If you plan to make ethical investments, the first step should be to revisit your investment policy.
An investment policy is a document that sets out the rules under which a portfolio manager will run a portfolio for a client. Typically, it includes the general investment goals and the strategies the manager should use to achieve them. Asset allocation, risk tolerance and liquidity are all relevant and should be included.
Here are five questions you need to ask your investment manager:
1. Does your investment policy accurately reflect your ethos and culture?
The need for an up-to-date investment policy is important because it ensures that the investment manager is making investments that are consistent with your ethical values. These can change over time, and that should be reflected in the portfolio. It can also be the case that companies or products become more or less ethical over time; these changes should also be taken into consideration by regular review to ensure that your objectives as an ethical investor are still being met.
2. What is your investment manager’s capacity to provide positive and negative screening?
We believe that positive screening is important to maximise the impact of ethical investment strategies. Positive screening could involve companies that invest in areas such as environmentally friendly technologies, renewable energy sources; or alternatively it could mean selecting companies that follow industry best practice, such as high health and safety standards for employees and commitment to reduce carbon footprint, etc. Positive investing aims to support responsible businesses that provide a good example for others to follow.
3. Does the policy include direct investment only or does it include funds?
Direct and indirect investment is a potential minefield for ethical investors. Indirect investments may involve investment in pooled funds, for example popular products such as exchange-traded funds (ETFs), which consist of baskets of securities bundled together and traded on exchanges, whereas direct investment involves investing directly in specific assets, such as a stock or a bond.
Ethical investors should consider all the components of the pooled products they invest in; some of these may not be in line with the investor’s ethical values. Alternatively, when considered with direct investments, those products may provide too great an exposure to an asset or sector, in which case it is probably best not to invest in them.
4. To what extent do you exclude your ethically constrained portfolios from your past performance figures?
Some fund managers exclude their ethical portfolios from their performance figures. This is usually done to pre-empt the possibility that ethically constrained portfolios might bring down the firm’s overall performance figures. Ethical investors should check with the investment manager whether the performance figures being advertised include or exclude ethical investments. We believe ethical portfolios should be included.
It is important to be aware that a properly managed ethical portfolio should not carry a higher cost than a non-ethical portfolio; an investment manager will typically find other investments with a similar performance to any excluded assets. However, one potential factor that could make it harder to achieve good results is the exclusion of entire industries based on ethical considerations. A portfolio that excludes more than half the available market capitalisation in equities, for example, will risk losing the ability to properly diversify and will reduce its potential to take precautions against risk.
5. Is sustainability included in your fundamental analysis?
To some extent, sustainability is simply a buzzword for what the industry has always done. Companies have always looked at whether a counterparty’s business model is sustainable before investing. Markets will ultimately find a way to reflect sustainability by shifting prices up or down; as coal becomes more expensive and difficult to extract, for example, coal mines close down. As an investor, the key question is whether ESG is included in your fundamental analysis.
In some jurisdictions, considering sustainability when making an investment is a legal requirement. Investors should be aware of such requirements; it is always best to check with the investment manager whether there is a solid sustainability policy in place and whether or not the investment manager has taken these requirements into account, even whether they are a legal requirement or not.
Ultimately, any ethical investment policy should take into account the needs of the beneficiaries the charity aims to serve. Asking questions of your fund manager is an important part of good governance; it also helps to ensure that your charity stays true to its ethical mission. As ethical investments continue to grow as a portion of the global investment pie, thinking carefully about the details of investments will help to protect a charity against a changing world and the risk of becoming compromised; it will also ensure that the charity and its beneficiaries continue to gain the maximum benefit over the longer term.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on www.smithandwilliamson.com prior to the launch of Evelyn Partners.