By Latifa Alkhanjary, Kinesis Money

Ethical investing is the practice of making investments that abide by your core values and principles.

People often think that their expected returns will diminish if they invest ethically, but this is not necessarily the case. In the US alone, ethical investing has become a $17.1 trillion dollar industry, involving over 800 investment companies.

Ethical investing has increased in popularity as many investors develop a greater understanding of the wider impact that their investment decisions can have. With the first socially responsible mutual fund, Pax World, launched in 1971, companies have since faced increased demands for more ethical and responsible practices across all levels of business.

However, this subject is not only crucial for active investors, but also for any individual who holds money in the bank. The nature of the fractional reserve banking system means that the majority of cash left in the bank is combined and loaned out to businesses or individuals. These loans could inadvertently be funding activities that the client is not aware of that adversely affect the wider environment – such as heavily polluting industries.

What is ethical investing?

Also known as responsible investing, ethical investing, is a value-based approach to investment. It considers the principles that guide the direction and behaviour of companies and industries, as well as the potential profit to be gained. ESG investing (which looks at environmental, social, and governance issues as investment priorities) is one of several categories of ethical investing and enables a commitment to financial decisions that stand for change.

Ethical investing can also be envisioned through impact investment, as explored below:

• Positive impact investing: in which investors consider a company’s commitment to corporate social responsibility or the duty to positively serve society as a whole.
• Negative impact investing: in which investors avoid industries and companies whose values do not align with their own and decide to omit them from their portfolio.

Types of ethical investing

When people are investing ethically, there are several guidelines that can be followed, namely social, moral, political, and/or environmental. Religious values can also play a significant role in decision making.

For example, Sharia law discourages any investment mechanism that is debt-based, as well as investment in tobacco and alcoholic substances.

Therefore, Islamic investors must seek out Sharia-compliant companies in order to engage in this form of responsible investing.

In addition to religious values, with the environmental crisis becoming one of growing concern, environmental or green investing is finding its way into investors’ ethical agendas. A commitment to sustainability and questioning whether a product is environmentally harmful, such as through the manufacturing processes involved, is the basis for this type of ethical investing.

Profitability of ethical investing

The rhetoric that ethical investing equals a compromise on performance and returns is still present, however, this is not always the case. That said, the worry that accessing a smaller investment pool of responsible funds might lessen the potential for financial returns is still a concern for some investors.

Nevertheless, evidence shows that responsible funds can match and even out-perform mainstream, traditional funds. For instance, in the last few years, the Morningstar UK Sustainability Index performed better than FTSE 100 and FTSE All-Share.

To help determine a company’s projected long-term exposure to environmental, social, and governance risks and to further aid investors in making decisions about ethical investing, companies are awarded an ESG score.

A company’s ESG score also includes how the company treats its employees internally, in order to establish if best practices are being met in this area. Lately, tech companies have taken the lead in ethical investing, with Microsoft earning a remarkably high ESG score of 76.3.

Advantages and disadvantages

One of the most significant advantages of ethical investing is its support of the belief that individuals should not have to sacrifice their principles when directing their cash flow. Furthermore, it helps investors benefit emotionally and financially when a company shares their values and can also provide the means for long-term, sustainable growth.

In addition, market competition in the name of ethical investment is stimulated as other businesses are encouraged to improve their practices to attract funding. When others consider ethical investment as important to them, companies begin driving their efforts towards that same goal. Simultaneously investors can be deterred from buying shares in companies that are not following similar ethical principles.

As for the downsides of ethical investment, the act of “greenwashing” is an issue that plagues this field as well as businesses branded as sustainable. The terms “sustainability” or “eco-friendly” can be highly subjective, meaning there is room for manoeuvre in the realm of ethical investment. Instead of ensuring they follow through with claims of sustainability in the long term, companies can latch onto investor sentiment. An example of this is when companies claim products are eco-friendly without evaluating the development process through which it was created.

With all aspects considered, a commitment to frequent revaluation of your portfolio, as well as a strong awareness of your own ethical principles is necessary for this category of investment, since personal principles are dynamic and constantly evolving. 

Future of Ethical Investing

Looking forward, it is clear that ethical investment is here for the long-term as investors and consumers are now placing more importance on issues of personal and corporate responsibility. In their attempt to be more sustainable, companies can provide stakeholders a sign that they’re aiming to achieve a long-term positive impact and provide greater certainty about the longevity of an investor’s chosen investment vehicle.

Rather than eliminating specific companies and industries like arms or alcohol through negative impact investing, there is a focus on the transition towards better systems or investment strategies. This change in approach can influence positive change, as well as developing more awareness about monetary flows and the resulting effects they have.