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30th November 2017

Busting the ethical investing myths

Nothing about socially responsible investing is incompatible with making money, argues FinchTech's Stephanie Sotiriou

Socially responsible or ethical investing is growing in popularity. Its central proposition, that it is possible to generate attractive investment returns whilst at the same time contributing positively to society, has obvious appeal. Indeed, the field is growing rapidly: ethical asset inflows increased by 18.1 per cent in 2016.

Nonetheless, a dissenting vocal minority in the investment community remain curiously dismissive. Their somewhat extreme opinion seeks to ridicule proponents as sanctimonious do-gooders who are less concerned about making money than they are about ‘saving the planet'. This misguided view, that the two aims are mutually exclusive, articulated by the few rather than the many in the debate, is nonetheless enough to ensure that ethical investing is treated with a higher degree of scepticism than the facts warrant.

Ethical investing is by no means purely a charitable endeavour, but is a legitimate means of boosting financial returns without compromising an investor's core values. Nothing about socially responsible investing is incompatible with making money. But it remains a victim of several common misconceptions which can hamper adoption - the main culprits are listed below.

Expense and return
The most common misconception about socially responsible investing is that it is more expensive and less rewarding than mainstream investments. This misunderstands both its appeal and benefits. Where cost is concerned, socially responsible investments only have a marginal premium over conventional investments - often necessitated by the requirement for more stringent due diligence checks. In terms of the average ongoing charges, the difference is typically negligible. And the emergence of ethical ETFs and passive funds providing even lower cost alternatives, is ensuring that fees overall remain very competitive.

The kneejerk idea that socially responsible investment leads to diminished returns is lazy logic at best. This ‘glass half empty' opinion may have once had some credence historically when socially responsible investing was in its infancy and options for the ethical investor were limited. Twenty years ago, the exclusion of the less ethically suitable industries such as tobacco, oil, gas and defence, might have introduced a degree of drag on
portfolio performance over time in certain circumstances.

However, fast-forward to today, where the ethical carrot and stick is driving firms to be ever more socially responsible in their activities, and the available universe of options for the ethical investor is attractively diverse. Companies which put health and safety, anti-corruption measures, and customer reputation at the forefront of their operations can benefit from sparkling PR, superior efficiency, less risk, and lower costs overall.
Empowered and emboldened by their mission to meet the needs of society, these companies are also typically more ‘switched-on' - minded to pay attention to trends in technology, politics, and economics, and adapt their business models to meet them.

This isn't mere conjecture: over a five-year time period, the FTSE4Good UK Benchmark saw 29.3 per cent returns, compared to the FTSE All Share's 26.4 per cent return. In this example, ethical investment was not just an effective substitute for mainstream investment: it outperformed it by almost three per cent.

Set against this context, the case for investing in funds which in turn invest in companies that are doing good for society, the environment, animal welfare, the aged, children, refugees, or any other cause becomes clear.

Expert opinion is predominantly positive
One of the more important litmus tests for ethical investment is the level of fund manager support. These professional investors are amongst the most knowledgeable on the subject and they would reject socially responsible investments if they were unprofitable, expensive, and overly risky.

The overwhelming majority of fund managers now either accept or proactively advocate the merits of ethical investing. Those at the forefront of the movement, lobby businesses for greater visibility and disclosure policies around sustainability, and actively engage retail companies on issues such as supply chain management and gender diversity.

And while many will doubtless be doing so with the best motives, we must remember that fund managers are essentially creatures of exhaustive risk assessment, ever-focused on maximising returns. Incorporating ethical elements can enhance due diligence considerations and screen out potentially scandal prone ‘sin stock' investments thereby creating more robust portfolios.

A portfolio for optimists, a portfolio for cynics
Even if one were to believe that socially responsible investments offer little in the way of positive impact, they are still worth considering simply based on their performance history. But investors who also believe that they can contribute to positive change, have plenty of evidence to back that opinion up.

Impact investing focuses on achieving specific socially and environmentally friendly goals through investing in companies involved in the provision of sustainable home appliances, building vital infrastructure, supplying clean water, and offering responsible loans to entrepreneurs through microfinance organisations. These are just a few examples: whatever the favoured cause, there is a way to support it whilst targeting attractive returns in the process.

Neither mainstream investment nor socially responsible investment are immune from underperformance, but it's only the latter that is regularly subject to naysaying criticism from a small sub-section of the investment community. It is not naïve or sanctimonious to pursue this kind of investment: For investors approaching ethical investing from a position of apathetic cost-benefit calculation, it's often an excellent option. And for those who also want to make a tangible difference to corporate practices, social issues, and people's lives, it provides the opportunity to do just that.

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