Green is the New Black – A Guide to Ethical Investing
Ethical investing has exploded both in size and popularity over the past 5 years. Now more than ever, investors are demanding options to invest their money in ways that support their moral beliefs. According to the responsible investment association of Australia, responsible or ethical investment constituted approximately $622b of assets under management, an increase of 9% over FY15. Of this, $557.1b is managed via a broadly responsible strategy, while $64.9b is managed under a core ethical strategy.
What exactly is Ethical Investing?
Ethical investment approaches apply at least one of the following primary strategies: negative, positive or norms based screening, sustainability themed investing, impact investing, community finance or corporate engagement. The most substantial ( and in my opinion, the most important and concrete) are those strategies which involved screened investments. Screened investments grew to $33.6b FUM in FY16, an increase of 36% year on year.
Ethical Investment is growing incredibly quickly, and it looks like a sustainable trend. The three key drivers of this growth is the alignment of the strategy and underlying investor values, ESG risks being identified as increasingly important by investors and increased demand from institutional and retail investors. The two primary constraints for growth include performance concerns (although this might not be as much of an issue as first thought…) and capacity constraints – there simply aren’t that many people who have the appropriate qualifications or expertise to deliver an ethical investment product.
Whats the difference between core ethical investing and broad ethical investing?
Given the relative newness of ethical investment, there are a lot of terms and concepts that are still being defined and fleshed out. One of the most important concepts is the difference between what is becoming known as core ethical investing and broad ethical investing.
Core ethical strategies apply at least one of the following:
- Negative, positive or norms based screening;
- Sustainability themed investing,
- impact investing,
- community finance or
- Corporate engagement
These “core approaches” are traditionally referred to as sustainably responsible investing (SRI) or ethical investing, and it is this core strategy that I believe shows the most promise. Again, according to the RIAA, core ethical strategies (from now, “ethical”) have increased 26% year on year.
Broad approaches “use ESG integration as the principle responsible investment strategy”. ESG stands for environmental, social and corporate governance, and utilising these factors in traditional analysis and making a determination based on these factors comprise a broad approach. Broad strategies are are not typically referred to as ethical strategies.
I mentioned previously the strong growth of ethical investing in Australia. Approximately 4.5% of assets under management in Australia are now managed in an ethical manner, and there are approximately 200 products in Australia servicing this niche, with positive and negative screening by far the most common strategies applied. Issues that are typically screened for include old faithfuls such as weapons, tobacco, alcohol and gambling – but interestingly, there has been an increased focus on human rights abuses and nuclear power.
While investors, particularly younger investors, are increasingly look to be invested in a manner consistent with their values, if performance is not acceptable, ethical products won’t thrive. Thankfully, the performance of ethical investment strategies has typically been pretty good!
You should always take these sort of tables with a grain of salt – they have been produced by an organisation with a stated goal of promoting ethical investing. While the numbers are most likely true, I would expect that they have been sliced and diced in order to present the most favourable outcome for ethical products. Noentheless, the performance has been good, and anecdotally at least, its is my experience with some of the larger products.
Future of Ethical Products
With ethical products performing well and seemingly endless demand for them, I expect ethical investing to become more and more popular in the near future. Ethical investing as a percentage of total assets under management has exploded over the last two years after being relatively static for a long time, and I expect this trend to continue.
Australian Ethical Investment Managing Director Phillip Vernon states that “We have always believed that ethical investing will come of age and be part of the mainstream rather than a fringe sector”. With the exceptional performance of Australian Ethical small cap fund, I expect this to continue in the future.