Features | From Pivot Magazine

The case for ethical investing

The corporate world is getting ready for a new wave of socially conscious investors 

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Forest setting with a graph background Ethical investing connects socially conscious investors with companies that pay attention to environmental, social and governance factors (iStock)

In June, my financial adviser offered me an opportunity to buy into a high-yield bond fund that had long been closed to new investors. It’s the kind of thing I often ignore—I don’t have buckets of money, and I usually leave my portfolio static and hope for the best. But this time I was curious. I clicked the link she sent and discovered the fund was dominated by traditional energy companies. 

I drive a car, fly (guiltily) to vacation spots and understand weaning society off fossil fuels won’t happen overnight. Yet somehow it felt wrong, given the threat posed by global warming, to invest in oil and gas industries. I told my adviser I didn’t feel good about the makeup of the fund and if she could find me something that was a better value fit, I would be happy to change. She got back to me in a heartbeat with a selection of sustainable options. Now I had a decision to make. My greedy side feared going green would lose me money. But my conscience won out and I asked her to shift the bulk of my investments into fossil-free funds.

The experience made me wonder how many others are making the switch and how their investments are performing. It turns out ethical investing, which connects socially conscious investors with companies that pay attention to environmental, social and governance factors (ESG), is going mainstream. In 2017, EY reported that this investment strategy has grown 107.4 per cent each year since 2012. In the United States, assets in ESG funds on offer to ordinary investors have more than doubled, from about US$40 billion in 2013 to close to US$90 billion in 2018, according to a June 2019 Morningstar policy research report. Europe is experiencing similar trends, the report states. 

People with small amounts of money to play with can’t exert much influence on the companies they invest in. So, like I did, they often adopt a negative screening approach to winnow out investments that don’t mesh with their values, says Sarah Keyes, a CPA who works for ESG Global Advisors. A savvy adviser will ask questions to reveal a client’s values and tailor investment advice accordingly. Once my adviser knew I wanted to avoid fossil fuels, she asked how I felt about firearms manufacturing, gambling companies and pornography production. There are ethical funds catering to all manner of hot-button concerns. 

According to Keyes, shifts toward ESG funds are also happening on a large scale. Giant investors like pension funds typically don’t rule out entire sectors. Instead, they may cherry-pick the best-in-class ESG performers across all sectors and use their clout to push for even greater change. In Canada, 51 per cent of all professionally managed assets have now adopted ESG integration strategies, which means they factor into their assessment whether the company understands and tries to mitigate their environmental and social risks, Keyes says. That percentage—which represents $2.1 trillion, according to the Responsible Investment Association—grew by 42 per cent between the end of 2015 and the end of 2017. 

Which begs the question: Are investors who increasingly choose ESG funds doomed to be money-losing martyrs, or do they come out ahead? Keyes says my negative screening approach might compromise returns. “It is definitely possible because you have reduced your investment universe.” However, Imran Jiwa, a CPA and director of impact and finance with Active Impact Investments, disagrees. “You definitely don’t lose money,” Jiwa says, provided you choose top-performing responsible investments and are seeking non-concessionary funds (that is, funds that are aiming to achieve market value returns). The Responsible Investment Association provides a quarterly report that compares the benchmark performance of responsible mutual funds with traditional investments. “I know the last time I looked they were on par or exceeded traditional ones,” Jiwa says. “If a company is able to identify these risks in addition to all the other technological risks, it shows good governance and an ability to look into the future, plan and adapt.” 

A 2019 Morgan Stanley report backs up this view: In an analysis of over 10,000 funds active in any given year from 2004 to 2018, the firm found no real difference between the returns of sustainable and traditional funds. Despite the fact that 53 per cent of investors believe investing sustainably requires a financial trade-off, sustainable funds may even offer a lower market risk, according to the report. 

I made a gut decision to swap my investments and I confess I didn’t investigate the performance measures of the funds that my adviser suggested. I trusted her to do her best, given my value constraints. But investors younger than me, who have grown up worrying about climate change, will likely start out demanding high-performing ethical investments.

In May of last year, Deloitte released its 2019 Global Millennial Survey, which was based on input from over 13,000 millennials in 42 countries, plus more than 3,000 Generation Z respondents people born between the mid-1990s and mid-2000s. The report found that business priorities are “out of step” with those of most millennials: When the respondents were asked what businesses should try to achieve, 32 per cent said “improving society,” while 28 per cent said “generating profit.” But when asked what businesses actually achieve, more than half said “generating profit,” while just 16 per cent said “improving society.” And the share of respondents who feel that business has a positive impact on society decreased from 61 per cent in 2018 to 55 per cent in 2019.

There are clear signs the corporate world is getting ready for this new wave of investors. Every year, BlackRock CEO Larry Fink writes an open letter to CEOs. Given that BlackRock is the world’s largest asset manager, you can bet everyone listens. In January 2020, Fink pledged to transition clients away from fossil fuels, noting that “sustainable investing is the strongest foundation for client portfolios going forward.” Companies that fulfill their purpose and responsibilities to stakeholders reap rewards over the long term. Companies that ignore them stumble and fail. This dynamic is becoming increasingly apparent as the public holds companies to more exacting standards. And it will continue to accelerate as millennials—who today represent 35 per cent of the workforce—express new expectations of the companies they work for, buy from and invest in. Fink’s words made me more confident about taking my own small investment stand. They also made me feel young at heart

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Learn more about ESG disclosures by downloading the discussion brief, Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making.