Ethical investment: Articles

This section of the site deals specifically with investment products that claim to pursue an ethical investment strategy. For whatever reason, these products will exclude investments in companies that are considered dubious under the terms of a specific ethical mandate.

This is an increasingly popular field of investment, and is not restricted to those whose investment preferences are dictated by religious considerations.

This area of investment is sometimes called socially-responsible investing (SRI) and has changed over the years from simply screening companies to ensure they meet ethical requirements, to buying into companies in order to change they way they are managed. Products in this area can be divided between those that screen companies in order to ensure that they conform with the fund's established ethical policy, and those that seek proactively to engage the management of the firms they invest in to make them more ethical businesses.

Investors cannot expect superior performance from these funds, however, as by restricting their investment universe, they cannot compete against fund managers with a more liberal ethical mandate. Research by Pictet & Cie, the Swiss investment bank, in 2003, found that a portfolio investing in companies with well-defined environmental policies would have underperformed the MSCI Europe Index by 15%.

'Vanilla' SRI Funds

The basic format for a standard socially-responsible fund is fairly easy to understand. One journalist has described them as "the purer-than-pure, mainly retail funds, screening out anything that makes the more squeamish punters choke on their breakfast cereal."

This will include tobacco companies, many firms in the defence sector, as well as those that pursue dubious research policies in the pharmaceutical and biotechnology sectors. In the past oil companies and other multi-nationals that have supported tyrannical regimes in developing countries have also been excluded. Manufacturers of sports goods who exploit cheap labour in Asia and Latin America can find themselves on the banned list.

Corporations are becoming increasingly sensitive about their ethical record, as it can affect a company's ability to raise capital in the financial markets. Ethical funds are an increasingly powerful force as stockholders, and directors of large businesses are being forced to take this into consideration.

There are currently some efforts underway within the fund management industry in Europe to coordinate some kind of commonly accepted socially-responsible investment policy. In the UK, probably one of the most mature markets for this kind of investment, bodies like the UK Social Investment Forum are working towards closer coordination of ethical fund managers. It is hoped that, by working together, fund managers will be able to augment their leverage with major corporations they invest in.

Green Funds

These are funds which pursue an environmentally-orientated investment policy. Many ethical funds will incorporate environmentally-conscious criteria into their investments, but green funds use a company's impact on the environment, or its efforts to minimise this, as their principal criteria. As an investor in such a fund, you will not necessarily be investing in companies that are actively engaged protecting and preserving global resources, but you should be able to see that many of the underlying companies have an advertised 'sustainability' policy. For example, a green fund available in the US, and analysed by this site in 2004, had the likes of Microsoft, AIG, Coca Cola, and Wells Fargo in its portfolio, all mainstream businesses without a bias towards environmental activities but with a good record in this area. However, the fund in question also included companies like Wellman, one of the world's largest recyclers of plastics, and Clarcor, a designer of engine and mobile filtration products for industrial and environmental use.

Like other ethical funds, the many green funds do not usually exist as offshore funds open to investors from all over the world. They tend to be targeted at investors in specific countries. It is worth checking with your financial adviser to find out which green funds are available in your country of residence.

Islamic Funds

These are funds that comply with Shariah religious law when making their investments. They will tend to only make profits from capital gains or dividends paid out by the underlying companies in the portfolio, and will not follow a guaranteed principal or fixed return process. In addition, they will only buy the stock of companies that are considered to be compliant with Islamic ethics (e.g. they will screen out producers of alcoholic beverages). Funds managed by non-Muslims will generally by advised by experienced Islamic scholars who should be identified in the fund's prospectus.

If a company conducts all its transactions in full conformity with Islamic law, including neither borrowing money on interest or keeping funds in interest-bearing accounts, then it may qualify for an Islamic fund, although many Islamic funds will include additional ethical criteria.

