Ethical investing - does it really work?

At a superficial level, investment may seem to be all about dollars and cents, gains and losses or risks and rewards. Behind all these financial aspects, however, investment is really about the human activities of a business or institution creating and consuming. Without this production and consumption, there would be nothing to invest in.

As society becomes more aware, informed and connected to the impacts that businesses have on the natural world and on human welfare, we have also become more discriminating about where we place our investments.

This increased awareness has led to the emergence of ethical investing as a way of reconciling our desire for personal financial security with our sense of responsibility for the wider world.

What is ethical investing?
Ethical investing is a universal term used to describe the practice by investment managers of directing the funds that they manage into business that have ethically responsible operations. Specifically, this could manifest in things such as the way those businesses care for the environment, the way they treat their workers and the health effects of the products they produce.

Ethical investing is now a sophisticated and significant sub-section of the investment industry. The peak body representing ethical investment managers in Australia, the Responsible Investment Association Australasia, states that at the end of 2015 the total responsible investment industry accounted for $633 billion in assets under management.*

Categories of ethical investing
Rather than simply being based on vague notions of ‘doing the right thing’, the industry is careful in the way it defines, identifies and classifies ethical investments.

In general terms, a fund manager may allocate its investments using either a positive screening or negative screening process. Positive screening involves the manager actively seeking out companies that have a positive social or environmental impact. Negative screening is the practice of excluding companies that have a negative social or environmental impact.

Within these general approaches, fund managers may also apply more specific criteria in its selection process, such as targeting companies involved in clean energy, green technology, sustainable agriculture and green property. Still others will target investments that are focused on addressing social or environmental problems.

Ensuring it really is ethical
To have confidence in the ethical credentials of a fund manager that claims to invest ethically, it is wise to check if they are members of the Responsible Investment Association Australasia. The RIAA manages a certification program that helps to ensure a uniform standard of disclosure is applied and requires fund managers to provide hard evidence of their screening and selection practices.

Does ethical investing mean sacrificing performance?
At first glance it may seem that ethical investing may narrow the options for an investment manager and limit their ability to produce competitive returns. The historical evidence, however, would seem to suggest that this fear is unfounded. An RIAA report published in 2016 shows that performance of its member investment funds compares favourably with benchmark indices and with other mainstream funds that do not apply ethical criteria.

Is it right for you?
Fortunately for personal investors, investing ethically and profitably are not mutually exclusive objectives. Using their research and portfolio construction resources, a financial adviser can help you to factor in your ethical concerns into your portfolio, while still targeting strong performance.

* The Responsible Investment Association Australasia: Responsible Investment Benchmark Report 2016.

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