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Can ethical investing be profitable?

It goes by many names – ethical investing, sustainable investing, socially responsible investing, ESG investing – and it is an increasingly popular practice among investors and fund managers. But how exactly does it work? And does it mean sacrificing returns? Let’s look a little deeper. 

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What is ethical investing?

When it comes to investing, everybody has different goals and expectations. While many will focus solely on maximising returns, growing numbers of investors are looking to get something else out of their assets. Today, many investors look for personal connections to their investments, investing in companies whose practices and values align with their personal beliefs. Known as socially responsible investing (SRI), ethical investing or ESG (Environmental, Social and Governance) investing, it focuses on three areas:  

Environmental

In this area, investors, or fund managers, will look into a company’s environmental impact. Emissions targets, water usage and recycling policy are just some of the things that will influence a decision. A company that has particularly good green credentials will be looked upon favourably by ethical investors using the ESG strategy. 

Social

The social component relates to the company’s treatment of people – whether that’s it’s employees, customers or suppliers – and, in some cases, animals. Some issues that might influence opinions in this area are safety policies, employee treatment including pay, and ethical supply chain sourcing. Ethical investors will often shun companies they deem to have a negative societal impact.    

Governance

Finally, governance relates to the company’s corporate oversight. Here, ESG investors will analyse how the business is run, factoring in things like its transparency with shareholders, the diversity of the board, and the perks and payouts executives are entitled to. By investing in a company that has a positive corporate culture, not only can investors feel secure that they are supporting a fair organisation, but they may also be limiting their risk exposure. Companies that are well regarded for their corporate governance tend to be better performing and less scandal-prone. 

The biggest issue with this strategy is that it can be difficult to find a company that ticks all the boxes. ESG investors may prefer to decide what issues are the most important to them rather than looking for the perfect company. 


Ways to ethically invest

There are ethical options out there to suit investors of any level. Knowing what you want to get out of your investments and how much time you can put in is key when deciding what the best option is for you. 

Funds

Managed funds are probably the most popular and easiest option for ethical investors. If you don't have the time or knowledge to research individual companies and apply these techniques yourself, you could invest in funds that are managed in a way that fits your views. Funds can be a great way to invest in lots of businesses of different sizes, in different industries across the globe. The trade-off is that this ease of use comes at an expense and you will be charged ongoing management fees. 


ETFs

Exchange-traded funds (ETFs) can be a great option for those who want access to a portfolio of selected ethical companies but don’t want to pay the ongoing management fees. One thing to be aware of is that some funds may track companies that don’t quite match your principles, and there have even been cases of environmental ETFs tracking indices including oil and gas companies. It pays to do additional research into the individual assets that make up an ETF if there are certain sectors or companies you do not want to be associated with. 

Learn more about what ETFs are and how they work.


Investing in individual companies

Another option is to build a portfolio of investments that meet your ethical criteria. This could be as simple as choosing to avoid certain stocks or industries, like tobacco companies, or could involve a more detailed ESG framework. The challenge here may be finding the time to do the necessary research.


So is it possible to get a good return from an ethical investment strategy?

There are certainly examples of investors and fund managers that have done well by following an ESG framework. In fact, some funds have delivered three-year returns as high as 70 percent. There is also some evidence to suggest that SRI funds that exclude mining and resource assets can actually outperform non-SRI funds when there is a market slump as these are typically the most negatively affected industries.

At the same time, sin stocks like alcohol and tobacco tend to be strong performers during market downturns, so by overlooking these stocks, investors may be missing an opportunity to offset their losses in other areas. In fact, studies have shown that sin stocks outperform the market, so using an ESG framework will likely mean excluding a great number of high-performing stocks. Ultimately, it is possible to see healthy returns from ethical investment, but by placing restrictions on what you can invest in makes this a somewhat more complicated process.  

The bottom line on ethical investing

While it may require more time and consideration, it is possible to see a return from ethical investments. However, as ethical investing is based on your own conscience, the key to making SRI work for you is deciding where you stand on certain issues and how rigid you are in that stance before you make any moves. 

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