Recent academic thinking has, however, broadened the investment remit of Islamic funds, basing criteria on debt-to-asset ratios that allow investments in corporations that only earn below a specific level of income from interest when weighed against their total assets. Income derived from such investments can be purified by donating such proceeds to charity while the fund still benefits from the capital gains of share price rises. This gives Islamic fund managers a wider universe to companies to choose from, and can help raise the overall performance of the fund.

Like other ethical funds, Islamic funds benefit from a lower risk profile because of their focus on the debt facilities being used by the companies they invest in. This will lead them to screen out corporations with high debt burdens at an early stage.

Catholic Funds

These funds are used by devout Catholics, as well as institutions responsible for managing the massive wealth of the Roman Catholic Church. They often focus on 'the sanctity of life' exclusion screen which will rule out investments in companies that directly participate in abortion. In addition, the funds' investment policies draw heavily on the teachings of the Catholic Church when making investment decisions. Catholic funds can adopt an engagement policy (see below) when investing in firms that are not necessarily Catholic-compliant.

The base of teaching propagated by the Catholic Church is a broad one, and constantly changing in small ways, leading some asset management firms with Catholic mandates to focus on core values. For example, the "dignity and primacy of the human person" can figure highly on the list of criteria, and will focus on the way firms treat their employees, including compensation structures, executive pay, working conditions, and independence of directors.

In the words of one manager of a Catholic fund: "The board of directors selected these core Catholic values because they are grounded in the very fundamental Catholic value that every person is made in the image and likeness of God. Also, each relates to the protection of innocent victims who have no choice or whose choices are extremely limited under the relevant circumstances, such as unborn children and people who have to earn a living."

Jewish Funds

Given the strong focus on the ethical conduct of business affairs in the Talmud, it is not surprising that there is a very clear ethical doctrine governing Judaic investment. Judaism does not divorce the ethical responsibility of the investor from the actions of the entity he owns a stake in. The modern concept of limited liability is alien to Jewish thought. Under Jewish teaching, investors should feel responsible for the harm done to others by the companies whose stock they own.

Amongst the core principles Jewish investment funds should adopt, according to senior rabbis, are: no profit from forbidden activities, such as pollution or exploiting the labour force, no partnering with other firms that might engage in forbidden activities, and no ownership of assets that cause others harm (e.g. a firm in the defence industry).

Jewish investment funds, like their Catholic counterparts, subscribe to the process of positive engagement with corporations in order to raise their general ethical standards. Amongst the issues raised by Jewish investors recently have been the record of drugs firms on the HIV/Aids epidemic in Africa, executive compensation, transparency in corporate political participation, global warming, the affordability of prescription drugs, and equal employment opportunities.

Engagement Funds

Strict ethical screening processes can mean that funds are excluded from some of the more profitable investment opportunities. Hence, some asset managers are now launching funds that seek to force companies they invest in to adopt more socially-responsible policies. Fund managers are finding that the ethical demands of investors are strongly influenced by local culture: there are very few engagement funds marketed on a global basis, mainly because it is hard for a fund manager to provide a consensus investment policy that the bulk of investors would agree on. Such funds tend to be made available only to single markets as a result.

As an investor in a fund which claims to pursue a policy of engagement, it is also important to ensure that the fund manager is achieving the results he sets out in his mandate: i.e. above and beyond the performance numbers he achieves, is he succeeding in influencing the companies in his portfolio?

Conclusion: Risk and the Ethical Portfolio

It can be argued that, in these days of increased litigation against big business, the ethical fund does benefit from a lower risk profile, in that its investments are less likely to be compromised by damaging lawsuits. A company's share price can be ruined overnight by litigation or even the prospect of litigation. In the US particularly, where class action suits are part of everyday business risks, firms regularly see their share price plunge as soon as a suit is filed, regardless of the outcome. The mere threat of legal action can cause investors to offload stock.

By restricting the available investment universe, ethical managers do often rule out more profitable businesses, but at the same time they are unlikely to invest in firms that are not forthcoming with information, allowing them to avoid companies with dubious financial track records as well.