Purpose-driven investment for purpose-driven organisations: The case for ethical investing

Whatever the future holds, ethical investing will continue to increase its impact. In this article, Mathew Browning, U Ethical chief executive officer, answers three common questions about investing ethically.

For many, ethical investing remains a mystery.  So in this article, we shall answer three questions:

• What is ethical investing?
• How popular is ethical investing?
• Does ethical investing come at the cost of returns?

What is ethical investing?

The practice of ethical investing was borne from the early exclusionary strategies employed by religious organisations who wanted to align their investments with their ethical principles and ideals, for example not profiting from the slave trade.

The notion of what is considered ethical has expanded over time. Since the mid 20th century, ethical investment concerns have spread across many aspects of society, the natural world and corporate behaviour. In the 1960s, US colleges and other institutions decided they did not want to invest in apartheid South Africa. Today, a similar shift is underway with fossil fuels.

In the 21st century, the days of assessing investments solely on the basis of financial risk and return are long gone, but newer terminology and methods can be confusing. A jumble of terms are used in general discussion, often interchangeably, when they partly overlap or have slightly different meanings.

Socially responsible investing considers financial returns along with social and environmental impacts. Investors applying such strategies often integrate environmental, social and governance (ESG) standards to screen potential investments.

However, “responsible investment” may not constitute “ethical investment”. An ethical investment strategy uses some of the same tools, such as ESG evaluation, but then applies an ethical filter based on the investor’s own principles. This can get complicated because what is considered “ethical” can vary from investor to investor and from organisation to organisation.

Ethical investment involves research and judgment as well as standards when determining what sectors and companies to invest in. For example, in the knowledge that renewables will replace fossil fuels including gas in electricity production in Australia by 2030, how do you accommodate the need for gas as a transitional fuel in industry well beyond 2050? When excluding animal cruelty, does this capture the testing of pharmaceuticals for safety and efficacy?

How popular is ethical investing?

Responsible and ethical investing now accounts for about one quarter of assets under management globally and continues to grow apace. It reflects the worldwide debate over the sustainability of our present industrial and consumer ethic and the need for business to respect the limits of environmental, social and human capital.

Importantly, it has been driven by bottom-up demand from investors who want to take non-financial considerations into account, while still generating a market return. The demand is underpinned by:

• Demographics – capital transferring to women and millennials.
• Fiduciary duty – ethical principles are increasingly being adopted by regulators and governments.
• Increased transparency – big data has enabled deeper analysis of companies’ environmental, social and governance performance.
• Corporate financial performance – companies which adopt effective responsible business practices (including ESG standards) deliver better long-term financial performance.

Does ethical investing come at the cost of returns?

The tremendous growth of ESG investing has fuelled debate on its merits from a financial return perspective.

Previously, many assumed that ethical funds were compromised and the prospect of poor returns was enough to curb growth for some time. More recently, however, a significant body of research has emerged that dispels this idea and shows that attitudes towards the financial imperative have shifted markedly. In fact, the integration of ESG factors into the investment process delivers benefits that more than offset any loss resulting from a more limited investable universe.

The latest benchmark report from the Responsible Investment Association of Australia (RIAA) reveals that responsible investment funds outperformed mainstream funds over most time frames and asset classes. Australian responsible investment share funds outperformed mainstream Australian share fund benchmarks for all periods except for three years.

This outperformance is less surprising than it may first appear. After all, investing in a company which implements high governance standards, delivers environmentally sustainable products and services, takes care of its staff and suppliers, and treats its customers well is simply more likely to be able to demonstrate better operational and financial performance and sustain its success over the long term.

Where to from here?

Responsible investment now accounts for about one quarter of assets under management globally and is growing. Ethical investing applies a further filter to seek a positive environmental or social impact, such as alignment with the UN sustainable development goals. Evidence shows these strategies do not involve earning sub-market returns.

But sound ethics is a dynamic rather than a fixed goal. Community attitudes shift over time so that activities once considered acceptable become unacceptable, as do the companies associated with those activities. On top of this, businesses, industries and technologies will arise in future which pose new challenges.

Whatever the future holds, ethical investing will continue to increase its impact.

U Ethical is an investment manager with a difference. We believe in creating a better world by investing with purpose – today and into the future. If you’d like to know more about ethical investing, visit uethical.com. Or drop us a line at info@uethical.com.

The information provided is general information only and does not constitute financial advice. Before acquiring a U Ethical product, you should read the relevant Product Disclosure Statement or Offer Document for the product and seek independent advice to ensure it is appropriate for your particular objectives, financial situation and needs. The disclosure documents are available from www.uethical.com or by contacting U Ethical on 1800 996 888.