Derek Anderson: What is sustainable investing? Can it be an alternative to ethical investing?
Derek Anderson, senior paraplanner at Edinburgh-based Mearns & Company, chartered financial planners, discusses sustainable investing and whether it can act as an alternative to ethical investing.
As individuals, it may seem that our own savings each year can’t make much of a positive difference to our environment or society. However, if you consider that in the tax year 2017/18, £28.2bn was contributed to personal pensions in UK, then all together they definitely could!
We all have the choice as to how our pension and investment money is invested. This made me think, what choices do I have to make to make sure my savings have a positive environmental or societal impact? Is it enough if I choose to invest in funds that have a sustainable mandate, or do I need to invest with an ethical mandate to make the biggest difference? To answer this, I first wondered what the difference between sustainable and ethical funds was.
Sustainable funds look to invest in companies that have a positive impact on environment, society and governance factors (they are sometimes collectively known as ESG investments). The International Monetary Fund estimates that there are more than 1,500 funds with an exclusive mandate to invest in sustainable companies.
To be categorised as a sustainable business, companies in general must contribute to improving the environment or be more socially responsible. This is achieved in many ways such as developing new technologies, reducing waste, being more energy-efficient, offsetting its carbon footprint or making a social difference in the local community.
Funds that adopt an ESG approach take into account environmental, social and governance factors, alongside standard financial data, when deciding whether to buy or sell a stock. For example, they might try to identify companies that are focused on ESG factors and may profit in a world which is more environmentally aware, for example, electric car manufacturers.
Ethical funds tend to have much stricter mandates in place as to what they cannot invest in. People who chose to invest in these types of funds tend to have strongly held beliefs. For example, some of the oldest ethical funds stem from the Quaker movement, so they do not invest in companies that sell or produce alcohol, weapons, tobacco or pornography. The fund manager must screen each fund to ensure no investments are made in the type of company that would breach the fund’s mandate.
Today many ‘ethical’ funds have a more environmental remit. However, while some funds will automatically exclude whole sectors such as oil and gas, others take a ‘best of breed’ approach, investing in those companies with better track records on issues like pollution, water waste and recycling. Those who take this approach argue it encourages companies to improve environmental standards and engage with wider issues such as climate change.
My next question was – does investment performance suffer if I decide to invest in ethical or ESG funds? Like most investors I want a positive return on my investments, and I always thought it was more difficult to achieve this if they were invested in ethical or sustainable funds (given the lack of choice of funds and the reduction in the diversity of companies that they could invest in). However, the increase in fund choice over the past few years and the improved ability to diversify a portfolio has resulted in me changing my view. I have also seen strong performance figures in the sector over the past five years. Although it is always worth remembering that past performance does not guarantee future performance.
So yes, there is a chance that your performance will not be as high as if you had the full market to invest in, but if fund choices are made with consideration and performance is monitored, the issue of performance is not as significant as it once was.
In conclusion, investing with an ethical mandate is very different to investing sustainably. You could look it this way – strict ethical funds are really a sub-set of the wider family of ESG funds. So sustainable investing is not an alternative to ethical investment, it is just a wider interpretation of ethical investment – both types of investments should have a positive impact on the environment and society, for the next generation.
For me personally, I am now looking more closely at what I invest in and making sure that my investments match my own environmental and ethical position.