Ethical Investing in an Age of Cynicism
We are living in a time of great cynicism and distrust. Our institutions and social norms are being challenged daily. The very idea of being communally minded and socially engaged via the use of one’s investments has come under fire. There are political actors who are seeking to suppress the use of ethical and “ESG” metrics in portfolio construction. In a moment such as this, socially conscious investing has become both more important and more scrutinized.
Ethical investing is an overarching term that encompasses several approaches, including Socially Responsible Investing (SRI), Environmental, Social, and Governance (ESG) investing, and Impact Investing. These approaches are not mutually exclusive, and many investors use a variety of lenses to construct a portfolio that aligns with their values, delivers market rate returns, and contributes to a world that is more just and sustainable.
Traditionally, SRI begins by excluding certain industries that have negative social impacts. Such industries might include firearms and weapons of war, tobacco, alcohol, fossil fuels, gambling, and companies that profit from mass criminalization. Some of the earliest proponents of such exclusions were religious communities for whom profiting from these companies were anathema to their values and beliefs.
ESG investing integrates environmental, social, and governance factors into investment decisions but does not necessarily exclude any industries. Some who use these metrics will take the approach of buying the “best of breed” among various industries, using the ESG criteria as a methodology that focuses on risks that are material to a particular company and thus risks to the overall portfolio. For example, a company that is more highly ranked in the Environmental component may have received that ranking because they are doing more to mitigate the risks of climate change to their own business. (Think of property insurance companies as well as those companies that are vulnerable to climate related supply chain issues.)
The Social metric focuses on how a company treats its employees and supply chain relationships, as well as the communities in which it is embedded. This measurement helps distinguish those companies that understand that humans are not simply interchangeable widgets and that cultivating talent is indicative of a company’s long term success.
The Governance metric has been used for years among institutional investors to make discernments about the strength and functioning of the company’s board of directors, and to ferret out any conflicts of interest or potential nefariousness in accounting practices.
It would be very typical to use the SRI approach to exclude certain industries entirely, and then overlay an ESG analysis, choosing the highest ranking ESG metrics among the remaining companies to derive a list of publicly traded companies that would be investable through this ethical investing lens. If concerns about diversification arise, it is good to remember that it is commonly understood that you only need 25 to 30 stocks, well selected, to create a diversified portfolio. (See “Peak Diversification: How Many Stocks Best Diversify an Equity Portfolio?”.)
The last of these three lenses, Impact Investing, takes a more direct approach by targeting companies and projects with measurable positive social or environmental outcomes and is often most effectively done using non-publicly traded investments, though there surely are publicly traded companies that are not just avoiding the “bad,” but are trying to bring about the “good.” The 17 Sustainable Development Goals (SDGs) that were codified by the United Nations in 2015 and adopted by all member nations at that time is a framework for this. They include things like affordable clean energy, clean water and sanitation, and good health and wellbeing. Goals such as these can translate into market-based solutions that are investable.
A common criticism of ethical investing is that it has limited real-world impact and may even come at the cost of financial returns. But as I already asserted, the push back we’ve seen of late is a great indication that it does in fact “work” – if work here means that it is impacting corporate behavior and demanding more accountability and transparency. It also works in delivering market rate returns. Companies that prioritize environmental, social, and governance issues tend to have better risk management, stronger reputations, and more resilient business models, all of which contribute to financial stability and growth over time. (See “The Impact of Environmental Social and Governance (ESG) Reporting on Corporate Financial Performance”.)
Moreover, the rise of impact investing – where capital is directed toward businesses and projects with tangible social benefits – demonstrates that financial growth and positive impact are not mutually exclusive. Investors can make a difference by supporting ventures that directly address social and environmental challenges, while treating their employees and other stakeholders as humans who are deserving of safe workplaces and fair wages.
There is no perfect system, and it is almost impossible to invest in publicly traded companies and do NO harm. But it is possible to not only do LESS harm, but to be an agent for a more just and sustainable world. Ethical investing, when done with due diligence and a critical eye, remains a powerful tool for promoting a more just and sustainable world.
Photo by Jason Mavrommatis on Unsplash
