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Do your own legwork when investing with an ethical hat

Socially responsible investing is difficult which makes it all the more important to have clear objectives.

by
Garry White

in Features

04.12.2017

Despite a plethora of products on the market, investing ethically is much harder than it looks. It is impossible to outsource your own personal morals to a money manager, since everyone has a different view on what is right and wrong. What is outrageous and offensive to one individual may leave another relatively unconcerned. This means you have to do a lot of research yourself.

In general, ethical – or socially responsible – investors encourage business practices that promote environmental stewardship, consumer protection, human rights and diversity. Some may wish to avoid companies that are associated with alcohol, tobacco, fast food, gambling or pornography, while others are averse to weapons manufacturers, contraceptive makers or extractors of fossil fuels.

But, if you want to invest according to your own personal moral code, you have to be prepared to do a lot of legwork. Just because an investment brands itself as “ethical” does not mean it will meet your requirements – you can’t just throw money into a few funds and be done with it.

When you invest in an “ethical fund” it is important to look at its major investments to see if it fits in with your own principles. Taking a look at some of the popular funds marketed as “ethical” uncovers a whole array of investments. These range from investment banks that have dubious records of misconduct through the financial crisis, to electronics companies that need components made from materials that have to be dug up from remote locations in the Democratic Republic of Congo and even makers of concrete. So, if you have strong feelings on a subject, it may be better to invest in individual companies that you have thoroughly researched yourself.

It is also important that your portfolio is diversified and not focused too much on narrow investment themes. For example, government subsidies a few years ago prompted investors to rush into the solar panel sector. But the so-called feed-in tariff subsidy had started at such a generous initial level the subsidy was costing too much and was eventually slashed. This caused a plunge in related equities and hurt investors across the solar supply chain.

But perhaps the major issue is that so-called “unethical” sectors tend to offer very good returns over time. Historically, this is especially true of the “sin” investments of tobacco, alcohol and gambling. Quitting tobacco investing, for example, is hard because it has historically offered some stunning returns. The MSCI world tobacco index has returned double digit gains in seven of the last 13 years and has only fallen in three of them.

The best way to manage risk in any portfolio is through diversification – but ethical investing is essentially investing by exclusion, a move that reduces diversification. That’s why portfolio construction is key. Socially responsible investment funds can play an important role here, as they invest across all sectors, choosing those stocks that exercise best practice, and including companies from energy, telecoms and pharmaceuticals sectors that pay healthy dividends.

It’s not just about your conscience, there are solid arguments for investing in companies that are environmentally responsible. Green legislation means that there is real long-term value in companies that will not fall foul of environmental laws. There are genuine financial risks for companies that do not behave in a sustainable or responsible way, and rules and regulations could be a good indicator of sectors in which to invest.

There was much cheer from environmental lobbyists a couple of weeks ago when Norway’s central bank, which runs the country’s $1 trillion sovereign wealth fund, recommended to the government that it should divest its shares in oil and gas companies. This was claimed as a victory by some who are calling or divestment from hydrocarbons as an environmental imperative.

However, the issue was not one of ethics but one of sensible portfolio management. The fund exists because of the country’s vast oil wealth, so investing this money in oil leaves the country as a whole overexposed.

Indeed, the central bank said that during times of stable oil prices, energy stocks were closely correlated with the broader market, but tended to fall much harder when energy prices fell. It argued that this was a reason not to be overexposed to the sector and the Norwegian government will now look at the proposals.

Interestingly, Yngve Slyngstad, chief executive of the fund, argued that ethical investing is often more effective if you actually hold on to the assets in question.

“As an owner of oil companies, you can influence your investments, possibly with regard to the energy shift up ahead,” Mr Slyngstad said earlier this week.

Socially responsible investing is therefore difficult and so it is important to have clear objectives.

So, the most important advice is to do your research and, if you are lucky enough to find a fund that is both diversified and fits your own investment priorities, then all the good. If you have very strong feelings about a subject then perhaps investing in collectives is not the way forward for you.

In that case, being a self-directed investor choosing individual companies yourself is the answer. However, the policy of “exclusion” in your investment strategy may increase risk – but maybe that is a price worth paying to keep your conscience clear.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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