What is Ethical Investing

Ethical investing is a form of investment that involves choosing investments that align with an individual's values and beliefs.

This can include avoiding investments in certain industries, such as tobacco or weapons, and instead focusing on companies that prioritise environmentally sustainable practices or fair labour standards.

There is no single, universally-accepted definition for Ethical investing (as it is also known as socially responsible investing, ESG investing amongst others).

So in short, ethical investing is when you choose investments based on their moral behaviour – not just their potential for a financial return.

Ethical investing may improve your personal satisfaction. When you only invest in companies whose missions you support, you may find that you have a higher level of satisfaction from your investments since you’re supporting causes you believe in.

It also allows you to support companies instituting change. By investing in ethically or socially responsible companies, you back companies that are making a difference in areas important to you.

Ethical investing may pressure other companies to follow suit. If more people choose to invest in ethically and socially responsible companies, other companies may have to adapt their own practices to compete.

ESG stands for environmental, social and governance. ESG investing takes these factors into consideration, alongside of financial factors.  ESG investing is a specific investment approach that evaluates companies not just on their ability to make a financial return, but also how they measure up on ESG criteria.

For instance, a company with a high carbon footprint wouldn’t score well on environmental impact. Similarly, a company that treats its staff poorly and negatively affects people’s health wouldn’t score well for social impact. And a company that frequently flouts rules and regulations by not having the appropriate structures and processes to ensure good corporate decision-making wouldn’t score too well for governance.

At Castlefield we often refer to the E.ST. credentials of investments, which takes into account Environmental, Social, Transparency & governance factors. 

At the beginning of the 1900s, the Methodist Church in North America decided to invest in the stock market, having previously viewed such practice as a form of gambling.

However, their decision came with a proviso: they wished to exclude certain types of companies, specifically those involved in alcohol or gambling. The Quakers soon followed their example and were especially keen to avoid weapons manufacture.

Public demand for ethical investment vehicles took off in America with the launch of the Pax Fund in 1971, as a reaction to the Vietnam War.

Discontent caused by the war had led some investors to question how their money was being used. Many were particularly angry with the manufacturers of Agent Orange, the defoliant sprayed on Vietnamese jungles, which caused deformations in the babies of people who came into contact with it.

One of the individuals involved was Charles Jacob, then an investment manager with the Methodist Church. He prepared a proposal for the first ethical unit trust in 1973. At that time it failed to obtain approval from the Department of Trade, but a few years later permission in principle was granted.

The apartheid regime in South Africa accelerated the promotion of ethical investment in the 1980s, and in 1983 EIRIS was established as the UK’s first independent research service for ethical investors.

In the same year, Friends’ Provident (which had been founded in 1832 to provide life assurance for members of the Society of Friends, more commonly known as Quakers) offered to manage an ethical fund, with the investment criteria determined by a separate committee. This led to the launch of the Stewardship Unit Trust, the Stewardship Life Fund and the Stewardship Individual Pension Fund in June 1984. Meanwhile, Charles Jacob was appointed as a founder member of the Stewardship Committee of Reference.

As the twentieth century drew to a close, more churches, charities and individuals were beginning to take ethical criteria into account when making investment decisions. By 2000, the field had gained a major coup: it became UK law that occupational pension schemes should declare whether they took account of any social, environmental or ethical factors when deciding where to invest.

Early ‘ethical investing’ practices started by avoiding investments in specific industries, the so called ‘sin stocks’.

The principle being that a) some people feel uncomfortable supporting and profiting from such industries, and b) by reducing the demand they should eventually become less profitable and therefore less successful.

Traditional harmful industries include the likes of tobacco, alcohol, pornography, arms, nuclear power and trading with oppressive regimes. Over time this has grown to include things such as businesses with dire environmental credentials and those with poor human rights records.

The ethical investment industry has evolved to include the promotion of initiatives that have a positive impact on the world. At the forefront of such ‘positive impact’ investing has been a drive to encourage anything that favours environmental initiatives.

There has been a profound increase in ‘green tech’ over the last 30 or 40 years, with the proliferation and development of technological innovation in many areas, from solar panels to wind farms to low energy light bulbs to electric vehicles.

Many such initiatives have been and continue to be supported by ethical investors. Indeed, forward thinking individuals – including many of our clients - were the first to invest in such sectors, long before institutional investors followed their example.

Industries that work more efficiently have obvious environmental advantages (i.e. the less energy used in manufacturing the less this leads to global warming).

But beyond the purely environmental impact, there is usually also a cost saving opportunity associated with this, so it’s something that should appeal to all business owners whether they are concerned about the environment or not.

