Scandals, fraud, lies, and cheating; words that aren’t quite as commonplace in financial markets as they used to be. But they still do exist. One factor that reduced it is arguably Ethical Investing. But what is Ethical Investing exactly? What types of ethical investing are there? And where should you start? Let’s find out.
What is Ethical Investing?
Firstly, what is Ethical Investing?
Ethical investing can be described as the practice of investing only in those companies with a proven track record of taking an active role in improving the world.
That’s a pretty broad definition, for sure.
Furthermore, what’s “improving the world” in one person’s eyes may well be destroying the world in another’s eyes.
So it’s not an unambiguous definition by any means.
But on a major level, that’s precisely the point with ethical investing.
It’ssomewhat ambiguous.
But increasingly, there are several types of ethical investments you can focus on.
And the finance world is catching up by tailoring new products to make this process easier.
Why Is Ethical Investing Important To Investors?
It’s almost commonplace these days to be watching the news and find out that either a company or a well-known executive has entered the spotlight because they got caught doing something between uncomfortable and horrific.
As a person going about their day, it just makes it seem like the world keeps getting darker and darker.
As an investor, it makes you second guess the value of supporting those types of companies with your hard-earned capital.
Whether you own a very small part of a company or you’re a major stakeholder, your investment in a company shows you believe in the company and want them to grow.
Importantly, your motives for investing are yours, and no one should tell you whether you’re making the right decision.
But generally speaking, it’s fair to say that ethical investing matters to investors because it helps them better align their investments with their core values.
Now, one of the goals of this article is to provide a bit of perspective on your investments that you may not have thought about.
These aspects may be a good consideration if you want to change your portfolio around and get it to better align with your personal values.
Understanding Investments and Personal Values
As with everything in the finance world, the first step is to understand what exactly it is you’re investing in.
You may already have a large portfolio full of mutual funds and ETFs, providing you with a comfortable retirement account that gives you decent returns.
However, if you own any shares in the S&P 500, FTSE 100, or other large-cap mutual funds, you are essentially a shareholder in some of the largest companies in the world.
In order to find out what you’re invested in, you may want to start by doing even a few minutes’ worth of research into what is in your portfolio.
You can open the fund on your investment firm’s website and look at the allocations.
Most countries require investment firms to publish the details of their funds for investors to research at their leisure.
If you go down the list of stocks or corporate bonds and see a company that has practices you don’t agree with, perhaps it’s time to consider another strategy.
Avoiding Stocks That Don’t Align With Your Values
You can invest in companies that have put effort into:
- ethical business practices,
- environmental consciousness,
- social interests, or
- a combination of all of them.
If you fancy yourself a bit of a stock picker, then this strategy has always been available to you, though most other investors were restricted to investing only in the most accessible products.
All you had to do was read pages and pages of annual reports and decide whether the company was engaging in practices that you agree with, let alone that would lead to an attractive return.
Reading annual reports is not, however, something most investors would like to spend their precious time doing.
Sure, there are ways around this. For example, one could apply Natural Language Processing techniquesto analyse large volumes of annual reports.
And by the way, if you’re interested in doing that, you should definitely take a look at our Investment Analysis with NLP Course.
You do need to know the basics of how to code to take that course though.
That being said, the finance world is catching on to the interest in ethical investing.
As a result, much of the work can be done for you.
For instance, funds are increasingly packaging new products that allow investors to put money in companies that meet various ethical parameters.
There are also websites devoted to tracking the ethical practices of companies to help those who would rather not read financial statements better understand which companies are actually worth investing in.
Okay, hopefully, you now know what Ethical Investing is.
Let’s now get into some of the different types of ethical investing to help you decide which way is best for you.
What Types of Ethical Investing Are There?
As with any relatively new investing concept, there are somewhat wide-ranging ideas about what the exact types of ethical investing should be.
However, we’ve included three of the main types that investment firms are focusing on:
- Impact Investing
- Socially Responsible Investing (SRI)
- Environmental, Social, and Governance Investing (ESG Investing)
Let’s consider each of these three types of Ethical Investing,
Impact Investing
Companies that strive to make profits while also benefiting the world fall into this category.
