What Does Ethical Investment Actually Achieve?

What Does Ethical Investment Actually Achieve?
David Vincent

I believe that all investors, whether individuals or institutions, share a moral responsibility for the products, services and behaviour of those companies which they collectively own and from which they seek to derive profit.
I also believe that in order to merit the term “socially responsible” shareholders should seek to have a positive influence on how their companies behave and what they provide.
For this reason I do not believe that it is sufficient simply to compare an investor’s personal list of preferences to each fund’s criteria in order to come up with the best match. It is also necessary to look at the commitment and ability of the fund manager to bring about positive change.
These qualities can be gleaned from a number of indicators, which are in my opinion far more valid but perhaps less easy to tabulate and assess objectively than, for example, a simple checklist of exclusions.

What is the product provider’s own policy on social and environmental issues?
What organisations and forums does the product provider belong to and what initiatives has it undertaken?
How many ethical funds does it offer and how do these funds cater for the financial needs of socially responsible investors?
What resources does it devote to issues of social responsibility?
To what extent do the stocks actually held in the portfolio reflect the pictures in the marketing literature?
How is engagement carried out and reported - and how successful is it?

The answers then have to be balanced by other factors – the size of the product provider and the history of mergers and takeovers, the size, age and track record of the funds and the degree to which it provides diversity in the market place.
I believe these factors are more important than agonising endlessly about the inclusion of any particular individual stock within a portfolio.
However, the real reasons for questioning the level of emphasis placed on screening as means of evaluating ethical investment funds are far more fundamental.
Normally when we talk about investment we really mean the trading of stocks and securities on the stockmarket, which have already been issued.
A typical fund will hold a portfolio of stocks, which are listed on the stock market. The market value of a stock will change as investors alter their perception of a company’s ability to generate future profi ts. The fund manager will buy stocks which he (or she!) feels are undervalued and sell stocks which he feels are overvalued. In other words it is really no more than professional gambling.
Logically, refusing to buy certain stocks on ethical grounds should not in itself directly alter that company’s ability to generate profi ts or the value of its assets. Even if every ethical fund and individual investor in the country joined forces to boycott a particular stock the impact would be fairly limited. Even if the boycott did cause the share price to fall, all that would actually happen is that less “ethically sensitive” investors would see a bargain and buy the stock instead!
Taken to its logical conclusion, nice investors would end up owning all the nice companies whilst nasty investors would end up owning all the nasty ones!
That is about as effective as attempting to reduce your carbon footprint by selling your Porsche to Jeremy Clarkson – it might make you feel less guilty but it’s still the same car - just with a different, driver.
Similarly, focussing your investment on paragons of corporate virtue will not actually improve their financial prospects or make the world a better place either. Other investors provided the company with its “development capital” by subscribing to the “initial public offering” (IPO).
All you are doing is paying them (or subsequent traders) an acceptable price for the right to a share of the anticipated future profits – until you decide to trade in the shares yourself.
That is not to say that companies are completely unperturbed by movements in their share price. Companies are still keen to bolster their share value because it makes them appear a better credit risk. This means if they can negotiate a better rate on any bank debts. Similarly, if they wanted to raise capital by issuing fixed interest securities, they would feel more confi dent in attracting investors or conversely could afford to offer a lower rate of interest than a less valuable company.
So, simply having your name on a share certificate does not change how a company behaves or how much profit it makes. Without action it makes no difference whether it is your name on the certificate or anyone else’s.
So if what you invest in an “ethical fund” because you want to “make a difference” then your best method is by engaging with the company in order to influence its behaviour.
This means either doing it yourself or paying someone else to do it for you - your financial adviser and your fund manager. The only company which is profiting directly from the trading of shares is the fund manager. Secondly, ethical funds offer an opportunity for like-minded investors to exert greater influence collectively through their fund manager – so our view is that you should make sure you are paying one that can and does exert an influence on the companies it chooses or rejects on your behalf.
If you are paying a financial adviser to help you promote social responsibility, and of course I hope you are, it makes sense to choose one that can and does!
There is a further even more effective impact that you can have as an investor, although one which normally involves a higher degree of risk.
For a company to be able to start up and develop it requires capital. Capital is created in three basic ways:

issuing new shares
borrowing - either from the bank or by issuing “fixed interest” securities
retaining profit

The most positive action an ethical investor can take is to invest in new issues of shares by “virtuous” companies.
Unfortunately new shares are generally only offered in either small, privately owned companies or those seeking a stock market listing for the first time.
These are therefore often speculative or illiquid investments and investors may not see a return for many years, if at all, and they may also be in for a roller coaster ride along the way. The golden rule for such investment is never commit more than you are prepared to lose!
It is however quite common for larger, listed companies to raise further capital by issuing “fixed interest securities” or “corporate bonds”. These are essentially loans on which the company will pay a fixed rate of interest and then return the initial sum at a fixed maturity date.
This is obviously less risky than buying new share issues although there is a “credit risk” that the company may not be able to honour its debt at maturity. Unfortunately private investors rarely get a look in and new issues of fixed interest securities are normally snapped up by institutional investors.
So in addition to active engagement the best way to change things with the power of your capital is to make a true investment and provide “development capital” or new money for worthwhile projects. Remember of course that there may be significant additional financial risks so proper advice is essential. Unfortunately most financial advisers will not get to hear about many of these investment opportunities. Since most such schemes will not pay commission, even those that do may not be too interested in promoting them. The sensible option is to seek out an adviser who shares your own commitment and enthusiasm and has some experience and standing in the market. However you should also be prepared to pay for objective advice.
David Vincent is an Independent Financial Advisor and Managing Director of the practice Ethical Investments. 0114 236 8168 or dav@ethicalinvestments.co.uk