The drive to promote industrial efficiency can give rise to various investment opportunities, from the introduction of more efficient manufacturing processes, to better built, longer lasting products, to consultancy firms that specialise in seeking out and recommending efficiency gains.

Another important area focusing on environmental issues is to consider how we make best use of the world’s limited resources (such as rare metals, drinkable water, etc), and what we can do to stop these being completely exhausted and/or manipulated to such an extent that they no longer become useable.

For many ethical funds, especially those with an environmental bias, this is a theme that they support. It means backing companies that are at the forefront of waste management and recycling, those that are working to use less material in their products, packaging and processing methods, and those that promote less water usage and more internal recycling within their own manufacturing processes.

As with any other type of organisation, charities need funds in order to conduct their business. Where charitable giving is not enough, some larger charities have used other initiatives to raise money, often in relation to specific projects for example to build a particular building for them to use.

They may raise the money by issuing an investment bond. Investors can purchase part of the bond and in return they receive a set interest payment over a number of years after which their capital is returned.

Charities often finance the returns given to investors using government grants, which is a fair relationship as the investor takes on the risk of the project failing and is rewarded for removing this risk from public finances.

This can be a fantastic way for thoughtful investors to promote charitable endeavours whilst at the same time aiming to make modest returns from their money.

One of the most powerful elements of ethical investing to have evolved over recent times is that of active stewardship and engagement.

The shareholder uses their status to influence the underlying business, typically by voting at AGMs and other shareholder meetings, although other direct engagement as a shareholder can sometimes be involved.

The bigger their holding, the bigger the influence they have, which is why funds and other collective investments can often have a greater shareholder influence than individual holders.

One common use of this influence is to question excessive executive pay. Where those at the top of an organisation receive pay that is many, many multiples of the lowest paid, it’s only right to question this as a matter of fairness. It may be justifiably argued that those at the top are paid handsomely because they have exceptional talents that the business as a whole benefits from.

But all too often it’s simply greed and opportunity, with no one opposing them. A thoughtful investment team will always question this and often vote against excessive pay rises or bonuses if there is no clear evidence to justify it.

A second area of influence where stewardship can play its part in is to take on inequality and other discriminations – sexism, racism, ageism, homophobia, disability rights.

A good stewardship process will set out to question a business’s experience and approach to such things. For example, encouraging greater transparency over gender related pay and board diversity, or demanding change when surveys reveal fewer numbers of women in senior positions.

They will also set benchmarks to use as internal standards i.e. minimum standards to which they expect their investee businesses to adhere to.

This can help certain businesses to work better, especially growing, fledging businesses with limited experience and resource in this area.

If there are no investors invested in harmful industries demanding that action be taken, then the stewardship examples given in point 6 and 7 hold no weight, as there’s no one holding them to account and keeping them in check!

There is some validity to this, but it needs to be handled carefully. There can be an argument to invest in, for example, a major oil business that promises to convert to supplying renewable energy rapidly over the near term.

But that investor has to do so with deep conviction and the ability to properly police the investee. If the firm’s promises are actually achievable with enough conviction and momentum behind them, it is essential that they are held to account.

They need to prove that they are being achieved and if they fall short they need to give valid reasons as to why. This needs to be an ongoing process and ideally the world at large needs to be told about this – both when things go well, and when not so well.

Businesses who are generally revered as being ethical for one reason or another can, on occasion, be exposed for undertaking certain poor practices that, until then, the public at large were all unaware of.

Stewardship can play its part in this too. When this happened the standard response of the exposed business is to own up to their mistakes and promise to make amends in order to save face and, hopefully, retain or repair their image (and profitability!).

A thoughtful investor will assess the situation and may well choose to give them a second chance if they do successfully change their ways, but sometimes such businesses fail to do so in which case, after a period of reprieve, it could be time to disinvest and seek opportunities elsewhere.

This article has been a whistle-stop tour of some of the most obvious as well as number of the less well-known advantages of investing ethically.

One final thing to stress, and which builds on all of this, is the power of doing this together. The more that the issues within this article are publicly exposed and acknowledged, the greater the influence responsible investors will have, and the more business and the wider world will want to react to them.

Fund managers should also be held to account for following through on their ethical mandates. By questioning an invested business thoroughly or holding them to account following poor practices we can avoid many of the greenwashing practices that invalidate the theory! 

The wider industry is becoming more sophisticated too. For example, ShareAction works to influence businesses to work better via collective share ownership, and collaborates with certain responsible investment teams.

The deeper and wider the means of tackling the issues at hand, the deeper and wider their impact will be, which, ultimately, is better for us all. Not only better for humankind, but better for the planet and our collective futures.