John Fleetwood of Ethical Money Limited on making social factors an integral part of investment decision-making
Finance is commonly seen as the domain of facts, figures and men in grey suits. Yet, we rarely make important decisions solely on financial grounds – having a family, getting married, buying a car – so why should it be any different for investing?
Financial planning is all about identifying life goals and implementing a plan to achieve those aims. Too often this has been restricted to cashflow analysis and risk-adjusted financial returns, without considering wider factors.
Yet the financial turmoil of recent years has led to a growing distrust of the financial system and investors want to know more about how their money is invested.
This provides a perfect springboard for incorporating non-financial factors in to the planning process and makes social factors an integral part of many investors’ decision-making, albeit with differing degrees of importance.
The nutty fringe
Traditionally, such an approach was seen as the preserve of the ‘nutty fringe’, a small group of die-hards comprising religious groups, environmental activists, animal rights campaigners and pacifists. For this group of people, moral and environmental issues have long been a critical part of their thinking and the origins of ethical investment date back to serving this limited market.
In 1984, the Friends Provident Stewardship fund became the first ethical fund to be launched in the UK. Like the majority of the ethical funds that followed, the Stewardship fund primarily adopted a strategy of avoiding ethically unacceptable activities, although even at this early stage, the fund did seek to invest in areas it considered of benefit to society.
More than 25 years later, many people still think of ethical investment in this vein, but over the last 10 years it has evolved to embrace a broad range of differing approaches and in doing so, offers attractive alternatives for a much wider group of investors.
Innovation
The first innovation dates back to 1988 when the Jupiter Ecology fund became the first fund to focus on solutions to environmental challenges.
In recent years, the Ecology fund has been joined by at least 12 environmentally focused funds in the UK alone.
Like the Ecology fund, some of these avoid activities commonly regarded as unacceptable by ethical investors, but many of the more recent entrants are pure thematic funds which have no such ethical constraints.
Funds like Impax Environmental Markets fund and the Lyxor World Water fund are designed to appeal to the conventional investor on their financial merits alone. The Impax Environmental Markets fund has rewarded investors by delivering a capital gain of 60% over the last five years, outperforming the IMA Global Growth Index by a margin.
It is little wonder, therefore, that investors are coming to recognise the long-term potential of such funds and are doing so in increasing numbers, with Impax alone having amassed over £1bn in assets under management. This has led to the launch of more funds in the cleantech, climate change, water and renewable energy sectors, latterly including sector-specific ETFs.
Thematic investing
Thematic investing constitutes a completely different approach to ethical investment. Rather than focusing on the problems, it seeks out solutions. It appeals to a much wider cross-section of investors than applying ethical exclusions since there are sound demographic, environmental and legislative reasons why these will make good investments in the longer term.
At the same time, a form of investing has emerged that serves a relatively small, but important investing community. This community of investors seeks to use their money to make a social or environmental impact.
Unlike stock market investment which essentially represents a trade between buyer and seller (rights and new issues excepted), impact investing makes something happen that would not happen without that investment.
There are a growing number of these investments such as Big Issue Invest, which funds social enterprises in the UK, and the Cochabamba Project, which is an industrial and provident society investing in the reforestation of the Bolivian Amazon.
However, ethical investment has also developed in a quite different direction. Rather than focusing on specific industries or avoiding particular activities, a number of investors have chosen to take account of social and environmental factors in their investment process.
Preference is given to companies with better social or environmental performance in their sector, other financial factors being equal.
Clearly this has more widespread appeal since it does not act as a constraint on the investment universe, but it does require a major research resource as provided by companies like Aviva, F&C and Henderson. A forthcoming fund
launch is set to take this further. The Active Earth funds seek to invest in securities where environmental factors have not been fully recognised by the market and as a result, present financial opportunities.
Nor is ethical investment limited to equity investment. Although the UK market is still dominated by equities, there are several ethical bond funds, a number of multi-asset funds and it is also possible to invest in sustainable property and forestry funds. This wider range of assets has prompted specialist fund manager, King & Shaxson, to launch a range of five ethical discretionary portfolios with different risk profiles.
Ethical development
This is just the latest in a long line of developments in ethical investment that mirrors the rise of environmental and social factors in the public and commercial consciousness. Climate change has possibly had the biggest impact, with almost every large company now recognising the material impacts that this will have on operations.
At the same time, companies understand they need a moral licence to operate and the experience of retailers such as GAP and Nike (who were forced to change their sourcing policies by the weight of public opinion) demonstrates that social issues do matter.
In the same way, ethical investment is changing from a niche market comprising less than 1% of the total to something that is an integral part of the investment industry.
John Fleetwood is director of Ethical Money Limited
