Ethical Investment Portfolios: Doing Well By Doing Good

Ethical investment portfolios are becoming increasingly popular as investors seek to support companies that share their values and contribute to a positive societal impact. Ethical investment portfolios are collections of investments that align with an individual's or institution's values, beliefs, and social concerns. These investments consider environmental, social, and governance (ESG) factors in addition to financial performance to promote responsible and sustainable growth. While there are challenges and limitations to ethical investing, such as the subjectivity of ethical criteria and the potential for greenwashing, it has gained prominence due to its potential to address global challenges such as climate change and social inequality. By prioritising their values in investment strategies, investors can help foster a more responsible and sustainable global economy.

Environmental, Social and Governance (ESG) criteria

Environmental Criteria

Environmental criteria serve as tools to assess a company's environmental risks and potential damage to the ecosystem. They encompass critical challenges such as climate change, water security, environmental health hazards, waste management, the loss of biodiversity, and potential extinctions. Companies can help address these risks through proactive management and sustainability initiatives, thus contributing to both environmental protection and long-term business success.

Some key examples of environmental criteria include:

• Initiatives to reduce carbon emissions and mitigate climate impact, such as adopting renewable energy sources and setting science-based emission reduction targets.
• Practices to enhance energy efficiency, including investing in energy-efficient technologies and implementing smart energy management systems.
• Strategies to address water scarcity and ensure sustainable water use, such as water recycling and implementing water-efficient processes.
• Efforts to combat air and water pollution, including the use of non-toxic materials and adhering to environmental regulations.
• Implementation of effective waste reduction and recycling programs, promoting a circular economy approach.
• Measures to prevent deforestation and promote reforestation, supporting sustainable forestry practices.
• Actions to protect ecosystems and prevent species loss, such as preserving natural habitats and promoting sustainable land use practices.

Social Criteria

Social criteria encompass a company's engagement and interaction with various groups, including employees, suppliers, customers, and communities. These criteria may include efforts to reduce inequalities, uphold human rights, and safeguard the health and safety of workers and surrounding communities. Social considerations enable businesses to cultivate inclusive, fair, and positively impactful operations, supporting vibrant communities on both a local and global scale.

Examples of social criteria include:

• Ensuring fair and ethical treatment of all individuals, both within and outside the organization, and compliance with labor standards, including fair wages and safe working conditions.
• Implementing strategies to understand and enhance customer experiences and satisfaction levels.
• Protecting personal and sensitive information through robust data security measures and privacy policies.
• Fostering an inclusive workplace by supporting equal opportunities and representation for all genders and diverse groups.
• Encouraging a motivated and committed workforce through programs that promote employee involvement and well-being.
• Building and maintaining positive relationships with local communities through engagement and support activities.

Governance Criteria

Governance is the third component of ESG criteria, focusing on business leadership and transparency mechanisms. This encompasses policies that promote a diverse board of directors, stringent corporate accounting standards, proper executive compensation, public disclosure, conflict of interest management, and addressing legal and ethical considerations. Governance criteria serve as a tool for responsible and ethical business conduct.

Examples of governance criteria include:

• Establishing fair and transparent policies for compensating executives, aligning their incentives with the company's long-term goals.
• Ensuring a diverse and balanced board of directors with a range of skills and perspectives to enhance decision-making.
• Implementing strict policies to prevent and address bribery and corruption within the organization.
• Adhering to ethical guidelines and legal requirements regarding lobbying activities to ensure transparency and accountability.
• Monitoring and regulating political contributions to avoid conflicts of interest and ensure alignment with the company's values.
• Establishing secure channels for employees to report unethical or illegal activities without fear of retaliation.
• Creating a robust audit committee to oversee financial reporting, internal controls, and compliance with laws and regulations, ensuring the integrity of financial practices.

Positive and negative screening

Positive screening identifies and focuses investments on companies that are considered top performers based on chosen criteria. These are organisations that score highly in terms of environmental impact, social justice, and corporate ethics. Positive screening is sometimes referred to as 'best-in-class screening' and encourages companies to compete with each other for investment dollars.

Negative screening, on the other hand, refers to excluding companies that do not meet certain ethical standards or are involved in controversial industries, such as tobacco, weapons manufacturing, alcohol, gambling, or fossil fuels. It is a more basic method of screening and is much less restrictive than positive screening. Negative screening simply excludes investments in companies that actively work against the investor's values.

Both methods work well together and can be used in combination to create a well-rounded screening process.

Impact investing

One of the key benefits of impact investing is the ability to tailor your investment portfolio to specific causes that are important to you. For example, if you want to support clean energy initiatives, you can check the ESG (Environmental, Social, and Governance) scores of different investments and choose to invest in organisations with the highest marks in that area.

It is important to note that impact investing requires time, effort, and research to determine the best partnerships, and there may be a need to hire a financial advisor to make ethical decisions and acquisitions. Additionally, impact investments may not always generate optimal returns, and there could be limitations in the number of investment opportunities that meet your ethical standards.

However, impact investing allows you to make a positive impact with your investments and encourage others to do the same, leading to measurable change in various industries. It also helps reduce investment risk by focusing on well-governed and socially responsible companies.

Thematic investing

For example, a thematic investment product in the water sector would involve selecting and financing companies that operate globally to improve access to water, save water, and make it drinkable. While investors' intentions may be to enable access to water for those deprived of it, it is challenging to prove additionality, i.e., how the capital provided was specifically used to provide water access to more people.

Mutual funds and ETFs

Mutual funds and exchange-traded funds (ETFs) are popular investment vehicles for those seeking to create an ethical investment portfolio. They allow investors to gain exposure to a diverse range of securities that align with their values and beliefs while also considering financial performance.

Mutual funds pool investments from multiple investors and invest in a variety of assets, such as stocks and bonds, offering an easy way to diversify one's portfolio. Ethical mutual funds focus on companies that meet specific ethical criteria, such as environmental, social, and governance (ESG) standards. These funds may be actively managed, with fund managers making decisions about asset allocation, or passively managed, tracking market indexes or specific sector indexes. Actively managed funds tend to have higher fees due to increased operational and trading costs.

On the other hand, ETFs are traded on an exchange, like stocks, and can be bought and sold throughout the market hours. They are usually passively managed and often track a market index or sector sub-index. ETFs are typically more affordable to invest in, with no minimum investment requirements, making them accessible to a wider range of investors.

Both mutual funds and ETFs provide a way for investors to support companies that share their values and contribute to positive societal change. They offer diversification across different industries and sectors, reducing investment risk and optimising returns. However, it is important for investors to conduct thorough research and due diligence to ensure that the funds they choose align with their specific ethical criteria and investment objectives.

Frequently asked questions