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Ethical Investing – Can Ethics and Profits co-exist?

Ethical Investing – these two words can elicit strong views in investors!

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Some view them as puritan fringe investments across limited categories of asset classes. Investments that benefit of the planet to the detriment of profit. Others struggle to define “ethical”. Ethical investors themselves view this investment style as the future of investing – the ultimate win:win.


So who is right?


Before we seek the answer let’s start by elaborating on the concept of Ethical Investments – what is it?

Ethical investment is also known as sustainable investment and socially responsible investment (SRI). The term describes an investment process that incorporates environmental and social factors when selecting investments, in addition to the objective of achieving a competitive financial return.[1]

In other words, Ethical Investing is as much about where ethical investors are NOT prepared to invest in, rather than just simply looking to generate financial returns. If an investment will likely lead to environmental or social damage, then this is excluded from the “universe” of investments available to select from. For instance, companies operating in gambling, tobacco, carbon-intensive industries and slave labour are not deemed to be “ethical” and are thus excluded. Individual ethical investors will have their nuanced filters however ESG (Environmental, Social and Governance) considerations are usually key.


This may be great for the world, but surely it is also to the detriment of profits, right?


The focus of Ethical Investors on generating profit, is similar to any other investor in the sense that it boils down to the investor’s fundamental approach and investment discipline. The more focused on quality and fundamentals, as well as the price/value equation, the more likely the investor is to generate positive returns. The key differentiator is the investment universe from which each type of investor can select.


So what is the Ethical Investment Universe? 


Given that Ethical Investors are only going to consider investments in certain categories, they tend to have overweight positions in certain industry sub sectors, and none in others. The “overweights” include technology, health, education, clean-tech/energy production and fin-tech. They tend to have a better understanding and acuity for these sectors (and the specific companies and investments therein) and can invest with more confidence than an investor selecting from the broader market.


Just as importantly, the prospects of the industries which fall under the ethical banner tend to be higher-growth and more sustainable than the broader market. The focus is often on the disruptors, not those being disrupted. Companies which are not considerate of the environment or their stakeholders tend to face ever-increasing scrutiny and regulation as well as negative coverage on media platforms. The outcomes include higher regulatory costs, and reduced demand. 


Customers ultimately vote with their wallets or purses (virtual or otherwise!), choosing products and services aligned with their own views about society and the planet. As these views shift to companies considerate of their broader stakeholders and environmental impacts, so does demand.  


What about the performance?


The financial performance of “Ethical Investments” has clearly outperformed the broader market over time on a global basis. There is significant evidence from places like Europe where it has been a core investment strategy for decades.

While the ethical investment community in Australia is still nascent (albeit growing strongly), the evidence points to superior financial returns compared to the broader market as shown in the following performance data reported by the Responsible Investment Association of Australia showing the sector's 10 year outperformance over the period 2008 through 2018.

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So yes, it is indeed possible to care for the planet and its people while generating outsized profits!



This is the first of a series of articles I will be posting in coming months to delve into some of the issues touched on here, helping to uncover why Ethical Investing makes sense not just for people and planet but for mainstream return-driven investors.


Adrian Gurgone

Chief Investment Officer

ETHICAL CAPITAL

Published: 15 April 2019


FOOTNOTES:

[1]https://www.australianethical.com.au/what-is-ethical-investment/ (accessed 15 April 2019)

[2]https://responsibleinvestment.org (accessed 15 April 2019)

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