Ethical investing used to centre around the Five B’s boobs, booze, baccy, betting and bombs. Or using slightly better grammar – an investment fund which 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’s light green, dark green, cleantech, climate change, sustainability, Corporate Social Responsibility (CSR) and Socially Responsible Investment (SRI) funds. 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.
SRI investing 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.
Many ‘ethical funds’ will continue to hold shares but engage with companies and actively vote against, for example, over-generous remuneration for directors.
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.
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 Nestle due to the company’s consistent marketing of baby food against World Health Organisation advice in favour of breastfeeding and despite widespread condemnation.
On a broader level, ‘ethical funds’ may insist UK firms they invest in adhere to the principals of the Living Wage campaign – which 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.
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.
The advertising bill promoting their ‘green’ credentials may significantly outweigh the amount spent on environmentally-good practices.
A win-win situation
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.
Social responsibility is something that is taken far more seriously in board rooms these days. Companies are aware that social media can spread bad news globally within seconds which is not only damaging to a brand but off-putting to potential investors.
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.
Of course, 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.