Ethical investing has many names, and takes many forms. Global estimates for the sums involved vary significantly with estimates ranging between $34trn and $45trn (£24trn and £32trn). Just taking the US alone, around one in every six dollars under management was invested in an ethical strategy in 2013. By any measure, it is clear that it is big and growing fast.
Putting aside the moral and social aspect of ethical investing, the economic and financial basis for investing is sound for a long-term stakeholder. The aim is to invest in companies that are run on a sustainable basis, which have superior corporate governance and, typically, a loyal engaged customer base.
To emphasise the importance of good corporate governance, and the rewards for investing in such businesses, a recent study found that companies with no female directors had a lower return on equity of 13 per cent, than firms with at least one woman on the board, which returned 20 per cent.
A different study looked at the financial services industry and, perhaps unsurprisingly, found companies whose boards were composed of a majority of industry experts not only generated higher return on equity but also experienced significantly fewer controversies – 1.1 cases per $100m vs 4.5 cases per $100m.
Ethical investing is dynamic and adds another layer of analysis onto an already complex subject matter. An asset considered best-in-class today, may not achieve the required standard tomorrow and be sold irrespective of share price. While gambling and firearms businesses are clear cases, there are numerous grey areas. Supermarkets sell scratch cards, alcohol, tobacco and oil, for example.
One of the most significant challenges when running an ethical mandate is ensuring investments are consistent with the clients’ expectations of what is allowable in their portfolio. Even when both parties are in agreement anomalies can occur – an example being the Church of England’s indirect investment in payday lender Wonga.
A certain level of pragmatism is therefore needed when applying ethical criteria to prospective investments. Likewise, ethical investments require constant attention and reappraisal. In cases such as the Deepwater Horizon oil spill, a company such as BP could be considered to have made the transition to ‘unethical’ overnight.
Arguably, a well-diversified investor would have an exposure to ethical investments as a part of their overall portfolio and should benefit from how a socially responsible investing fund is constructed. The extreme volatility seen in markets over the past few months has largely stemmed from emerging markets and commodity prices. Given the composition of the ‘average’ ethical fund, a corresponding SRI variant would most likely have benefitted on a relative basis from a smaller exposure to both.
There are many structural drivers to growth in the ethical market, from wave after wave of legislation designed to combat climate change, to a growing desire from investors not to support companies that have values inconsistent to their own. Renewable energy such as wind, solar and hydro are becoming increasingly more important as they approach cost parity with fossil fuels and increasingly will become larger constituents of mainstream indices and that will follow through to client portfolios, ethical or otherwise.
While the institutional investors dominate in the socially responsible space, accounting for 96 per cent of the market, demand and products available are growing strongly for retail investors. It might not be too long before the average UK investor sees terms like ‘ethical’, ‘sustainable’ or ‘renewable’ as commonplace in their statement of holdings.
Gary Waite is portfolio manager at Walker Crips.