In the Q1 newsletter we wrote a ‘teaser’ article indicating that we would be launching an ethical range of portfolios, available to both discretionary and advisory clients. Ethical is a rather loose term in the investment sense but essentially has two distinct approaches, negative and positive screening, with portfolios evolving over time to include both approaches together with an increasing emphasis on engagement and sustainability. The latter is the belief that companies that will thrive are those which improve quality of life through advances in medicine, technology and education and those that drive improvements in the efficient use of scarce resources to build a more stable and prosperous future.
Attitudes to ethical investing have changed markedly over the last ten years as society’s attitude to the environment has itself changed, led by the millennials and Generation Z. Climate change, the environment, equality, human rights and labour standards drive todays agenda in society and companies increasingly understand this in how they manage their businesses. Investors are increasingly wanting their investments to have a positive impact in a changing world.
There are a somewhat confusing array of terms and labels surrounding ethical investing, and they can be applied rather randomly by the asset management houses to their funds and propositions.
Ethical investing in the UK dates back many decades originally associated with the Methodists and the Quakers and so became an investment philosophy that was closely associated with the church and charities. Investment is based on ‘negative screening’ avoiding investments considered harmful such as addictive products (tobacco, alcohol and gambling), pornography, weapons manufacture and later extending to poor environmental practises (the large energy companies), animal testing (the large pharmaceutical companies) or abuse of human rights (oppressive regimes or poor employment practices).
Positive screening targets companies which generate a positive social and environmental impact with investors looking for businesses that clearly demonstrate corporate practices prioritising the environment, human rights, diversity and sustainability.
An additional approach is engagement which is a practical and measured form of shareholder activism where investors use the power of their share ownership to enter into a dialogue with companies to encourage behavioural change for the benefit of society and the environment.
Combining negative and positive screenings alongside a policy of engagement is the basis for what became known twenty years ago as SRI (socially responsible investing), though in practise until recently most ‘ethical’ funds were more about exclusion than targeting a positive impact. This led to a certain amount of cynicism with the genuinely ‘dark green’ funds such as the Friends Provident Stewardship range which excluded over half the companies in the stock market being bracketed alongside many ‘light green’ funds whose investable universe seemed to be about 98% of the FTSE!
ESG (Environmental, Social and Governance)
ESG takes a broader approach and incorporates environmental, social and governance values and practices in these areas as part of their wider research, though the main focus still remains the company’s financial metrics and business outlook. ESG is thus one of the least restrictive ways to invest ‘ethically’. The concept of ESG first gained prominence post the 2008 financial crisis with a sense that a failure of governance and increasing inequality in society has contributed to the financial crisis. ESG investing is a bigger debate than just the ‘feel good’ ethical considerations. Proponents will argue that irrespective of the ethical benefits, companies that follow an ESG philosophy will benefit from improved revenues and profits over the longer term because the companies values are now aligned with societal values. Examples of where poor practice and governance have resulted in huge losses to shareholders include VW (diesel emissions saga), BP (Deepwater Horizon oil spill), Tesco (mis-stating accounts) and the big Banks (numerous examples of poor governance).
Cynics will claim that ESG portfolios are just virtue-signalling tokenism, a marketing tag added to a portfolio that is barely distinguishable from a traditional portfolio. ‘Greenwashing’ is the term frequently used, an example being ESG portfolios which hold British American Tobacco because it has an environmental policy. In isolation then ESG may look lightweight but in reality most funds will incorporate positive shareholder engagement in addition to just a loose ESG framework.
Impact investing has a core focus on the contribution the invested money will have on making a positive contribution to society alongside generating an acceptable financial return. These investments typically focus on the opportunities created by the transition to healthy, low carbon and sustainable future investing in sectors such as resource efficiency, environmental services, water management, clean and renewable energy, and accessible basic services including housing, healthcare and education.
UN Sustainable Development Goals
The Sustainable Development Goals were set by the UN in 2015 with the aim of being achieved by 2030. They are the blueprint to achieve a better and more sustainable future and address the global challenges we face today, including those related to poverty, inequality, climate, environmental degradation, prosperity, and peace and justice. These goals are being adopted by governments and businesses and the funds we invest in will often use these goals as a framework for the companies in which they invest.
The HFMC Portfolios
We know that a lot of our clients want to support a more sustainable future, making better use of scarce resources and tackling issues such as climate change, the environment and improved quality of life. We also appreciate that we need to produce the investment returns our clients require to meet their long term financial objectives. We think that the funds we have chosen and the portfolios we have constructed will meet both these criteria.
We have constructed three portfolios, which have the same risk/reward characteristics as our traditional Quadrant portfolios.
All the funds we have selected have tailored their investment approach to incorporate either:
A relatively straightforward ‘ethical’ screen to typically filter, amongst others, the ‘bad stuff’ like tobacco, arms and the big polluters.
A more nuanced use of an ‘ESG’ framework (Environmental, Social & corporate Governance) to not only filter the bad stuff, but to constructively engage companies to deliver positive societal and environment change.
A more encompassing ‘Sustainable’, ‘Socially Aware’ or ‘Positive Impact’ approach to its current, where investments are made in firms that are actively engaging in a business that deliver a positive benefit to society or provide solutions to environmental and social challenges.
Over time, we expect these portfolios to evolve in line with not only the traditional investment considerations we employ, whether it be fund performance, asset class valuations or changes to our outlook, but also in line with the evolution of responsible investing more generally. It is our current expectation that this will mean an increased use of funds with a greater focus on generating a positive social and environmental impact.
Several of the funds in which we are invested are the ethically screened versions of funds we already own on the traditional Quadrant Portfolios, such as Newton Sustainable Real Return and Troy Trojan Ethical. We also include funds from asset management houses with a long tradition of ethical investing such as BMO (formerly Friends Provident) and Edentree (formerly Ecclesiastical). Other fund groups from which have selected funds include M&G, Threadneedle, Jupiter and Premier.