What is Ethical Investing?
Do you want to make a difference to the world around you through your investments? It’s a request we receive more and more. How can I invest consciously? What does it mean to do that?
Ethical investing is sometimes referred to as ESG investing. This stands for Environmental, Socialand Governance. In practice, it means investing in structures that both select firms for their ESG credentials and avoid investing in firms that are deemed not to be up to an ESG standard. That could mean avoiding companies with a focus on the production of armaments, unsustainable energy production, poor record of corporate governance and operational procedures; for example, staff exploitation. It also means supporting companies that focus on social good.
What we have found is that what is important for one investor may be different from what is important for another. Our approach via the Extended Investments Limited Investment Selection Committee is to have an ethical benchmark or standard applied to all potential investments. This means we look at the underlying investments and how the investment is managed through an ESG lens. We then look at the investment manager’s corporate structure, governance, stability and compliance, before then analysing performance. We have done due diligence on a number of specialist ethical investment options that have diverse focuses, from water to green energy, to diversified ESG structures.
How do fund managers define a portfolio or investment as ethical?
The principles surrounding ESG investing originate from the United Nations. The UN Principles for Responsible Investment (PRI), provides a framework for how an investment manager may assess potential investments. A common reference point is the United Nations General Assembly Sustainable Development Goals. The 17 goals are set out in the infographic below:
When applied that could mean any of a number of themes:
Providing affordable healthcare globally
Enabling healthier lifestyles
Delivering healthier foods
Providing education
Improving management of water
Improving the efficiency of energy use
Increasing electricity from renewable sources
Connecting people
Increasing financial resilience
Ensuring a sustainable economy
Saving for the future
Building better cities
The fund managers will undergo a process that follows a consistent analysis that they would conduct for all investments, with some additional steps. They typically consider a potential investment in relation to the ESG theme as per above and then analyse the sustainability credentials. Following that they will move to the details of the business fundamentals to ensure there is a business case that can generate a return on investment. Then they review the business valuation in the market to ensure they are buying what they deem to be good value so they can generate returns for investor clients. Finally, they have to consider all potential investments in relation to the existing portfolio, so they are thematically consistent but remain diversified.
What about performance?
Many investors are interested in investing in ESG solutions but are not so willing to forego returns. The research suggests there is no return penalty for focusing on ethical investment solutions. The performance of ESG, according to the PRI should actually lead to enhanced returns. Research conducted by Morningstar reinforces this. In 2019 they showed that having an ESG focus does not inhibit investment performance.
How do you incorporate it into your financial and investment plan?
It depends on your goals. Your portfolio construction should always reflect both your goals and your risk profile. It is no different for ethical investments. Your portfolio breakdown must match these factors.
The nature of ethical investments means fund managers will be investing predominantly in corporations. That means the way a fund manager can invest in them is largely by buying shares (equities on a stock market or via private equity) and/or by purchasing corporate bonds (fixed interest) or derivatives of both. To maintain diversification in your portfolio, it therefore makes sense for most investors to use an ESG specialty fund as a part of their portfolio to maintain adequate diversification.
If you would like to understand more about ethical investing and consider it for your investments, speak with us and we can guide you through the options and opportunities available to you.
