to the principals of the Living Wage campaign. This demands workers are paid an hourly rate determined by the real cost of living.
This is distinct from the more recently named National Living Wage introduced by the government and which is substantially lower.
In extreme cases, unethical companies across the globe will pay little or no wages at all. The term modern slavery is frequently heard these days and this refers to businesses that force employees to work under the threat of some form of punishment.
Bonded labour – a widespread form of slavery, is when people borrow money they cannot repay and are required to work to pay off the debt. They subsequently lose control over the conditions of both their employment and the debt.
For ethical investors, the onus is on having a clear picture of how companies treat employees and if they are transparent on working conditions and human rights.
Indeed, transparency is a key point, in some instances large companies can be guilty of greenwashing. This is when a company’s PR and marketing teams put a misleading spin on their products or services giving the impression that they are environmentally friendly.
Drinks giant Coca Cola serves as a case in point. Back in 2013, the company was asked to revise the marketing materials for its so-called PlantBottle packaging after a consumer-protection ombudsman found that it exaggerated the product’s environmental benefits without offering proof.
The bottle was made partially from plant-based material however the ombudsman insisted the reduced carbon footprint claims without an existing full life-cycle assessment of the bottle were misleading.
Coca Cola is by no means alone with regards to green washing. In the 1980s, US oil giant Chevron commissioned a series of expensive TV and newspaper ads to convince the public of its environmental principles. Titled People Do, the campaign showed Chevron employees protecting bears, butterflies, sea turtles and various other cuddly animals.
The commercials worked in 1990, they won an advertising award. However the ad campaign also drew the attention of environmentalists who saw the company as the epitome of greenwashing - making the most of tenuous sustainability claims to cover questionable environmental credentials.
There are numerous cases of companies whose advertising bill promoting their ‘green’ credentials significantly outweigh the amount spent on environmentally-good practices.
A win-win situation
The more ombudsmen, pressure groups and investors haul major corporates over the coals for either greenwashing or corporate governance – the more companies will react. And if they react positively they could, in theory, find themselves on an ‘ethically approved’ list rather than a ‘blacklist’.
In a world where social media can point the spotlight on good or bad practice at the click of a mouse or a touch of a screen, corporates can no longer pay lip service to social responsibility or claim sustainability credentials than can be proved flimsy after a rudimentary online search. Their brand can be damaged very easily and news spreads fast on the web.
Whatever stipulations ethical investment managers apply when stock picking, corporate governance often improves which is of benefit to both the corporates themselves and to those who have invested in the fund.
Companies that pay consideration to social and environmental issues are often better managed, less liable to litigation and more profitable than those companies that don’t.
SRI funds will actively seek companies making a positive social impact on the world. The firm may in fact be an energy stock that for many ethical funds would be routinely blacklisted but the SRI manager has identified positives – for instance, environmental impact work. The company may be raising the standards of corporate governance or safety within its own sector.
Corporate Responsibility and Corporate Social Responsibility
A common term label these days is CR (corporate responsibility) or CSR (Corporate Social responsibility). Companies demonstrating how they operate and perform to the good of the community.
Over 15 years ago, Starbucks developed standards for ethically sourced coffee in partnership with Conservation International. The company now sources most of its coffee from producers with independently-verified, environmentally-friendly operations.
However, if a company subsequently falls from grace, investment managers will review their position on that company. Stock evaluation is a continual process.
There is a tendency to view cleantech as solar, wind, hydro-electric energy solutions but it is much broader than that. It also includes sustainable smart grid solutions – looking to reduce energy usage.
Cleantech funds could include oil and gas companies that are looking at ways to reduce pollution levels and increase energy efficiency.