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There is a perception that ethical investing is a niche area which appeals mainly to the younger generation and committed environmentalists.
But the demand for ethical and sustainable investing has reached new levels in recent years. Investors are seeking higher standards of social and environmental responsibility within their portfolios.
This is driven not only by a desire to reduce harm in the world, but also to benefit from the innovation and technological advances driving improvements in sustainability. Sustainable funds have performed exceptionally well in 2020 during a difficult period.
With changing attitudes and strong performance potential, ethical investments are moving firmly to the mainstream.
Traditionally, ethical investing involved excluding companies involved in certain trades or business practices.
An ethical portfolio would typically rule out companies involved with:
- Animal testing for cosmetic purposes
Beyond these, the focus can vary, but other potential areas for exclusion are:
- Gas and oil
- Nuclear energy
- Factory farming and meat production
- Animal testing for medical purposes
As well as considering the products made by a particular company, an ethical portfolio will also take into account how the business operates and interacts with society. Companies could be excluded if they are involved in:
- Environmental pollution
- Human rights abuses and workforce exploitation
- Tax avoidance
Some ethical funds may even exclude entire countries based on their laws or human rights record.
However, attitudes towards exclusions can be diverse even amongst the most dedicated ethical investors. While an investor may feel strongly about weapons manufacture and animal testing, they might be less concerned with alcohol and tobacco.
An investor would need to decide which areas are completely out of bounds and which could be compromised on.
This leads to the ethical investor’s dilemma. Is it more important to stick to your principles absolutely, bearing in mind that your investments are likely to be more expensive and have lower performance potential than a standard fund? Or can a degree of compromise be made for a more diverse portfolio?
Until recently, investment into ethical propositions was somewhat niche. But the sector has moved beyond a system of exclusion and there are now ethical and sustainable investment options to suit almost everyone.
A Changing Society
There are a number of reasons why ethical and sustainable investing have become more mainstream. For example:
- Increased awareness of climate change and environmental matters.
- The rise of the internet and social media, influencing social norms and shaming companies (and individuals) behaving unethically.
- Increased transparency and accountability in business.
- The possibility of influencing a company’s practices by favouring more ethical and sustainable businesses.
- The move away from manufacturing and heavy industry to a more service-based and technology-dependent economy.
- Scientific developments in the areas of healthcare and environmental conservation which are not only positive for society, but also profitable for investors.
- The increase in sustainable funds which operate positive screening, considering companies fully on their own merit rather than automatically excluding them.
Environmental, Social & Governance (ESG)
The modern interpretation of ethical investing aims to incorporate Environmental, Social and Governance (ESG) factors when selecting stocks. A chosen company will typically have strong credentials in any of the following:
- Reducing carbon emissions
- Moving away from fossil fuels
- Innovation in renewable energy
- Sustainable recycling
- Re-purposing waste products
- Reducing pollution
- Having a positive impact on the local community
- A strong human rights record
- Healthy working conditions
- Fair treatment of staff
- Upholding consumer rights and service standards
- Fair and transparent business practices
- Ethical competition and co-operation with other businesses
- A commitment to equality and diversity
An ESG portfolio seeks out companies which have a positive impact and aim to reduce harm. This does not necessarily mean excluding a company for a single red flag. Rather, the investment manager would aim to understand the company and look for signs of improvement or an opportunity to influence it.
ESG investing does not specifically look for companies in particular sectors. Instead, the goal is to consider each company on a holistic basis. This means that the sectors and business areas within an ESG portfolio can be diverse.
However, there are certain sectors which have thrived throughout 2020 and are likely to continue to do so. It is no coincidence that these areas feature heavily in the most successful ESG funds.
Society was already moving towards increased reliance on technology. But the pandemic has accelerated this at an unprecedented rate. This has led to increased demand for:
- Computers and the technology to work from home
- More options to connect and collaborate with colleagues
- Seamless video call technology to stay in touch with family
- E-commerce and home delivery
The convenience of these technologies is unlikely to lose its appeal once the pandemic is over. A consequence of better communication and connectivity is the reduced need for travel. This, in turn, can help to reduce carbon emissions. Additionally, many technology companies do not manufacture a physical product, which can help to control consumption and waste.
Like technology, the healthcare sector was already thriving. With an ageing population, the demand for products that can keep us healthier for longer is on a steady upward trajectory. For example:
- Apps and devices for medical monitoring or self-care
- Surgical advancements and prosthetics
Of course, the healthcare issue that has dominated the industry in 2020 was Covid-19. First came the task of identifying the virus, followed by establishing treatment protocols. Effective mass-testing was the next hurdle. We are now at the stage where vaccines have been approved and are becoming available to the public. All of these developments have benefited the healthcare industry.
The financial sector is not typically associated with ethical investing, and the reasons for its inclusion in sustainable funds are less obvious.
A financial company may be included in an ESG portfolio due to:
- Fair treatment of customers
- A policy of ethical investment
- Transparency over business and financial matters
- Leadership with integrity
- Diversity and equality at senior levels
Of course, the main role of banks, investment companies and payment processors is to make money. Ethical concerns are usually secondary, which means that companies with strong ESG credentials stand out. A few carefully selected financial stocks can benefit any portfolio.
The Benefits of Ethical Investing
There are multiple reasons why an investor may select an ethical or sustainable investment strategy. For example:
- A wish to invest in environmentally sustainable companies to combat climate change and pollution.
- A requirement for companies to operate fairly, treating their employees ethically and upholding human rights.
- An interest in a specific area, such as animal rights or sustainable food production.
- A belief in corporate responsibility and accountability.
- A desire to influence business practices towards a more ethical model.
- An interest in technology and innovation.
- A belief that sustainability and fair practices will lead to higher long-term growth.
- A general ethical outlook and a desire to ‘do the right thing.’
Whatever your reasons for investing ethically, it’s likely that you can find an option to meet your needs.
How to Incorporate Ethical Investing into Your Portfolio
Ethical and sustainable investing is more accessible than ever. The main options available to investors are as follows:
- Ethical or sustainable tracker funds
- Ethical or sustainable multi-asset funds
- Specialist funds investing in a particular sector or business area
- A model portfolio created and managed by an investment company
- A bespoke portfolio of specially selected stocks under the care of a discretionary manager
These are listed broadly in order of accessibility, cost, complexity and the ability to meet a specific ethical remit.
If you are new to investing and wish to incorporate some ethical options into your portfolio, an ethical tracker or sustainable multi-asset fund could be the best fit. These can be easily purchased and the costs and performance potential are usually similar to more mainstream funds.
A discretionary manager may be more appropriate if you have specific ethical requirements and need other services, for example generating an income or managing your tax allowances. This is usually the most expensive option and is more suited to wealthier investors.
Our 5 Top Tips for Investing Ethically
1. Decide what’s most important to you, whether this is the exclusion of certain industries or a general sustainable outlook.
2. Keep an eye on costs and value for money.
3. Invest for the long-term and select funds based on their own merits. Avoid hotly tipped stocks or following the crowd.
4. Hold a wide range of different assets.
5. Take an appropriate level of risk.
Please do not hesitate to contact a member of the team to find out more about your investment options. Book a free call with a member of our team today, without obligation. We look forward to speaking with you.