To those who invest in the stock market, knowing what funds their money is invested in — and what industries it’s supporting — is something that more and more people want to know. Is it possible to be an ethical investor and if so, how can ordinary investors make sure that they are?
What is ethical investing?
Ethical investing in many ways has always been part of traditional investing and has existed for a long time, says Conor Grimley, investment manager, Brewin Dolphin. “In other words, investors have always had an opportunity to request industry ‘exclusions’ to their portfolios, such as alcohol, armaments, gambling, and tobacco. From time to time, ethical exclusions have been expressed towards individual companies for reputational reasons which might run contrary to an individual or an organisation’s own ethics.
“The Paris Accord of 2015 placed great responsibility on the investment management industry to marshal its 17 social development goals — which are environmental, social and governance-related — and arguably early momentum was slow. However, by 2018 and 2019 with nations outlining their objectives for carbon neutrality and financial ratings agencies adopting negative risk scoring for certain industries a whole new momentum has arrived to ethical investing. Companies too are issuing sustainability statements and aiming to prove their environmental, social and governance [ESG] standing.”
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Ethical investing is another layer to have within the investment process, says Robert Meaney, responsible investment lead, Mercer Ireland, so it’s not just purely about investment, but also about thinking of the ethical outcomes and impacts of investment at a broader level. “It’s fair to say if you were speaking to me even 10 years ago and asked me what ‘ethical investing’ was, I would have said it’s only for a select group — that ethics as a broader aspect has been brought into investment, where ‘ethical investment’ has expanded to also mean things like sustainability and broader climate change. Rather than historically, 10-15 years ago, it was charities and universities etc thinking about their own particular ethical stance.
“To some extent, all investors, be they individuals or large institutions, are a lot more conscious now of the broader impacts of how they invest and how their investment managers invest.”
A growing trend
To say that ethical investing is a growing method of investing is definitely true and importantly carbon emission, social and governance criteria are providing investors with more data, says Grimley. “Where previously the data was collected and shareholder awareness was driven by not-for-profit agencies, the screening tools are now created by the large rating agencies.”
Everyone is hopefully on that journey towards more ethical investing, says Meaney. “You see individual companies have talked about this area in terms of what they’re doing and the plans they have, but now it’s becoming more technical and analytical in how we approach this, how investors can take that information and how we report on it to markets.
“Like any new reporting requirements, the first year or two will be one of development, and a consensus growing within the industry, the disclosures as they are that are made and how calculated and how they evolve will be important. We’ve come a long way but there’s a lot more in the journey as well.”
Meaney says moving to more ethical investing is a huge and ongoing change in the investment industry in terms of the expansion of the ethical agenda in terms of sustainability, climate change and energy focus and that the EU is at the forefront of that in terms of driving companies and investment.
EU Regulations
Meaney says the EU is introducing new regulations that will mean companies will now — if they didn’t already — have to disclose certain information and that will include things like “how they’re managing their climate risk, the plans they have, the journey they’ve been on, their plans for the future and how they’re going to manage those types of risk”. This is all aligned to the EU taxonomy which is a huge piece of work undertaken by the EU that is trying to provide a reference point for all activities and ascribing them whether they are sustainable type activities — particularly with regard to climate change — but also their broader impacts on markets generally. “When you think about it from the investment industry or an individual’s point of view, what will happen from next year is that there will be a lot more data available to be scrutinised, and that allow investment managers to differentiate between companies and previously they might not have had that data.”
Impacting investors
In terms of how these new regulations will affect investors, Grimley says: “For ordinary investors, these regulations mean that the specific risks surrounding ESG in their portfolios are explicit. And, there are two factors, firstly regulators are looking at funds which profess to have certain ESG criteria but don’t, so-called ‘greenwashing’. There has also been some commentary around the idea that ‘E’, ‘S’ and ‘G’ should be measured separately because companies who rate very highly on social and governance factors could rate very poorly on environmental factors, or, different combinations of the three criteria.
“A key consideration with respect to investment performance is that a portfolio which scores very highly on ESG factors may not, in fact, benchmark well against international indices such are the numbers of investments which need to be left out. Undoubtedly, however, there is a strong argument that companies with better processes of all types will ultimately earn higher returns on capital and greater shareholder returns, but, it’s the potential pitfalls which need to be understood.”
The ethical individual
When it comes to having control over the funds or stocks your money is invested in, Grimley says investors can express preferred exclusions of their own and they can ask their investment firm to guide them through a process. “After all, the investor needs to set investment goals which balance not only ethical requirements, but, their financial needs as well.”