Why Responsible Investing Is More Popular Than Ever Before

Why Responsible Investing Is More Popular Than Ever Before

Demand for so-called ‘responsible’ investment assets is higher than ever before. And it’s continuing to grow. Retail (individuals, not big funds) investment has grown an impressive 24% over the past year, to over $32 billion.

The Responsible Investment Association of Australasia (RIAA) has just released a new report. The ‘Responsible Investment Benchmark Report 2015 Australia’ is a 20-odd page review of the state of responsible and ethical investing in Australia. It’s the 14th annual review in the series.

The Report also found that institutional investors are getting more ethical. They’re integrating ‘responsible investment strategies’ in to the way they run their funds. That’s not to say they have the same set of rules or principles as those retail investors, but they’re on the right track. The RIAA estimates that funds with these strategies manage a further $598 billion in assets.

That means that, with a total of $630 billion of assets, responsible investment makes up 50% of the investment industry.

Highlights from the Report

Simon O’Connor is the chief executive of RIAA. He commented on the drive behind the increased demand for ethical investment products. ‘Growing consumer confidence in responsible and ethical investments plus the finance sector taking ever-stronger positions on issues such as tobacco and fossil fuels are driving the strong uptake of responsible investing,’ said O’Connor.

Some of that is coming from activist groups. These groups are encouraging regular people to think twice about how their retirement wealth is invested. For example, climate activists encourage their audiences to find out if their super funds invest in fossil fuel companies. The RIAA estimates that fossil fuel divestment activists have had a significant impact on ethical assets under management.

On a wholesale level, activist groups have had a similar impact on super funds. Over the past year, several large super funds have got rid of their tobacco assets. Many groups are still working on divestment campaigns, and are yet to have a full impact. For example, Netherlands-based international peace organisation PAX has a campaign called ‘Don’t Bank on the Bomb’. This campaign regularly reports on institutions that invest in the development, production and maintenance of nuclear weapons. They’ve got a hall of fame for divestors, and a hall of shame for investors. If you’re interested, you can check out the report summary here.

O’Connor added that ‘Consumers in ever greater numbers are awakening to the fact that you can invest prudently and profitably without compromising your values which is resulting in the growing retail interest in responsible investment.’ He’s not wrong about that. Several funds with a focus on responsible investment have reported impressive returns over the past year.

Take Australian Ethical Investment Limited [ASX:AEF] for example. They’re a member of RIAA. Since September 1994, its flagship fund has returned 10.1%. The S&P/ASX200 has returned just 5.5%.

According to the Report, ethical funds have outperformed regular funds, on most scales and time frames.

ethical investment outperforms
Source: RIAA
[Click to enlarge]

What does ‘ethical investing’ really mean?

Recently, Money Morning had the honour of posting an opinion piece from federal senator David Leyonhjelm. Senator Leyonhjelm discussed the poor definition of ‘ethical’ investing. And how a lack of understanding can hurt businesses which don’t actually have a negative impact.

His argument focused on the definition of ‘sustainability’. Sustainability, as a general criterion, is often used to screen unethical investments. Leyonhjelm likes a definition put forward in a report overseen by former Norwegian prime minister Gro Harlem Brundtland in 1987. This definition is ‘Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.’ Leyonhjelm pointed out that:

It’s the use of modern technology — so despised by green dogmatists — that makes this possible. Vaccines (increasingly the product of genetic engineering) and chemicals help keep cattle healthy. Pasture management using hybrid seeds and chemical fertiliser means there is enough food for them.If agriculture is to feed the world, it needs more sustainability like this.

‘What’s needed is recognition that human impact on the environment is not only unavoidable but mostly highly positive. … It is a simple fact that nature is resilient and adaptable. In a thousand years the farms of today will be producing far more food and fibre they do now. That makes them sustainable.’

He makes a good point about food security. After all, food security is an important part of improving equality and reducing the impact of poverty.

