Introduction to Ethical and Sustainable Investing

The Cambridge English Dictionary defines ‘ethical’ as relating to beliefs about what is morally right or wrong. Morals are personal standards, the values we hold as individuals, particularly at the granular level. So naturally, the meaning of ‘ethical’ is personal to each of us.

Ethical investing is a very broad field of investment practices, with a problem: there is no one unified and generally agreed set of definitions for the field. All of the commonly used terms and acronyms can mean different things to different people

SRI – Socially Responsible Investing / Sustainable, Responsible & Impact Investing

Originally, the term socially responsible investing, or sometimes just responsible investing, referred to investors wishing to avoid certain companies based on their personal values. This values-driven, socially conscious, investment approach relies on negative-screening or values-based exclusion of businesses that are active in areas such as alcohol, gambling, tobacco, armaments, animal testing, or fossil fuels, amongst others.

The socially responsible investing definition of SRI is the most common (Wikipedia), but more recently, an acronymic alternative has started to be used (USSIF): sustainable, responsible, and impact investing. The two are sometimes used interchangeably, but neither is hugely useful, because the term SRI has become a generic ‘catch-all’ rather than indication of a specific focus.

Ethical investing covers not only regular companies listed on stockmarkets, but also other asset classes such fixed income and bonds, private equity, alternative investments and real estate. This means that we can reflect our personal SRI values in every element of our portfolio strategy.

Sustainable Investing

Sustainable investment strategies consider humanity’s future generations, and encourage businesses to make decisions with a long-term horizon – years or decades, not just next quarter’s earnings report. This means directing capital to companies that have positive policies towards global issues such as climate change, plastic waste reduction, natural resources usage and renewable energy, amongst many others.

Although companies implementing policies such as “cut emissions by 5% by 2023” or “source 50% of product supply from fair-trade organisations by 2025” may incur implementation costs that might affect financial performance in the nearer term, evidence suggests that sustainable strategies make companies more future-proof and more likely to have consistent cash-flows.

Sustainability policies help businesses challenge long-standing operational processes, strategic goals, and perceived corporate truths. For instance, Mark Carney, former head of the Bank of England, commented on the realities of carbon-budgeting to fight global warming – many fossil-fuel reserves of firms could become worthless:

“If we were to burn all those oil and gas [reserves], there’s no way we would meet carbon budget,” he said. “Up to 80% of coal assets will be stranded, [and] up to half of developed oil reserves.”

In this context, consider the largest IPO of all time, Saudi Aramco, in 2019. How will it’s massive valuation be affected by the declining prospects for oil? Or for another example, consider that the energy sector’s share of the S&P500 has more than halved in ten years, and now stands at just 5%. Yes, the oil price has fallen by a third in the same period, but to what degree are corporate and private investor values wielding influence?

Impact Investing

Impact investing strategies have an explicit intention to make a positive and measureable impact on the world. Impact investing is usually focused and theme oriented, for example:
  • Access to clean drinking water and sanitation in rural India
  • Low-income housing in South American rural communities
  • Microfinance for African women farmers and entrepreneurs
Depending on the priorities of an impact investing fund, it may or may not have an objective of returning a market rate to investors.

Impact investing has tended to be a niche area of investment, but is now becoming more mainstream. Speakers from the United Nations Impact Finance Team, the EU, the OECD, as well as banks, asset managers, and UNICEF, will be at the Impact Investing World Forum in London, April 2020.

ESG – Environment, Social and Governance

Environmental, Social and Governance factors provide a guide or framework to help investors analyse investment opportunities in the context of sustainable, responsible, and impact investing.

There is substantial growth in asset managers considering ESG factors into their investment strategies, for example Liontrust, Mirabaud, Stewart Investors, BNP Paribas, Schroders.

