This brief paper aims to set out some of the considerations behind the question of ethical investing. Specifically, its aim is to frame the debate for a typical group of charity Trustees to help decide whether specific ethical investment criteria should be formally adopted for the assets that we at Castlefield might be asked to manage on your behalf. Any such decision can only be taken if you are satisfied that you are not neglecting your prudential duties. The paper specifically does not discuss factors such as the growth of the ethical investment market, nor does it attempt to distinguish between the different branches of the broad ethical/sustainable/socially responsible universe. (Separately, we have defined ‘responsible’ and ‘sustainable’ investment for our own approach to managing money and can demonstrate how that might apply to your assets in practice). Rather, it attempts to present concisely the relevant factors that Trustees are obliged to consider when discussing potential ethical investment policies.
In the first instance, an attempt to define what we mean by “ethical investment” may be useful. The terminology can lead to confusion – SRI, ESG, CSR to name but three examples – and so it needs to be reduced to something simple that is applicable to the body of investments. In addition to the acronyms mentioned above, also for consideration are the subtleties of applying an investment screen with positive and/or negative criteria, as well as the concept of activism. However, the reality of the broad spectrum represented by the ethical investment movement is that it is ultimately unique to each individual charity. There is no “one size fits all” policy that can be presented to you as a ready-made solution. Therefore, our proposal would be to suggest that the starting point for ethical investment is based upon the guidance given by the Charity Commission, as follows:
“Ethical investment means investing in a way that reflects a charity’s values and ethos and does not run counter to its aims.”
As such, a first step is perhaps to consider which particular businesses or types of businesses represent activities that conflict with your values and aims. This could provide an effective long list for candidates for possible exclusion from the portfolios, the impact on the investable universe of which we could assess and show to you.
Subsequent to this are two further arguments, both of which concern the impact on returns. These discuss whether ethical investment policies could lead to lower rates of return for the portfolios, and whether a lower rate of return is legally justifiable as the result of an ethical policy being applied.
To the first argument, the reality is that there is no fundamental reason why an ethically invested portfolio should underperform one with no such values considered. The universe of ethical funds should simply mirror its broader peers, in that some funds will be relative gainers over different time periods, and others will be relative losers. There is no statistical evidence pointing to either a structural headwind or indeed tailwind: it should be generally possible for a fund to offset any performance drag caused by an excluded sector by virtue of successful investments in other areas of the market. Furthermore, the legal underpinning to the Charity Commission’s stance is that “an ethical policy may be entirely consistent with this principle of seeking the best return”, as it is unlikely to result in a portfolio lacking in sufficient diversification. To the second argument, lower rates of return can be an acceptable result of an ethical investment policy, provided that three key legal criteria are met. These criteria permit such a policy if an investment conflicts with the aims of the charity; if the charity might lose supporters or beneficiaries if it does not invest ethically; and provided that there is no significant financial detriment. These criteria were explicitly laid out in the 1991 judgement in the “Bishop of Oxford” case, when the Bishop and two colleagues launched proceedings to try to force the Church Commissioners for England into giving more weight to ethical considerations.
To sum this part up, there is no evidence that adopting an ethical investment policy should hinder potential returns from the outset, and furthermore any lower rates of return materialising due to ethical policies can be justified provided the legal requirements are met. In general, Trustees must balance any risk of potential lower returns against the risk of reputational damage.
There is further nuance to consider, namely the question surrounding the influence on policy of moral disapproval. Here, the room for manoeuvre of Trustees is more limited. Views of inappropriateness based on moral grounds may be accommodated provided that Trustees are satisfied there is no “risk of significant financial detriment”. However, it is important to note that “Trustees are not free to use their investment powers to make moral statements at the expense of their charity”. Investment opportunities should therefore be judged in light of a charity’s own circumstances as opposed to a sense of “public opinion”.
To conclude, we would make the following points:
- Charities are entitled to invest ethically, even to the extent that it may prevent the achievement of the maximum returns available (our belief is that investment returns can be improved by considering such a policy and we can explain why – here we refer solely to the legal justification)
- There is no evidence that investing ethically should compromise returns compared to an unconstrained fund. Referring again to the “Bishop of Oxford” case, the judgement referred to the reality that Trustees are unlikely to select a set of criteria such that a properly diversified portfolio could not be selected
- Beyond positive reflection of certain values and negative exclusion filters, an ethical policy could seek to emphasise the identification of the factors most likely to aid the long-term financial sustainability of their investments
As to how to proceed, the first step as described earlier is key in that it will allow you to reflect on your values and aims and whether these conflict with the business practices of current or potential investee companies. If you choose to work with us, we will then pursue a process to ensure that you can best foster your aims via your investments, whilst acting in accordance with the prudential duty required of Trustees.
With investment capital is at risk. Information is accurate as at 18.05.2020 This material may not be distributed, published or reproduced in whole or in part. Opinions constitute the fund manager’s judgement as of this date and are subject to change without warning.
Sources and References
 SRI = Socially Responsible Investment; ESG = Environmental, Social & Governance; CSR = Corporate Social Responsibility
 https://www.thirdsector.co.uk/news-focus-charities-fire-investments-arms/article/614434 date accessed 01/02/2012