Good Money Week (formerly National Ethical Investment Week) is an annual campaign by organisations championing the ethical and sustainable financial sector to raise awareness of sustainable, responsible and ethical finance. It is an initiative that has run since 2005. Yet despite these best endeavours over the last 12 years, according to data from the Investment Association, just £14.4 billion is invested in ethical funds, out of total UK investor assets under management of £1,154.1 billion. This tiny 1.2% market share has barely moved in a decade, which is disappointing and mystifying given the growth in ethical consumerism in other parts of the economy.
Why aren’t more people investing responsibly?
There are numerous reasons why responsible investment (the current preferred term) has not gained more traction. Part of it is perhaps demographic, as there are indications younger people are more interested in applying environmental and ethical considerations to their economic activity, but those in a position to invest are typically more mature in age. Some providers of ethical products can also be patchy in the promotion of their products.
There is also a fair degree of confusion around what constitutes ethical funds, since there are no specific ethical sectors. Policies and approaches differ from fund to fund with no standard criteria. Even ethical advocates seem unable to make their mind up over how funds should be badged. Since former life office Friends Provident launched the UK’s first retail ethical fund in 1984, the Stewardship fund, the industry has adopted various nomenclatures including:
- Ethical investment
- Socially Responsible Investment (SRI)
- Environmental Social & Governance (ESG) investing
- Sustainable Investing
- Governance & Sustainable Investing (GSI)
- Responsible Investing
Funds lumped under this broad coalition of products range from traditional screened products originally aimed at faith communities that won’t hold stocks in ‘sin’ sectors such as tobacco, gambling, alcohol and arms manufacturing, through to funds that target ’best of breed’ companies for good governance, transparency and managing their environmental and social impacts. Also in the mix are niche funds specifically focused on environmental issues. No wonder investors find it difficult to navigate this area!
How to choose responsible and ethical funds
Fund selection therefore is inherently more complex. In addition to weighing up the quality of the management team and scrutinising their record and investment process, it is important to delve deep into what their stances are on particular non-financial screening criteria to make sure they fit with an investor’s particular concerns. It is also important to understand the process for arriving at such policies and how these might adapt over time, since they may not be set in stone.
Then, once invested, the investor needs to monitor for policy developments that could prove problematic. For example, BMO Global Asset Management’s range of F&C-branded responsible investment funds delegates the development of its policies to an independent Responsible Investment Advisory Council, which includes Justin Welby, the Archbishop of Canterbury, and other experts in sustainable business. The fund managers then operate within the resulting stock universe that emerges from this process.
Shades of grey
Many areas of business activity are neither wholly ‘good’ nor ‘bad’ but are shades of grey. There are particular areas where ethically minded investors may have passionately different views, perhaps none more so than the area of animal testing. For some this will be a complete non-starter, while others may accept that this is valid where it is for the purposes of medical research to help develop treatments for diseases and to alleviate human suffering. Some investors may be concerned about environmental matters, but less animated about other traditional areas of focus for ethical funds, such as alcohol production.
Ultimately, it is important that potential investors think about what their key areas of concern are and which are genuine red-line issues that need to be prioritised and then seek out a fund that fits appropriately.
Too often, ethical or responsible investing is looked at through the prism of “does it cost investors in performance terms to invest according to their principles?” In reality, an investor who does not want their money invested in tobacco because they find it objectionable is unlikely to be swayed by arguments around returns.
How do responsible investment funds perform?
How responsible investment funds perform can change dramatically depending on the timescales we look at. While there are a wide variety of funds under the responsible investment banner, broad hallmarks include:
- underweight or no exposure to commodities because of the high environmental impacts
- often underweight exposure to banks with investment banking exposure
- zero exposure to tobacco
- a skew to mid-sized and smaller companies, as some large multinationals may be screened out because one part of their area of activities might filter out the whole business
This means responsible investment funds will deviate materially from most conventional stock market indices in their sector weightings and therefore in turn, performance may vary significantly – both positively and negatively – over certain time periods.
For example, during the commodity super-cycle, many of these funds were negatively impacted by their structural underweight to fossil fuels and mining companies. More recently, during a turbulent period for these areas, the relative performance of many responsible investment funds has been impressive. There is no reason why such an approach will not deliver good long-term returns where the management team is capable, but it is important to understand that deviations in relative performance compared to conventional funds should be expected over shorter periods.
Responsible investment is a force for good
We’ll end on a positive note. While the market share of responsible investment funds has yet to achieve the critical cut through it perhaps deserves, the wider institutional investment industry has raised its game since the global financial crisis, by using the leverage that comes with being shareholders and engaging with companies on matters of corporate governance, transparency and managing non-financial risks. This is down to developments in corporate governance codes both here in the UK (through the Stewardship code) and in other jurisdictions.
This is undoubtedly positive and when performed effectively – rather than just through a box-ticking approach – it is a force for good, as management teams need to be held to account. Companies that fail to manage their reputational impacts can seriously jeopardise shareholder value. They might be subject to potential costly litigation, regulatory penalties or exclusion from government contracts. In this respect, you could argue that responsible investment has entered the mainstream, as being aware of such risks and managing them is simply a very sensible approach to investing.
As always, if there is anything investment or financial planning related we might be able to help you with – do get in touch.
This article was previously published on Tilney prior to the launch of Evelyn Partners.