Ethical Investment: Navigating The Complex World Of Values-Based Investing

Ethical investing is an investment strategy in which an investor chooses investments based on an ethical code, such as religious or social values, and financial returns. Ethical investors typically avoid investments in companies that operate in industries such as gambling, alcohol, smoking, firearms, pornography, weapons, fossil fuels, or the military.

The origins of ethical investing can be traced back to the 18th century, when the Quakers restricted members from participating in the slave trade. Over time, ethical investing has evolved to encompass a range of approaches, including negative screening, positive ESG screening, and impact investing.

While there is no guarantee of performance when selecting investments based on ethics, some research suggests that ethical fund performance may be superior to that of traditional funds. Ethical investing allows individuals to allocate capital towards companies whose practices and values align with their personal beliefs, promoting environmental stewardship, consumer protection, human rights, and diversity.

Environmental, Social, and Governance (ESG) investing

Environmental Factors

The environmental pillar focuses on a company's impact on the natural world, including climate change, carbon emissions, air and water pollution, and natural resource conservation. Investors also assess a company's treatment of animals and its energy use and waste management practices.

Social Factors

The social pillar examines a company's relationships with internal and external stakeholders, including employees, suppliers, customers, and communities. This includes evaluating workplace conditions, health and safety standards, diversity and inclusion efforts, community involvement, and data protection and privacy.

Governance Factors

The governance pillar looks at a company's leadership, executive pay, internal controls, audits, and shareholder rights. It ensures that a company uses accurate and transparent accounting methods, pursues integrity and diversity in its leadership, and maintains accountability to its shareholders.

ESG investing involves screening investments based on these criteria and encouraging companies to act responsibly. It is sometimes referred to as sustainable investing, responsible investing, or impact investing.

While there is no universally accepted standard for measuring and evaluating ESG performance, several organisations, such as the Sustainability Accounting Standards Board, the Global Reporting Initiative, and the Task Force on Climate-related Financial Disclosures, are working to develop standards and define materiality.

ESG investing has evolved from earlier investment philosophies, such as Socially Responsible Investing (SRI), which typically used value judgments and negative screening to decide which companies to invest in. In contrast, ESG investing seeks to find value in companies by evaluating their performance across these three pillars.

Socially Responsible Investing (SRI)

SRI investors typically avoid investing in businesses with negative social impacts, such as alcohol, tobacco, gambling, pornography, weapons, fossil fuels, and the military. Instead, they seek out companies engaged in social justice, environmental sustainability, and clean technology efforts.

SRI includes more proactive practices such as impact investing, shareholder advocacy, and community investing. Impact investing focuses on creating social or environmental impact through investments, while shareholder advocacy and community investing are considered pillars of SRI by investor Amy Domini.

The origins of SRI can be traced back to the Religious Society of Friends (Quakers) in the 18th century, who prohibited members from participating in the slave trade. John Wesley, a founder of Methodism, also preached against investing in industries that harm neighbours, such as tanning and chemical production.

SRI has evolved to reflect the socio-political climate of its time. During the 1960s, for example, SRI investors focused on addressing women's rights, civil rights, and labour issues. Today, SRI continues to focus primarily on environmental and social impacts.

SRI is a growing market, particularly in the US and Europe, and is governed by various organisations and regulations. The term "socially responsible investing" can refer narrowly to practices that seek to avoid harm by screening companies for ESG (environmental, social, and governance) risks, or more broadly to include proactive practices that promote positive social and environmental impacts.

While SRI considers financial returns, it is important to remember that these investments are still subject to market risks and may not always provide optimal returns. The success of SRI depends on investors' willingness to prioritise social responsibility alongside financial gains.

Sustainable investing

The basic idea is to invest in companies that help the planet rather than harm it. This means investors will favour enterprises that demonstrate exceptional behaviour regarding environmental impact, social responsibility, and the quality of internal governance practices.

For example, environmentally conscious investors will look to minimise ecological devastation by investing in companies that prioritise the planet. Socially, investors want to contribute to the betterment of society. This includes treating employees with respect, promoting consumer protection, and supporting human rights and racial or gender diversity.

Corporate governance is also key. This means companies act with a high degree of transparency and adhere to impeccable standards of conduct.

However, as more people invest in ethical funds, these investments can grow substantially in the future. And as ethical investing gains importance, it will encourage other businesses to improve their ethical practices to attract funding.

Impact investing

The term "impact investing" was coined in 2005 by Mark Zapletal of Wartenberg Trust. The impact investing market has grown significantly, with over 3,907 organizations managing an estimated $1.571 trillion USD in impact investing assets as of 2024. The largest sectors by asset allocation are microfinance, energy, housing, and financial services.

Moral investing

The history of ethical investing can be traced back to the 18th century, when the Quakers restricted members from participating in the slave trade. John Wesley, a founder of Methodism, also preached refraining from investing in industries that harm others, such as chemical plants.

Today, ethical investing has evolved to include various approaches, such as socially responsible investing (SRI), environmental, social, and governance (ESG) investing, and impact investing. SRI involves avoiding investment in companies with negative social impacts, such as alcohol, tobacco, gambling, pornography, weapons, and fossil fuels. ESG investing considers how environmental, social, and governance risks and opportunities can impact a company's performance. Impact investing focuses on creating positive social or environmental impacts, such as investing in renewable energy or affordable housing.

While ethical investing allows individuals to align their investments with their values, it also presents challenges. It requires extensive research to ensure alignment with an investor's values and beliefs. Additionally, ethical investing may not always provide optimal financial returns, and the fees for ethical investing can be higher due to the research involved.

Despite these challenges, ethical investing has gained popularity, with a growing number of investors demanding that companies treat their employees with respect, create sustainable products, and avoid unethical business practices.

Frequently asked questions