According to research from AJ Bell Investments, during the past 12 months more than £3bn has poured into ethical funds, as investors start to plump for greener portfolios.
AJ Bell’s own customer research shows that millennials are more likely to rank ethical investing as ‘fairly important’ or ‘important’ than baby boomers. However, the long-held argument against ethical investing is that it they are more likely to underperform than their mainstream peers.
More positive than in the past
Adrian Lowcock, head of personal investing at Willis Owen, says ethical investing has made huge leaps during the past 10 years.
“For decades, ethical investing has been seen as a poor way to invest and has had an air of negativity surrounding it, with experts highlighting the fact it naturally reduces your investment universe and therefore negatively impacts on your potential returns,” he says.
“The negative aspect of ethical investing was also embedded in the investment philosophies of many portfolios as investors who wanted to invest ethically specifically wanted to avoid certain markets, such as tobacco or gambling.”
Lowcock notes that ethical investing was initially a response to the needs of some investors to reflect their personal moral views.
He adds the perception of ethical investing has changed significantly and the opportunities available have grown substantially.
“Ethical investing is no longer about avoiding certain markets. There is a more positive, collaborative attitude included for investors wanting to support change in ethical, environmental and social issues,” he says.
“At the same time, whereas ethical processes used to avoid certain markets, sustainable investing often looks to work with them in order to make improvements in how businesses in these areas operate and build in better practices to offset the negative impact they have.”
Defining ethical investing
Ryan Hughes, head of active portfolios at AJ Bell Investments, says the long evolution of ethical investing has been picking up pace in recent years.
“While there will always be a place for funds with strict ethical criteria, the past 20 years has seen the term ethical broadened to encompass socially responsible investing (SRI), through to ESG and on to impact investing, which has definitely widened the appeal of this type of investing,” he says.
“Historically, ethical and SRI was seen as a specialist field, but more recently we are seeing ESG principles make their way into just about every investment presentation. ESG elements are being incorporated into existing investment processes, right up to the world’s largest asset managers.”
This is a positive step for investors, according to Hughes, and any move that means asset managers become more conscientious stewards of client capital is welcome.
“At the same time, the depth of choice has broadened,” he adds, “making it easier to construct a portfolio that serves both active and passive investors better.
“While we are a little way from all of these approaches becoming mainstream, particularly when we analyse investor behaviour that continues to show a disconnect between interest in this topic versus money invested in the area, the movement is growing.
“I am certain this will continue to grow faster during the next decade than it has in the last.”
Virtually every fund manager is thinking about it
Put off by the notion that investing ethically comes with the caveat of average investment performance, the market share of responsibly invested funds has remained static for more than a decade.
However, Chris Metcalfe, investment director at Iboss Asset Management, says if the IA UK All Companies sector is taken as an example, the period following the global financial crisis has “undoubtedly seen a sea change in investor appetite” for ESG strategies. Whereas 10 years ago it was very much a specific theme for certain funds, it now plays a part in virtually every fund manager’s thinking and in every conversation,” he says.
“However, the one thing that hasn’t changed in the past decade is the huge divergence in adviser and client views of what titles like ‘ESG’ and ‘SRI’ mean in actuality.”
Rather than increasing exposure to particular funds or model ranges with SRI/ESG credentials, Metcalfe says Iboss will make these “eminently sensible credentials” a bigger part of its investment research.
“We also feel that in the coming years, as younger generations have increasing assets to invest, there will be a further move to environmentally aware companies. When customers vote with their feet, and wallets, things can change rapidly.
“Only last week some high-profile global CEOs were championing a greater degree of social responsibility and equality. As wealth disparity driven by politicians and central banks over many years continues to rise, many corporations are waking up to the fact that something has to fundamentally change.
“It could be argued that in the coming years every successful fund will be made up of many, if not all, companies that have a higher bar on SRI/ESG issues, if only for self-preservation reasons.”
ESG has had the biggest impact
Despite taking big strides forward, Lowcock believes the sector still struggles to gain mainstream acceptance due to the lack of clarity and consistency of what ethical investing actually is.
“With an increase in the different types of ethical investing there has been an explosion in the terms and jargon used to explain it, with little consistency across the industry leading to confusion for investors,” he says.
“This puts many off looking at specific ethical funds.”
While not a pure ethical strategy, Lowcock says ESG criteria has perhaps had the biggest impact on the industry. Decades of research into investment returns demonstrates that companies managed with good corporate governance, as well as strong environmental and social principles, tend to outperform over the long term.
“Ethical investing will always need to evolve as practices once seen as acceptable are disparaged today, such as the tech giants’ use of personal data, fast fashion or single-use plastic bottles.
“The next generation of investors, who are the consumers of today, will expect more from their investments and want their money to do more ethically.”