ESG is a broad shopping-list of issues, such as:

  • Climate change impact, carbon emissions, greenhouse gasses
  • Air and water pollution
  • Water usage and conservation
  • Waste management, landfills, recycling
  • Energy efficiency, reduction, alternative sources
  • Deforestation and land use
  • Human rights
  • Gender equality and diversity policies
  • Data protection and consumer privacy
  • Health & safety
  • Labour conditions
  • Community relations
  • Board composition
  • Company ownership
  • Financial reporting and tax strategy
  • Executive remuneration
  • Bribery and corruption policies
  • Political contributions
  • Lobbying activities
ESG issues can be incorporated into the investment selection process via several different methodologies, including:
  • Positive Screening – seeking to identify companies with best-in-class ESG characteristics relative to peers;
  • Negative Screening – excluding from selection those companies involved in activities considered unacceptable;
  • ESG Integration – the systematic and explicit inclusion of ESG factors into financial analysis.
Rules-based ‘ESG scoring’ systematically measures and rates a company in respect of relevant environmental, social and governance characteristics.

Market index providers, such as S&P and MSCI, use ESG ratings to create indices that reflect objective sustainability/SRI metrics of component companies, hence allowing fund managers to benchmark against such indices, and create tracker funds that follow them.

Additionally, some investment research firms, such as Morningstar, have created their own sustainability ratings, in an effort to help investors compare the ESG credentials of different investment funds.

Green Bonds and Climate Bonds

Green bonds are fixed-income instruments, i.e. bonds, that are designed to provide finance for projects that are environmentally positive in some way.

Climate bonds are logically a kind of Green bond, to finance projects specifically for climate change solutions. Although, the terms ‘Green bond’ and ‘Climate bond’ do sometimes get used interchangeably.

‘Certified’ climate bonds are those meeting rigorous scientific criteria established to ensure consistency with the goals of the Paris Climate Agreement to limit warming to under 2 degrees.

The scope of Green bond financing is broad, and includes categories such as:
  • Low Carbon Buildings
  • Low Carbon Transport
  • Geothermal Energy
  • Marine Renewable Energy
  • Solar Energy
  • Wind Energy
  • Water Infrastructure
  • Forestry
  • Bioenergy
  • Protected Agriculture
  • Land Conservation & Restoration
According to research published by the Climate Bonds Initiative, US $167.3 billion of green bonds were issued in 2018, and in the first half of 2019 this figure was already US $117.8 billion (up 48% on H1 2018).

Islamic Investing

Islamic investing is a unique form of socially responsible investing. It is a faith-based approach to finance, consistent with Islamic teachings. There is no one neat definition of Islamic finance. Experts agree that the principles of risk-sharing and ethical investment are paramount.

Islamic finance must avoid “sin” (i.e., prohibited) businesses; so for example alcohol, gambling, certain forms of music and entertainment, pornography and tobacco are prohibited for investment, as they are for consumption. It must also abide by the Islamic prohibitions of riba and excessive gharar, which are generally understood to include lending and borrowing of money at interest and sale of risk.

Shariah screening criteria provides guidelines for excluding companies conducting non-Shariah-compliant business activities. They also specify a set of financial ratio screens, designed to exclude companies with unacceptable levels of leverages, receivables and interest income.

Since conventional bonds are haram, because they yield riba, instead of ‘normal’ bonds, Muslims may purchase sukuk. First issued in Malaysia in 2000, sukuk represent undivided shares in the ownership of tangible assets relating to a specific project or investment activity.

Here are a few background points:
  • The ideas associated with Islamic finance have wide appeal and are not necessarily exclusive to Islam.
  • Whilst Islam dates back to the 7th century, modern Islamic finance practice is a 20th-century phenomenon.
  • Modern Islamic finance is a small but growing industry; it consists largely of commercial banking; most of its assets are concentrated in a few countries.

Why not leave more than only a financial legacy for the next generation.  Why not change the world?

Put your pension pot or other savings to work - to fight climate change, and address specific social and environmental issues you care about.

Please contact me TODAY for an initial chat about your options, and how I can help make sure your financial assets reflect your personal values.

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