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.
Indeed, some cleantech funds may not even follow an ethical investment strategy at all – certainly for some ‘green’ investors any investment in the oil and gas sector would be beyond the pale.
Clean tech start-ups are many in number but as with most fledgling companies, success depends not just on innovation but on access to capital. Investments such as Bill Gates’s Breakthrough Energy Ventures Fund (covered in more detail later) are designed to support clean tech companies in their infancy.
Cleantech are a good example of what are termed ‘thematic funds’. Climate change funds are another relatively recent arrival in the ‘thematic; fund’ space. HSBC and Schroder, with its’ Global Climate Change fund, were amongst the first to launch into this market.
The Schroder fund invests in companies worldwide that the manager believes will benefit from efforts to accommodate or limit the impact of global climate change. That’s a fairly loose definition, which means, as with all ‘labelled funds’, that looking at the make-up of the portfolio is essential.
The Schroder fund includes Amazon in its top 10 holdings – this might not tick every ethical investor’s box.
So how does impact investing differ from traditional investing in ethical funds?
The main difference is that for the investor there is greater security and control on where the money is going. The reporting is a lot more comprehensive and the investment parameters are personalised and clearly defined at the outset.
A degree of control is lost in a collective ethical or a Socially Responsible Investment (SRI) fund where certain sectors are screened out and the fund manager ultimately decides where money is invested to make the best return.
It is essentially an off-the-shelf product not a personalised investment. With impact investing, you are usually looking at a longer-term, targeted, more illiquid investment as opposed to an ‘ethical’ or ‘sustainable’ fund, which is more homogenised.
Collective funds have their appeal but have their limitations too. Investing directly in local projects which do positive good in your community is often more appealing than allocating money to a broadly invested fund. Impact investing is normally associated with higher net worth individuals.
An example of impact investing might be a bond linked to a social housing project. For instance, a short-dated five-year bond offering, for example, 4% interest.
The social housing project is benefiting from a low-cost loan; while the client is guaranteed a 4% return – which compared to current rates on cash might prove attractive.
Ethical Lending, has similarities to impact investing. The subtle difference is that while 100% of the loan is repaid, there is no interest or profit attached.
The loans could be to buy extra livestock or to get a small business off the ground. The micro finance loans are typically administered via Community Development Finance Institutions (CDFIs).
What becomes apparent in the world of ‘ethical’ investing is that you are seldom comparing like with like. SRI, ethical, cleantech, impact investing all differ in terms of their investment boundaries - oil companies may be out of bounds for one fund but not another.
An SRI fund might include some element of screening alongside its SRI process. The definitions and distinctions between funds are not always easy to fathom.
It is down to the individual investor or their financial adviser to drill down and see how far a fund’s investment criteria fit with an individual’s ethical stance or tolerance for risk.
EIRIS has produced an online guide showing all ethical funds and their exclusion criteria www.yourethicalmoney.org/investments.
Because ethical funds are restrictive in nature, must investors be realistic about expected returns and understand there is usually a trade- off for sticking to a moral stance?
Most, if not all, ethical funds avoid sectors such as fossil fuels and tobacco. So, for example, if the oil price soars ethical funds will probably lag conventional funds and vice-versa.
Ethical funds also tend to avoid larger companies, since most of the world’s largest companies have unethical aspects within their vast business empires. This focus away from certain sectors and a bias towards medium and smaller companies is important to appreciate, since it will often be the primary driver behind any shorter term under or out performance.
The general rule of thumb is that ‘stricter’ funds are prone to suffer more while those that are more ‘liberal’ in where they can invest typically fare better.
Funds that exclude large parts of the market will almost certainly be more volatile and higher risk, although much depends on the stock-picking skills of the manager.
This represents good longer-term performance, although not surprisingly ethical funds did lag behind the broader market in 2016 as the oil price recovered and mining stocks recovered from their lows.
Certainly the bias of ethical funds towards mid and smaller companies can make them more volatile in the short term and a focus on new technologies
Restrictions on investments are common
It is worth remembering that it is not just ethical funds that are restrictive – technology funds, Asia Pacific funds, smaller cap funds, gold funds are by their definition limited in where they can invest – this does not stop people investing in them and making money.
For some ethical funds, there would appear to be little trade-off between investment restrictions and the returns they able to generate.
For instance, the Premier Ethical fund is currently ranked in the top quartile in the UK All Companies sector over one, three and five years. It has returned 106.1% over five years compared to the sector average of 64.8% in the FTSE4Good Index.
The fund excludes gambling, and arms manufacturers but otherwise considers companies on an individual basis on whether they have an adverse overall effect on health, the environment or human dignity.
There is no strict exclusion on banks (HSBC is a current holding) and another top 10 holding, Unilever might not be included in a stricter ethical fund.
