Profit for purpose: the rise of ethical investments

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The war on single-use plastic, awareness on the environmental impact of palm oil, the USA’s withdrawal from the Paris climate deal, the gender pay gap, the #metoo movement, the rise of veganism, the debate over assisted suicide…. it seems that environmental and ethical issues have been pushed firmly into the limelight in recent months. People are becoming more mindful of the effect of their actions on future generations, but is the world of financial advice ready to meet the challenge? This was the question I asked myself a couple of months ago when I started to prepare advice for a client with a preference for ethical investments.

There’s long been a requirement for advisors to take their clients’ ethical preferences into consideration and specialist ethical and environmental funds have been around for a number of years. As the global mindset changes, opportunities for ethical investing are increasing in number and popularity. Although advice firms specialising in ethical issues exist, they’re still quite few in number; the likelihood is that they’ll increase as investors realise that they don’t need to make a choice between profit and purpose.

Ethical funds can generally be divided into two groups, depending on the screening process the fund manager uses:

  • Positive screening looks for companies that display favourable ethical procedures, for . example, those that have sustainable or environmentally favourable working practices or social responsibility programmes. The problem with positive screening is that it doesn’t necessarily discount companies with poor ethical procedures in some areas, for example a company may have a successful social responsibility programme but a poor environmental track record. Funds in this category are sometimes referred to as ‘light green’.

  • ‘Dark green’ funds are more discriminating; they use negative screening which tends to more stringent, as it actively excludes companies operating in certain areas such as alcohol, tobacco and arms, or in areas under the control of dictatorships, regimes with poor human rights records etc. Companies with bad employment conditions or poor pollution records are also excluded.

As the focus on ethical investing intensifies, it’s likely that the definition of an ethical investment will become stricter and more funds will fall into the ‘dark green’ category. However, this may create dilemmas for investors and fund managers alike. For example, negative screening will exclude multi-national fossil fuel companies, but the finance and research capabilities of these companies will put them at the forefront of research into sustainable energy. So ethical investors need to think carefully about the areas in which they are and are not prepared to invest and decide if they’re prepared to make a compromise in these areas. Some investors will decide to invest in ‘light green’ or mainstream funds but will choose to donate the profits from these funds to charity or use them to make environmentally sustainable home improvements.

Because ethical investing remains quite a niche area, ethical funds are still dominated by a group of fund management companies and individual fund managers. There also tends to be a smaller pool of companies for ethical fund managers to choose from, especially where the manager uses a negative screening process. So, creating sufficient diversity in an ethical portfolio has its challenges but the signs are that this is changing as more management companies enter the ethical fund market.

The good news for investors with an ethical preference is that ethical funds are becoming increasingly profitable. There’s no doubt pressure from governments on companies to address social and environmental issues has helped in this regard, giving ethical fund managers a more profitable pool of companies to choose from. Pressure from investors and advisors alike will also drive the sector forward.

A quick internet search shows that in addition to ethical funds, there are now a number of ethical banks offering savings and current accounts. It seems that ethical investors are being increasingly well catered for. Happily, profit and purpose aren’t two mutually exclusive concepts and are being increasingly successfully combined to produce good quality ethical investment options.