Every decision we make with our money, in the end, is a choice about what’s important to us and the sort of world we want. Our investments are no different.
Peninsula Walkway, Lake Tekapo
Ethical investing simply means aligning our investments with our values.
There’s a range of terms for it – ethical investment, Socially Responsible Investment (SRI), Responsible Investment (RI), Sustainable Investment, Environmental, Social, Governance (ESG) engagement, and Impact Investing.
As the Responsible Investment Association of Australasia defines it, “responsible investment is a process that takes into account ESG and ethical issues into the investment process of research, analysis, selection, and monitoring of investments.”
These ESG issues can include:
Pollution, climate change, water, and other resources scarcity.
Local communities, employees, health and safety.
Corporate governance issues
Prudent management, business ethics, strong boards and appropriate executive pay.
Increasingly, these issues are risks to the companies themselves, and to investors.
We use the term ‘ethical investing’ because it:
Is the term most people use in everyday life
Reflects the fact that, at its heart, it’s always about ethics and values
Is an active, ongoing advice-based process, not simply choosing an investment product
People generally have one or more of three aims for ethical investing:
Can mean excluding certain industries and companies such as tobacco or gambling.
This can be when investors may also want to make a positive difference, favouring companies that target key sustainability areas, such as clean energy. These often link with the ‘UN’s Sustainable Development Goals’.
This is where investments target a specific social or environmental issue of concern, such as social housing contributing to specific solutions.
Does investing ethically mean I get a lower return?
Many people assume that ethical investments don’t do as well as others. Fortunately, the news is good.
According to a 2021 research report* by the Responsible Investment Association of Australasia (RIAA), a typical Australian multi-sector ethical portfolio actually outperformed the multi-sector fund average over all time periods – 1, 3, 5 and 10 years, with the 10-year out-performance being an impressive 1.3% per annum. (*source: Responsible Investment benchmark Report Australia 2021). Even in New Zealand, with a much smaller pool of funds, a typical multi-sector fund outperformed the average by 1.1% per annum.
That makes sense to us. Companies which are better at ESG treat all their stakeholders better – their customers, their staff, the environment and so on. They’re more likely to have happier staff, more loyal clients, reduced environmental costs, have more diversity so make better decisions – so should be more profitable.
Because we are all different, there is no one approach that works for everyone. Nor is there a ‘perfect investment’ – there are always trade-offs. Ethical Investing NZ counsels taking a pragmatic approach: doing something is better than nothing, some approaches are more effective than others, and every year there are more and better options.
The biggest issue of all is climate change – yet until recently few ethical investments take it into account. We’re now seeing new, smarter approaches that explicitly look to measure and then reduce the CO2 impact of their investments. However, there is still the potential for ‘greenwash’ which is implying that a fund or investment is ‘greener’ (avoids more things or favours more things than it actually does).
Are all ethical funds worth considering?
Investments have to be ethical but they also have to be “financially sustainable”. That means that they can’t be too expensive, they have to be widely diversified, invest around the world and not only in NZ, and cover the major investment areas of shares, property, bonds and cash.
In particular, the evidence is strong that markets are generally efficient, so attempts to pick winners or time markets don’t work consistently in the long term. That’s why low-cost index funds are generally the best basis to build a portfolio – including ethical index funds. For more information about how we build portfolios click here.