Another notable fund is the Kames Ethical Equity fund managed by Audrey Ryan which has returned 80.94% over five years.
The company classes itself as ‘dark green’ in nature. Its screening means that its’ stock universe has a zero-potential weighting in banks or pharmaceutical companies, and a significant reduction in potential investments in the mining and oil and gas sectors.
The growth of ethical investments
Moving into the 21st century, socially responsible investing continues to gain traction. One of the key reasons is the growth of ethical consumerism, from ethical chocolate to pensions.
But it is not just the changing demands of consumers that is having a positive impact, the financial regulator now requires IFAs to consider clients, social, religious and ethical concerns when giving advice and UK government has gone as far as embedding certain requirements in statute.
In its white paper The Growth of Ethical Investment, the organisation Ethical Futures points out that as far back as 2000 the law was changed to require occupational pension schemes to declare in their Statements of Investment Principles (SIP’s), whether they account for any social, environmental or ethical factors when deciding what stocks to invest in.
Unfortunately, this potentially powerful tool is under-utilised and many pension scheme members are unaware of it.
What is undeniable though is the increase in money going into ethical funds. In 2000 there was just over £12bn invested in the ‘ethical market’ by 2005 this had grown to £30bn and by 2014 the figure had exceeded £80bn and rising.
From its humble beginnings in religious based groups ethical investment has now evolved to the point that anyone can seek out a product that reflects their values.
Investors, no doubt helped by online research and social media, are more empowered than ever before. In its 2014 report, Ethical Futures points to research showing that the UK population is actively boycotting specific products or retail outlets as a result of their ethical concerns.
It also highlights the fact that over 50% of people have either recommended, or followed a recommendation based on a company’s responsible reputation and more than 40% of consumers have bought a product primarily for ethical reasons.
For many looking to invest now, the only way is ethics.
Who’s who of ethical investing
In 2015, Bill Gates launched a $1bn investment fund in clean energy. The Microsoft founder and billionaire was joined by some of the world's richest business people in setting up a 20-year fund called Breakthrough Energy Ventures.
The fund invests in companies and technologies that have "the potential to reduce greenhouse gas emissions by at least half a gigaton."
It will specifically target innovations in electricity, transportation, agriculture, manufacturing and architecture. Many innovative, fledgling companies find it difficult to access capital from traditional venture capital firms. The Gates fund is designed to support these firms.
The investment guru and chairman of Berkshire Hathaway, Buffett, pledged more than $1bn, to each of his three children’s foundations. The Howard G. Buffett Foundation gives money to agricultural development, clean-water projects, and programmes working to fight poverty.
The NoVo Foundation, seeks to improve the well-being women around the world and supports economic and education programmes. The Sherwood Foundation, supports social-justice and early-childhood education.
More recently, Buffett was so impressed with the progress the Gates Foundation has made in global health and development, and in education in the US, that he decided to use his fortune to upscale the Gates Foundation's work rather than funnel money purely into his own foundation.
The founder of Facebook, is no stranger to the world of ethical investing. In 2010, Zuckerberg, pledged $100m to establish Startup: Education, a foundation to support programs to improve public schools in Newark, New Jersey. He is a board member of Startup: Education.
In 2013 he and his wife gave 18 million shares of Facebook, valued at about $99m, to the Silicon Valley Community Foundation, in Mountain View, California.
Zuckerberg is also one of the 20 or so high-profile financial backers of Bill Gates’s Breakthrough Energy Ventures fund.
Sir Richard Branson
The 67-year old founder of the Virgin Group is another business magnate who signed up to Bill Gates’s Breakthrough Energy Venture fund. In 2004, Sir Richard established Virgin Unite, which draws upon the resources of the group to establish projects and campaigns that empower budding social entrepreneurs and grassroots organizations.
Virgin Unite’s accomplishments include the founding of the Branson School of Entrepreneurship in Johannesburg, the creation of a rural transport system that has strengthened access to healthcare and the launch of a campaign that seeks to address issues of homelessness, poverty and violence among young people worldwide.
The Virgin Green Fund was established to invest in companies in the renewable energy and resource efficiency sectors in the US and Europe.
Sir Paul McCartney
The former Beatle has for many years invested time and money in projects and initiatives that adhere to his own ethical values.
In 2002 Sir Paul wrote to McDonald’s top 100 shareholders on behalf of Trillium Asset Management, People for the Ethical Treatment of Animals (PETA), and “caring consumers across the globe.”
He called on them to urge the fast-food giant to extend its US farmed animal welfare standards to all of the company’s 29,000 restaurants worldwide.
In addition to support for animal rights, the billionaire musician has been involved with several environmental projects such as the National Resources Defense Council and the Save the Arctic campaign.