Ethical Investing: Myth vs. Reality

Clean Energy

Ethical investing has been around for a long time, with the first recorded instance dating back to the 18th Century.  But despite its longevity, many investors are unaware that it is an option for them, and there are a number of common misconceptions. 

In this short article, we provide the facts so you can make up your own mind.

Myth 1: Performance is lower

Misconception: Investors may believe performance is lower as there is less choice available in terms of selecting investments in underlying companies.

Reality: There are multiple academic studies showing there is no evidence that an ethical portfolio should necessarily underperform, and in fact there are reasons why it might outperform.

Why may you ask?

  • 90% of the variability in performance is determined by your asset allocation, so this should be your primary focus.
  • Whilst exclusions to sectors such as oil and gas may lead your portfolio to behave differently to the wider market, these sectors typically follow the economic cycle with a lag, so it may have a greater chance of missing the up and downside.
  • Whilst you may not be able to invest in a company specialising in combustion engines, you can invest in manufacturers which reduce GHC gas emissions or improve safety standards. Arguably the latter company may have an improved outlook given the direction of regulatory change and consumer behaviour and regardless it still provides exposure to the automotive sector.
  • Investing in companies which consider the impact on their stakeholders (e.g. employees, the environment and suppliers) may actually improve long-term performance, as their products may command a premium in the market, they may be less likely to be sued and their employees may be happier and therefore more productive.

If we compare the portfolio of the FTSE4Good vs. traditional FTSE indices over the last 5 years, you might be surprised to hear that the former typically outperformed the latter.

Myth 2: It’s riskier

Misconception: Investors may feel that ethical stocks are more exposed to subsidy risk or are less diversified, as the stock choice is more restricted.

Reality: Ethical investments can still be well diversified, plus incorporating the impact on stakeholders over the long term, may actually lead to the selection of businesses which are less risky in nature.

Political risk is largely a thing of the past, as most products have become mass produced and the benefits of economies of scale has removed the need for subsidies which could otherwise be prone to the whims of political parties.

As illustrated above, exposure can still be gained to sectors through other opportunities and stocks have to be truly uncorrelated to lose any diversification benefit.

As such the majority of the variability in your returns (and therefore risk) is sourced from optimising your asset allocation.

Moreover, investing in companies which consider their impact on stakeholders may actually be less risky in the long term.

Myth 3: It’s too expensive

Misconception: Investors may feel that funds are more expensive as there is less fund choice available, funds are typically smaller and additional ESG (environmental, social and governance) research needs to be completed.

Reality: Compared to a traditional Active portfolio, Ethical portfolios are typically 5-10bps cheaper depending on the client’s Risk Grade.

With the birth of platforms and RDR, costs are now set by agency contracts across all funds, so there is no cost differential between ethical or non-ethical funds, just a standardised rate for cash, bonds or equity funds.

There are however some fund providers in this space, which recognise the significant growth in demand from consumers and are willing to offer super institutional terms to market leaders in this space, in order to retain or capture market share.

It’s the combination of these two factors, which can lead to an overall Active portfolio which is in line or slightly cheaper than a traditional Active portfolio.

Myth 4: It doesn’t make a difference

In the early days, Ethical investing was largely about avoiding companies that were considered to be unacceptable, such as those involved in armaments or tobacco, or those involved in the abuse of human rights and the environment.

Increasingly investors are realising that they have the ability to influence how companies operate.

By voting together at annual general meetings (AGM’s) and engaging directly with company management they have the potential to make companies think more seriously about their impact on stakeholders and thereby enact positive change.

Whilst this is great news for all of us, companies do not make these changes out of the goodness of their hearts. A business that considers its impact on stakeholders can also reduce legal and regulatory costs and even improve a company’s brand. Products that offer sustainable solutions to issues such as climate change, can also prove incredibly valuable.

Myth 5: It’s a niche market

In the US, there is $8.72 trillion invested in SRI strategies, equivalent to 1 in every $5.

In Europe, the figure is closer to €22 trillion, or 41% of professional assets managed or 2 in every €5.

The UK is the second largest country in Europe for Ethical investing with £5.5 trillion in ESG, SRI and Ethical strategies.

Clearly, client demand is increasing rapidly as consumers become more aware that they can incorporate their ethical values and preferences into the investment process.

“When the Facts Change, I Change My Mind. What Do You Do, Sir?” – John Maynard Keynes

Myths. Busted.

Ethical investing is a huge market and is continuing to grow as more and more investors demand a larger say in how their money is invested. Many of the common myths around today can be traced back to when Ethical Investing started to gain momentum in the 1960’s.  As such, many of these ‘issues’ have withered to obscurity.

 


The above article was first published by Parmenion on 19th October 2017