Ethical Sustainable & Responsible Investments

by on 19·04·2016

Since the emergence of the first ethically screened fund -The F&C Stewardship fund, which launched in 1984 under Friends Provident and dubbed 'the Brazil fund', not because of concern for diminishing rainforests but because someone had joked that you had to be nuts to invest in it, the demand for investing in sustainable, responsible and ethical companies that do something good for humanity has never been higher.

Figures released by the Investment Association on 25 January this year show that net retail ethical fund sales reached a new high in 2015, with sales of £715 million. Although only representing a 1.2% share of industry funds under management ethical/sustainable funds under management were £10.7 billion at the end of 2015, proving that more people are looking to put their principals into practice when managing their finances. Furthermore, for many investors, considering environmental friendliness, social responsibility and corporate governance (ESG) issues is as much about risk management and long term investment opportunity as it is about personal values.

One of the main criticisms of Ethical, Sustainable and Responsible Investment (SRI) is the belief that an investor has to sacrifice investment returns in order to invest according to their beliefs, however ethical and SRI investing is a considerably broader sector than many imagine. Whilst traditional ethical funds, referred to as "dark green" do take a very restrictive approach to investing, screening out stocks that are involved in "unethical" industries such as alcohol, animal testing, tobacco, oil and armament firms there are other key motivations for people wishing to invest in SRI funds including long term investment opportunities in global issues such as water shortage, waste disposal, clean energy and forestry. As Simon Howard, chief executive of UKSIF says, "More and more people are realising that sustainable and ethical investment is no longer just a moral issue.  It is a hard-headed decision about the best way to manage your savings and plan for the future in a changing world"; and given the general thinking that these markets could outperform the wider economy over the next decade and beyond, demand continues to rise.

As opposed to negative screening, where stocks are screened out, 'positive screening' or "light green" funds include companies that are deemed to either enhance or are committed to having a positive impact on SRI practices and are often involved with the themes mentioned above.  A 'best-in-class' approach to positive screening applies social, environmental and ethical guidelines to give a preferred selection when all other factors are equal. In other words, the average ethical fund contains many of these positive investments, but positive holdings are often in quite small companies and so they are balanced by companies deemed to be 'ethically neutral'. Criticism of ethical funds is often based upon highlighting these ethically neutral companies. For example, an ethical fund might have criteria which enable it to invest in the oil and gas sector, but only in those oil companies which are 'best in their class' as they have a better record on the environment and human rights than others in their sector.

A third approach, engagement, does not necessarily exclude, include or prefer companies but rather the investor or fund manager actively encourages companies to adopt social and environmental best practices. This can involve meetings with senior management or by using their shareholder votes. Many of the larger ethical pension funds tend to concentrate solely on engagement, while retail funds can combine all of the above methods.

Another strong motivation for investing in SRI and ethical funds is risk management through corporate governance and through the review of ESG criteria to assess the quality of management and the likely resilience of their portfolio companies in dealing with future challenges. You only need to consider the fatal fires at a textile factory in Bangladesh, the horsemeat scandal and the ongoing scandals in the banking sector to realise that ESG factors can have a serious impact on the profits of companies, their share prices and therefore investors' returns.  However, it's not just consumers and investors who are aware of all of these issues; politicians and regulators are too. Companies and shareholders have to consider not just the factors highlighted above but also how regulators and policymakers deal with them.

In response to rising demand, the universe of ethical and green retail funds has expanded considerably. There are now almost 100 green and ethical funds available to UK investors whereas a decade ago there were just a couple of dozen.

Of course, advising on these funds is by no way mandatory unless you are aiming to achieve the best practice adviser ISO standard ISO22222 (BS 8453) which requires advisers to ask an SRI fact find question. However, one of the main reasons people say they invest in SRI funds is because they want to make a difference, the other because they want to make money, and by taking clients SRI aims into account IFAs can help add value and form part of the investment decision process for all clients who have an interest in this area.