Ethical investing: can you make a difference?

Investing is about generating returns on your money. It is a way of saving for your future and helping you meet your financial goals. But it can also be a way of making a difference in the world, and you don’t have to sacrifice your returns to do it.

Ethical investing used to be all about avoiding the bad. These days, though, there is a growing trend to look for companies that are doing good. These two investment approaches, known as negative and positive screening, form the foundation of many ethical portfolios.

Understanding the key issues will help you to decide which investments are right for you.

Negative screening

This is perhaps what most people first think of when they think ethical. For investors who definitely don’t want their money supporting industries they don’t believe in, negative screening is a must. It simply means eliminating various industries completely from your list of potential investments.

Typical exclusions include arms, mining, pornography, animal testing, gambling, nuclear power, alcohol and tobacco. This rules out roughly one third of the UK stock market.

Positive screening

Positive screening means seeking out companies that are pro-actively trying to make changes for the better. This could be ‘obvious’ choices such as green energy and solar power companies or certain health care stocks, but it might also mean businesses in traditionally ‘unethical’ areas such as mining, where management are committed to best practice and becoming leaders in their field.

Other examples along these lines could include food and beverage companies ensuring ethical supply chains — for example, chocolatiers sourcing only from ethical cocoa farms — or clothing retailers committing to buy only from manufacturers with acceptable working conditions.

Within ethical investing parlance, these positive traits are collectively labelled as environmental, social and governance (ESG) characteristics. The gamut of issues is broad and may include reducing carbon emissions and fossil fuels, tempering exorbitant executive pay, introducing quotas for gender equality and diversity, improving emerging market labour conditions, eliminating corporate malpractice, committing to always act in customers’ best interests (for example, with the sale of financial products) and the list goes on.

While these kinds of investments obviously become more subjective in nature, positive screening gives investors the chance to have their money make a difference, which many people like the idea of.

What about the returns?

Someone who put £10,000 into the UK stock market 10 years ago, would have £17,462 today¹. But that money would have been made across every industry, including tobacco — which has been the best performing industry by far over the past decade — and mining, where key oil majors such as Shell and BP have kept many investors’ income portfolios afloat.

Fortunately, there are some excellent ethical funds out there whose returns have beaten the market over the long term. Funds can be a good way to go if you want to build an ethical portfolio, as fund managers have the resource and the reach to really research the companies into which they invest and ensure they meet ethical criteria.

Over the past 10 years, a £10,000 investment into the Elite Rated EdenTree Amity UK fund would now be worth £19,564, while the same into the Elite Rated Standard Life Investments UK Ethical fund would be worth £20,939².

We also rate the Rathbone Ethical Bond fund, which is an unusual play in the socially responsible investing space, as it buys bonds instead of equities (as the name suggests), giving the fund an income focus. It has a historic annual yield of 3.8%³, which is pretty impressive in the current environment, ethical or no, and has also turned a £10,000 investment into £18,667.

 

¹Source: FE Analytics, FTSE All Share, TR in GBP, 05/10/2007–05/10/2017
²Source: FE Analytics, EdenTree Amity UK, Standard Life Investments UK Ethical, TR in GBP, 05/10/2007–05/10/2017
³Source: Rathbone Ethical Bond fund fact sheet, September 2017

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views of the author and any people interviewed are their own and do not constitute financial advice.