What he’s missing is the ripple effect of the negative impacts of human activity. The part of the impact that’s not ‘highly positive’. For example, the way pesticide use can reduce biodiversity. The problem with the impact of chemicals and pesticides on biodiversity is that we don’t even know what we might be losing when species die off. For example, it’s widely believed that many future medicines will be derived from plant species that are yet to be discovered.

And then there’s the bee problem. Neonicotinoids are a class of insecticides that are commonly used on a variety of crops around the world. Unfortunately, in addition to killing harmful bugs, they also kill bees. Bees are a critical part of any ecosystem, as they play an important role in pollination. US grocer Whole Foods Market [NASDAQ:WFM] last year ran a campaign highlighting how many foods rely on bees at some stage during production.

whole foods produce without bees
Source: Whole Foods
[Click to enlarge]

If you’re interested, you can read more about the issue at Greenpeace, Save Our Bees, Pesticide Action Network International, and more.

The key isn’t stopping investment in agriculture altogether, as some firms like Australian Ethical have decided to do. It’s about finding ways to alleviate food insecurity that don’t rely on unrecoverable land clearing, irreversible pollution, and irrevocable damage to biodiversity. Like Leyonhjelm pointed out, the environment is a lot more resilient than we give it credit for.

Successful ethical investing is about knowing how resilient it is, and never pushing those boundaries. For example, fish farming doesn’t always harm the environment, if pollution is managed effectively. Many fish farms have a biodynamic, ‘closed cycle’ type setup. There are plenty of ethical investment opportunities within a variety of different sectors. It just takes a little research to uncover them.

How to invest ethically

Once you accept that there’s a little subjectivity in this area, it’s easy to design your own strategy for ethical investing.

There are three ways you can go. First, you can choose only investments that have a positive ethical benefit. The RIAA would call this ‘impact investing’. Basically, the aim of this strategy is to make sure your investment. That’s opposed to just not having a bad outcome. The Global Impact Investing Network maintains a database of impact investment vehicles. If you’re interested, you can check out ImpactBase here. Local organisation Impact Investing Australia also maintains a handy news feed.

Second, you could choose investments that don’t have a negative impact. This is what the RIAA would call ‘screening’. It allows you to choose from a lot more different options. For example, Australian Ethical avoids companies involved in human rights abuses, gambling and exploitative labour practices, amongst other things.

Wondering what counts as a ‘negative impact’? Well, that’s really up to you. There are a few basics that most people would be able to agree on. For example, as mentioned before, many Aussies have already got rid of their investments in fossil fuel companies. Some have also sold their tobacco stocks. In the past, publicly traded fashion retailers have suffered the backlash from publicity around their labour practices.

Then, there’s a grey area in between. Some investments have a positive impact in one area, but a negative impact in another. For example, a mine might bring much-needed employment and investment to an otherwise poor and isolated regional area. But establishing the mine might also permanently damage farming land, or hurt future tourism business opportunities. That’s what Brundtland was talking about, regarding compromising future generations.

Third, you could combine the two approaches. You could start with a screened list of investments from a variety of different industries. Then, you could choose to prioritise investments that have a positive impact on some level.

Use any of these approaches to generate a shortlist of investments to consider. Once you’ve done this, you can apply the same set of benchmarks and standards you’d apply to any investment you were considering.

Not sure what it is you need to research, discover and assess? Money Morning editor Sam Volkering has the answers. In his report ‘The At Home Investors Guide to Profiting from Australian Small-Caps’, Sam shares his smart yet simple four step guide to finding out whether an investment is good quality or not.

The first step is really understanding the business. If it’s a new industry, or an innovative company, this might take extra research and effort. You need to have a genuine understanding of the company’s core activity. To the point where you could explain the business to someone else, and answer their questions. In his report, Sam offers tips on how to get to that level of understanding.

Ethical and responsible investors are set to have an interesting next 12 months. Especially if they’re heavily invested in renewable energy, which is undergoing some serious regulatory upheavals. If you’re interested in getting in on the action, take a step towards better understanding of your investment options. Find out how to download your complimentary copy of ‘The At Home Investors Guide to Profiting from Australian Small-Caps’.

Eva Mellors,
Contributor, Money Morning

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