What is ethical investing?

by

Jack Derwin

October 15th 2021 3 minute read

Beyond understanding simply what a company does, investors are increasingly concerned with how it acts.

A growing number are asking whether or not their money is being used in a sustainable and responsible way, and making the conscious decision to invest it with those businesses that align with their own values.

This is called ethical investing, or sometimes ESG investing, which refers to the three major areas of concern: how a company deals with Environmental, Social, and Corporate Governance issues.

Is ethical investing less profitable?

There is an enduring perception that ethical investments inherently produce worse returns. But responsibility and profitability aren’t necessarily mutually exclusive, and benevolence can actually be good business.

In fact, sustainable equity funds actually outperformed traditional funds in 2020, according to Morningstar analysis.

The research shows that three out of four sustainable funds beat the returns of non-sustainable ones last year. Overall, 42% of those analysed ranked in the top quartile, while just 6% ended up in the bottom one.

A separate study found that in the ten years to 2020, sustainable funds outperformed their rivals, producing average returns of 6.9% versus 6.3%.

Naturally, not all ethical funds are built the same. Nor is past performance an indication of future performance. But the research does indicate that those who choose to invest ethically are able to reap at least the same returns – if not potentially better – as those who don’t.

How to invest ethically

If you’ve decided you want to be an ethical investor, then it’s time to take a few important actions.

1. Define ‘ethical’

While it is often thrown around as a catch-all term, ethical investing can mean vastly different things to different people. It’s important then that you know what you personally value and where you draw the line.

To do so, you’ll need to determine your own ethical benchmarks and ask yourself some key questions.

  • What does it mean to be ‘green’? Should a company be using wholly sustainable materials and processes throughout its operations? Is it enough to use renewable energy or do you need to see progress towards a net-zero carbon emissions target? Decide on the kind of environmental standards you require from an investment.
  • Do your values truly align? If you choose to invest via a fund, it’s up to you to determine if their standards are as high as yours. Any fund can call itself ‘ethical’ but you may go through their holdings to find a business that you wouldn’t touch with a barge pole. Facebook for example may fit neatly into somebody else’s ethical portfolio but it may not satisfy your own idea of social responsibility.
  • What is a deal-breaker? Would you be comfortable investing in a company that makes a profit from tobacco, alcohol or gambling? Are all fossil fuel companies on the no-go list or would you invest in an oil company that supports environmental projects? How about a mining company that is divesting its coal assets?
  • Which companies are proactively making a positive impact? While much of ethical investing tends towards screening out ‘bad’ companies, investors can also look for those advancing causes they support. If you’re passionate about the energy transition, perhaps you’ll want to back a company revolutionising renewable energy, or one manufacturing electric vehicles (EVs). Of course, you’ll still need to scrutinise their operations for other ethical issues.

2. Carefully divest from unethical companies

The above questions can help you develop your own ethical framework and determine what is and isn’t acceptable for you.

But just as those questions can guide future investment decisions, they can also help you reflect on old ones. By routinely reviewing their portfolio, an ethical investor can ensure they are still comfortable with their decisions as their ethics, and the companies they hold, change over time.

By divesting from those that don’t meet your expectations, you can effectively remove your financial support of harmful companies and pressure them to do better.

3. Check your super

Australians often forget about their superannuation fund, despite the fact it receives 10 cents of every dollar they earn over a lifetime.

Collectively controlling over $3 trillion, the superannuation industry wields enormous amounts of influence over business practices both in Australia and abroad and can actively lobby companies on the behalf of members.

Regardless of the size of your balance right now, your enormous earning potential means your superannuation decisions truly matter.

As with managed funds, ethical super funds can differ wildly in their values and their holdings. They can also lack transparency around how they allocate your retirement savings. Again, it’s crucial you check your fund to ensure it puts its money where its mouth is.

There are also alternatives that provide greater oversight. With Superhero Super for example,  members can choose to invest 75% of their super into direct shares and ETFs, giving them more clarity and control over their nest egg.

4. Do your research

Unfortunately, as pressure grows on companies to do better, some are tempted to make claims that don’t stack up. Some may make empty or tokenistic gestures on social or governance issues, while others may practise greenwashing, attempting to appear more environmentally friendly than is actually the case.

It’s always important to ask if a company is doing everything it claims to be. Ultimately, ethical investors need to do their own research to be sure they know where their money is going.

You can trade shares and track the performance of your ESG portfolio on the Superhero app. Trade Aussie shares for $5 and U.S. shares for $0 brokerage.

Superhero does not provide financial advice that considers your personal objectives, financial situation or particular needs. All investments carry risk so please consider carefully before investing. Past performance is not indicative of future performance. Graphics, charts and graphs provided for illustrative purposes only.

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