Just because an investment is ‘responsible’ doesn’t make it ethical. Here’s how financial advisers can help their clients understand the difference.
Once a niche market, responsible investing is now a firm fixture in mainstream investment. According to a 2018 report from the Responsible Investment Association of Australasia (RIAA) 55.5% of Australia’s professionally invested assets are responsibly managed.
This term ‘responsibly managed’ is broad and covers a range of approaches – from environmental, social and governance (ESG) investments, through to deep-green ethical funds.
But given the way the media talk about it, you’d be forgiven for thinking ESG investing and ethical investing are one and the same. But they’re actually at opposite ends of the spectrum – two very different shades of green. So how do they differ – and why should advisers care?
ESG: Pale green and ethically passive
With ESG investments, a fund manager considers the way a company is managing its environmental and social impacts and governance as part of their financial analysis and investment process.
This could mean understanding its practices in relation to energy, waste management, pollution and use of natural resources; and how the company treats its workers and global supply chains. It also looks at the company’s governance – including the diversity of its board, its accounting policies, and how it avoids conflicts of interest.
This may sound like ethical investing, but it’s not necessarily so. That’s because ESG fund managers are looking at these factors primarily to determine their impact on the company’s value and risk. And by extension, their potential investment returns.
For example, an ESG investor looking at a company involved in coal mining will consider the risks that burning fossil fuels has for the environment. But they may still decide that it is a worthwhile investment, provided that its share price reflects this risk.
It’s a bit like a passively managed fund, where the fund manager tracks an index rather than using their knowledge and skills to analyse and buy shares. In the same way, they can also be ‘ethically passive’: in other words, they don’t actively seek to invest in companies and products that do good.
Diving into the deep end: Investing ethically
Ethical investors, on the other hand, harness their power to make positive change using a range of tools. They actively seek out investments that are aligned with their agreed principles, screening them for both their positive and negative impacts.
They avoid those that don’t align with their investment principles – like cigarettes, weapons, coal-fired power and logging. They also actively seek out those that will shape a more positive future – such as renewable energy.
Taking Australian Ethical as an example, our investment portfolio is screened against an Ethical Charter of 23 principles. In a nutshell, it looks for positive investments that support people, quality and sustainability – and avoids those that harm people, animals, society and the environment.
We also engage with the companies we invest in, to advocate and help enact positive change.
This rigorous ethical and risk/return screening approach gears our investment portfolio towards future-focused industries like technology, health care and renewable energy.
Creating positive change
Unlike ESG investing, true ethical investing also gives investors the power to influence companies to create a better, safer future.
For example, if investors divested from fossil fuels and moved their money to renewable energy, they could bring down the price of renewable energy, encourage more investment in renewables, and promote sensible public debate about energy policy. Ultimately, their actions could help limit the warming of the planet to below 1.5 degrees Celsius, avoiding catastrophic global warming.
Values versus returns: Getting the balance right
Investing ethically doesn’t mean your clients need to compromise on returns. As a case in point, as at 30 June 2018, Australian Ethical’s flagship Australian Shares Fund returned an average 13.1% per annum for the last five years – and 9.9% annually since its 1994 inception.
Of course, past performance is not a reliable indicator of future performance. Providing sound financial advice is more than making your clients money in the short-term. It’s also about helping them meet the future with confidence by having a long-term view of their investments. Many Australians are understandably worried about the impact that climate change and pollution will have on their children and grandchildren’s future. Helping them invest ethically can help bring them peace of mind, knowing that they are investing in a brighter future.
What ethical investing means for advisers
As an adviser, having a clear understanding of responsible investing means you are better prepared to meet your clients’ needs and expectations.
Recent research says nine in 10 Australians expect their money to be invested responsibly and ethically. And younger generations in particular are more environmentally and socially aware than their boomer parents and grandparents – and are about to inherit their wealth.
So being able to choose ethical investment options will be vital if you want to attract and retain this passionate and growing market segment.