Simply put, ethical investing is the practice of applying your core values and principles to your investment decisions.
Many people think that if they invest ethically, they must suffer when it comes to their expected returns, but that is not necessarily the case. In the US alone, ethical investing has become a $17.1 trillion dollar industry, with over 800 investment companies involved.
As many investors have developed a greater awareness of the wider impact that their investment decisions can have, ethical investing has taken precedence as a matter of social responsibility. With the first socially responsible mutual fund, Pax World, launching in 1971, companies are now under pressure to respond to investors’ demand for more ethical and responsible practices across all levels of business.
However, this is not just a crucial subject for active investors, but for any individual who holds money in the bank. Due to the nature of the fractional reserve banking system, the majority of cash left in the bank is pooled and loaned out to individuals or businesses. These loans could inadvertently be funding activities that the client is not aware of or ones that adversely affect the wider environment – such as heavily polluting industries.
What is ethical investing?
Ethical – also termed responsible – investing, is a value-based approach to investment, that considers the guiding principles of companies and industries, besides the potential profit to be gained. The act of ESG investing (focusing on environmental, social, and governance issues) is just one category of ethical investment which enables a commitment to financial decisions that stand for change.
Another way that ethical investment can be envisioned is through impact investment, as outlined below:
- Positive impact investing: where investors choose industries and companies that align with their values, one example being investment into the production of green energy.
- Negative impact investing: where investors avoid industries and companies whose values do not align with their own, and decide to omit them from their portfolio.
Types of ethical investing
When people are investing ethically, the guidelines they follow can be social, moral, political, and/or environmental. In particular, religious values can often play a significant role when investors decide if they should invest or not. For example, Sharia law discourages investment in tobacco and alcoholic substances, or any investment mechanism that is debt-based.
This means that Islamic investors must seek out Sharia-compliant companies, such as Kinesis, in order to engage in this form of responsible investing. With public-private partnership projects positioned to support the full integration of the Kinesis system into the Indonesian national postal service, financial inclusion is provided for through the system’s usage-based yield model on gold, which serves Indonesian nationals with the stable value of gold.
In recent years, the environmental crisis is becoming one of growing concern, hence why environmental or green investing is finding its way into investors’ ethical agendas. Ethical investing in this field is centred around a commitment to sustainability and questioning whether a product is environmentally harmful, such as through the manufacturing processes involved, before investing.
Profitability of ethical investing
People often still believe that if they invest ethically, they need to compromise on performance and returns, but this is not always the case. However, the narrative that choosing from a more restricted investment pool of responsible funds might lessen the potential for financial returns, is still a concern for some investors.
Despite this, evidence shows that performance-wise, responsible funds can match and even out-perform mainstream, traditional funds. For instance, Morningstar UK Sustainability Index performed better than FTSE 100 and FTSE All-Share in the last few years.
To further aid investors in making decisions about ethical investing, companies are awarded an ESG score, which helps determine the company’s projected long-term exposure to environmental, social, and governance risks.
A company’s ESG score also extends to how the company treats its employees internally, in order to establish if best practices are being met in this area. Lately, tech companies have taken the lead in ethical investing, with Microsoft earning a remarkably high ESG score of 76.3.
Advantages and disadvantages
One of the most significant advantages of ethical investing is that it helps investors benefit emotionally and financially when a company shares their values. It follows through with the concept that individuals should not have to sacrifice their principles when directing their cash flow. What’s more, ethical investment can also provide the means for long-term, sustainable growth.
A further advantage of ethical investing is that when others consider ethical investment as important to them, it can encourage other businesses to improve their practices to attract funding. This further stimulates market competition in the name of ethical investment, as companies begin driving their efforts towards the same missions. This can simultaneously discourage investors from buying shares in companies that are not following the same ethical or responsible principles.
As for the downsides of ethical investment, one issue that plagues this field, as well as businesses branded as sustainable, is the act of “greenwashing”. There is ample wiggle room in the realm of ethical investment since the terms “sustainability” or “eco-friendly” can be highly subjective. Companies can latch onto investor sentiment to do good, rather than ensuring they follow through with claims of sustainability in the long term. For instance, companies that claim to be eco-friendly may simply consider the end result of a product, without evaluating the process through which it was developed or created.
Overall, since personal principles are dynamic and constantly evolving, a commitment to frequent reevaluation of your portfolio is needed, as well as a strong awareness of your own ethical principles.
Future of Ethical Investing
In the near-long-term future, ethical investment looks as though it’s here to stay, with consumers now putting more focus on issues of personal and corporate responsibility in the investment landscape. Companies attempting to be more sustainable can indicate that they are gearing towards long-term positive impact and planning, providing greater certainty about the longevity of an investor’s chosen investment vehicle.
In the past, the main focus for investors was on eliminating specific companies and industries like arms or alcohol, in negative impact investing. However, today there is a focus on the transition towards better systems or investment strategies that impact the world more positively, as well as developing more awareness about monetary flows, and the resulting effects they have.
While ethical investment is often looked upon with cynicism, the underlying directive of moving towards fairer, more ethical systems of business can be impactful when done correctly.
This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.