Ethical investing: from backwater to mainstream

Today’s consumers are increasingly demanding to know if their morning coffee is ‘fair trade’, their crispy-skinned fish is sustainably caught and their home can be run more efficiently on solar power. So it’s not surprising that many consumers are also choosing to align their ethics with their money.

Over the last decade, ethical investing has gone from backwater to mainstream. The amount of money invested in ethical funds – sometimes called sustainable or socially responsible investments – rose 62 per cent in the year to December 2015, to $51.5 billion.

The sector has also grown in relative terms, doubling over the past two years to 3.8 per cent of total assets under management. This was the finding of the Responsible Investment Benchmark Report 2016, an annual survey now in its 15th year.

But when it comes to investing your hard-earned cash, the feel good factor is not enough. In order to achieve your long-term financial goals, you need to earn the best possible return on your money.

Many happy returns

The numbers are in and they show that professionally-managed ethical funds have been performing strongly. Ethical Australian share funds and balanced (or multi-sector) funds have outperformed their benchmark index and comparable mainstream funds over 1, 3, 5 and 10 years. Ethical global share funds have outperformed over 5 and 10 years but not in the short term.

Of course, past returns can’t be relied on to predict future performance. But the figures do support the notion that it’s possible to invest responsibly without sacrificing returns.

What is an ethical investment?

The definition of ethical comes down to your personal values and can be as broad or narrow as you want it to be. You may want to support the development of renewable energy while others might want to limit the spread of poker machines. Or you may want mainstream fund managers to encourage high standards of corporate governance from the companies they invest in.

Here is a summary of investment styles on offer:

  • ESG integration – includes environmental, social and governance (ESG) factors into financial analysis and investment decision-making by fund managers. This is done in the belief that these factors drive returns and reduce risk.
     
  • Impact investing – targets investments aimed at social or environmental issues while creating positive returns for investors.
     
  • Negative screening – excludes specific industries, sectors, companies, practices or countries that don’t align with ethical goals. Common exclusions are gaming, alcohol, tobacco, weapons and animal testing.
     
  • Positive screening – selects investments with positive ESG or sustainability performance relative to industry peers. Sometimes called best-in-class screening.
     
  • Sustainability – targets investments in areas such as clean energy, green technology sustainable agriculture and forestry, green property or water technology.i

Investing for the long term

It’s not just consumers who are driving ethical investing. Increasingly, professional investment managers are incorporating factors such as ESG practices into their mainstream investment products. And they are doing so for hard-headed financial reasons.

A recent US study found that 90 per cent of professional investors believe there is a link between corporate sustainability and long-term financial performance. According to managed fund ratings group Morningstar, a good ESG rating can be an indicator that a company is thinking seriously about the long term. This makes them a good fit for long-term investors and superannuation funds.

Nine out of 10 of Australia’s largest asset managers have taken broad ethical principles on board.

How can I invest ethically?

The simplest way to put your money where your values lie is to select an ethical managed fund or investment option either inside or outside super. This will provide a diversified portfolio of investments even if you have only a relatively small sum to invest.

Ethical investing has come a long way from a standing start back in the 1990s. If you would like to include an ethical component in your investment portfolio, give us a call.

i Responsible Investment Association of Australia