The goals vary from social issues to environmental issues, so if you just want to support broadly ethical companies, impact investing is a good start.
For example, suppose you’re concerned about child labour and its association with the fashion industry.
You might consider looking at a textile-focused impact fund that focuses on companies that improve communities and support childhood education.
Socially Responsible Investing (SRI)
These funds will have a defined goal of supporting companies with a particular religious, political, corporate governance, or values-based mission.
One example of these funds is the 1919 Socially Responsible Balanced Fund, which invests in companies like Thermo Fisher Scientific and Beyond Meat(source: 1919 Funds Annual Report (2020))
As long as you trust that the fund will do what it says, you can be reasonably confident that your investments are going towards socially responsible businesses,
Environmental, Social, and Governance Investing (ESG)
These types of funds generally include companies that rate highly on environmental, social, and governance criteria.
While it might seem very similar to SRI funds, ESG funds focus on the quantitative measure of things like:
- pollution output,
- waste reduction figures,
- comparisons of several to show a net positive impact on the world.
As an example, you might think of Microsoft as a huge tech company that burns through electrical resources to support their enormous cloud network.
However, their goal of becoming carbon negative by 2030 is arguably a very realistic target.
Funds made of companies showing quantitative improvement would fall into ESG funds.
Now, remember how we said that investing in these types of funds means you don’t have to do all the research by yourself?
True as that is, it does also mean thatsomeone has to do the research.
And that has a cost associated with it, which can end up reducing your returns.
This brings us to the next point.
Won’t There Be Limitations to Investment Returns with Ethical Investing?
It’s understandable that some investors might be hesitant to fully adopt ethical investing since these efforts tend to cost money.
This is from both sides, including:
- companies facing higher costs, and
- investors potentially earning lower returns
When companies increase their spending, it reduces the bottom-line earnings. And investors generally frown on lower earnings.
However, it’s also important to remember that companies with effective policies in place to improve the world around them tend to have happier, more productive people working for them.
Not only are the employees happier, but companies with these ethical policies are also sought after by consumers.
The natural domino effect is that sales numbers may improve simply by enacting those policies.
As far as investors earning lower returns goes, this really comes back to the question of personal values.
Do your values prioritise ethical investments or the highest expected return?
Only you know the answer to that!
Once you figure that out though, it’s then a case of creating a successful ethical investment portfolio.
One that fits and aligns with your personal values.
How To Create A Successful Ethical Investment Portfolio
You will find that most major investment firms offer ethical investment funds with varying targets.
The first step in the journey to an ethical portfolio is to decide where you want to invest.
Since this concept is a bit young, it may be a good idea to focus on larger investment firms that are more likely to have the capital available to create new ESG, SRI, or impact-based funds.
The next step is to decide how active you want to be in the process and what matters most to you.
You can certainly be an activist investor, going through company reports and deciding which companies to invest in one by one.
For those with a genuine interest in knowing every detail of their portfolio, it is absolutely possible to learn how to:
- read annual reports,
- review company websites, and
- figure out which companies to invest in.
This will take some time to learn and may require special coaching, though.
And it assumes you have a solid foundation of the other side of the coin – investment analysis and portfolio management.
Alternatively, you can simply buy into one or several funds created by the large investment firms as we mentioned.
Robo-advisors like Wealthsimple and Betterment are also creating new products for investors looking to adopt ethical investing.
Importantly, remember that there’s a cost associated with using packaged funds (even if you can’t see it explicitly).
The last step is simply to put your money in those funds and leave it alone.
As with all investing, there is some risk involved.
The goal is always to see growth in your portfolio.
And most of the big companies with ethical policies will almost certainly grow.
Most investors will tend to benefit by making decisions and letting their money grow passively over time while also adding more money to the portfolio on a regular basis.
What’s Next: Ethical Investing
Ethical investing isn’t necessarily new. Activist investors like hedge fund manager Bill Ackman have been putting money into impact investing for many, many years.
However, the accessibility to ethical assets is now just becoming more widespread so that anyone can invest their money where they feel it will do the most good in the world.
You can learn how to pick ethical companies yourself and simply buy the stocks of those companies.
But it will take time and effort to be effective at doing this.
Remember that you can always seek advice to improve your potential portfolio returns.
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