What is ethical investing- and is it something you should consider?
Where you invest may make a difference to the world as well as to your financial future. But what exactly is ethical investing, and how do you get it right?
What is ethical investing?
Responsible and ethical investing is a holistic approach where the social, environmental, corporate governance and other ethical factors relative to an investment decision are considered – combined with traditional financial performance metrics.
Demand for ethical investing is increasing, with growing numbers of investors requesting that their money be invested responsibly and ethically.
In fact, the Responsible Investment Association Australasia (RIAA) reports that many Australians now expect their savings (87%) and superannuation (86%) to be invested responsibly and ethically. RIAA also reports that three out of four people would consider shifting their banking and superannuation to an alternative provider that invests responsibly and ethically.
This shift in investor preferences has been to key to the growth of assets managed in accordance with responsible investment principles. These assets now represent 37% ($1.149B) of Australia’s total $3.14 trillion assets under management (AUM).
When compared to the 2013 figure – when just $178B, or 17% of the total AUM, was invested in responsible funds – it is clear that ethical investing is increasingly becoming a preferred approach.
Australia’s experience reflects broader trends, with global responsible investment assets reaching $US30.7 trillion at the start of 2018 – which represents a 43% increase from 2016.
Why do investors choose to invest ethically?
For many, knowing that they are investing in companies that engage in more responsible business practices is a key benefit. Some consider it their contribution to positive change in the world.
There are a lot of different reasons that investors are choosing ethical investments. For some, it meets their desire to help the environment or to support a cause they are particularly passionate about; for others, they are motivated by the access it gives them to engage and hold companies accountable for their actions. At a core level, some investors indicate that ethical investing is their way of ‘putting their money where their mouth is’.
What does ethical investing involve?
There are a number of ways that an investor can engage in ethical investing. Definitions of a handful of different techniques are below, but some very broad examples include:
- choosing to invest in a program or social enterprise with a focus on tackling a social or environmental issue;
- choosing to divest from a company with a poor human rights record, or that is considered socially irresponsible – such as tobacco producers;
- proactively engaging with a company that is a part of an investment portfolio that has exposure to carbon intensive industries, and requesting that they change their practices;
- analysing and selecting a portfolio of companies to invest in based on their overall environmental, social and governance (ESG) performance
It is important to understand that ethical investment is not a ‘one-size fits all’ approach. Each ethical investment product or opportunity differs depending on the strategy or methods being used, as well as the features of companies or enterprises being invested in.
Ethical investing may be based on what a product or opportunity DOES or what it DOES NOT do. For example, one product’s responsible investment credentials may mean that it does not invest in tobacco or ammunitions, while another product may be labelled a responsible investment because it solely invests in projects that deliver renewable energy.
What are the different techniques for ethical investing?
There are many different ways to engage in ethical investing, and investors often use a combination of strategies including:
ESG integration: This involves the systematic and explicit inclusion of environmental, social and governance (ESG) factors into traditional financial analysis and investment decision-making by investment managers. This approach rests on the belief that these factors are a core driver of investment risk and opportunity, rather than being driven by ethical considerations.
Negative or exclusionary screening: Screening that systematically excludes specific industries, sectors, companies, practices, countries or jurisdictions that do not align with the responsible investment goals, and/or that create or support negative or harmful activities. This approach is also referred to as values-based or ethical screening, as well as divestment. Common criteria used in negative screening include gaming, alcohol, tobacco, fossil fuels, weapons, pornography and animal testing.
Positive screening: Screening in sectors, companies or projects selected for positive ESG or sustainability performance relative to industry peers. It may also be referred to as best-in-class screening. It involves identifying companies with superior ESG performance from a variety of industries and markets.
Norms-based screening: This involves the screening of investments that do not meet minimum standards of business practice, usually based on international norms and conventions such as those defined by the United Nations (UN). In practice, norms-based screening may involve the exclusion of companies that contravene the UN Convention on Cluster Munitions, as well as positive screening based on ESG criteria developed through international bodies such as the UNGC (UN Global Compact), ILO (International Labour Organisation) and UNICEF (UN Children’s Fund).
Corporate engagement and shareholder action: This refers to the employment of shareholder power to influence a company’s behaviour. This may be conducted through direct corporate engagement such as communications with senior management or boards, filing and voting on shareholder proposals and proxy voting in alignment with comprehensive ESG guidelines.
Sustainability-themed investing: This relates to investment in themes or assets that specifically relate to sustainability themes. This commonly involves funds that invest in clean energy, green technology, sustainable agriculture and forestry, green property or water technology where the fund has the explicit objective of driving improved sustainability outcomes alongside financial returns.
Impact investing: This is investing where targeted investments are made into organisations, projects or funds that address environmental and social issues, for example, renewable energy companies. The intention is to generate positive, measurable social and environmental outcomes, alongside a financial return.
Dark green and light green levels of ethical investing
The rising popularity of ethical investing has driven the development of a range of options for customers. There are numerous choices for those seeking to align their own values with their investment risk profile.
Dark green funds are the purest form of ethical investment options. This type of fund takes a highly restrictive approach – excluding any companies (and sometimes entire industries) deemed to be unethical.
There are also light green or sustainable options in funds. These options are socially responsible, and only invest in businesses that are assessed as highly responsible. However, they don’t tend to exclude entire industries outright.
How can you be sure that an investment is legitimately ethical?
Like any industry, there is some potential for deceptive behaviour. When funds overrepresent the extent to which their practices are environmentally friendly, sustainable or ethical, they are participating in what the market refers to as “greenwashing”.
The Australian Securities and Investments Commission (ASIC) is currently conducting a review to establish whether the practices of funds that offer ethical investment products align with their promotion of these products. Funds will be assessed on whether the financial product or investment strategy is as “green” or ESG-focused as claimed.
If you have questions about the legitimacy of an investment product, be sure to ask questions and do some of your own research.
Getting started with ethical investing
If you are considering making a change to more responsible investment options, or if you are keen to see how your current investments stack up, here are some steps you can take to get started:
- Think about what ethics and values are important to you. Everyone’s values are different, so to begin with – you need to work out what’s most important to you. From here you can identify the areas you don’t want to see your money invested, or perhaps investment products where you are interested to put your money to make a positive impact.
- Ask where your money is currently invested. Many super funds and investment managers now have information about sustainability and ESG on their websites. This is a good place to start to find out how your money is being invested.
- Do your research. There are now many responsible and ethical super funds, investment products and fund managers you can access.
- Ask for help. If you need assistance finding out what you’re invested in, or how to access more ethical investment options, please contact your Bentleys advisor.