Why the regulator has got it so wrong on ethical investing

We had the usual stellar line-up of powerhouse speakers, with keynotes delivered by Big Society Capital chairman and Apax Partners founder Sir Ronald Cohen, Overseas Development Institute chairman James Cameron, and sustainable investment veteran James Stacey.

What unites this triumvirate of big names is their dual beliefs in the importance of dealing with increasingly urgent environmental and social issues, and the power of profitable capitalism and investment to drive change.

I fervently and whole-heartedly support their views.

Moreover, I believe the stark reality of the threat posed by climate change and the irrevocable need to tackle widespread problems relating to, for example, water shortages and poverty that undermine global stability will make investing in vehicles that focus in these areas increasingly lucrative.

In short - and to borrow the wise and well-worn words of one stalwart delegate of this annual event, financial adviser and ethical investing champion Filip Slipaczek - ethical investing should no longer be considered the exclusive domain of evangelists and “lentil-chewing, sandal-wearing lefties”.

That the number of advisers attending the event increases every year tells a story of growing interest among intermediaries - and figures produced ahead of this year’s National Ethical Investment Week programme revealed 74 per cent of IFA clients are now asking for advice on ethical investments.

Depressingly, however, and despite the high-profile proselytising of Sir Ronald and others, there is still a long way to go before ethical investing ceases to be considered an ideologically-driven specialist sector and is widely welcomed by mainstream investors.

Figures that I quoted in my opening address are revealing: data from the Ethical Investment Research Service show assets under management within the SRI arena have grown to £11bn in the last 10 years, but this remains just 1.5 per cent of the £732bn total funds under management the IMA reported in the UK at the end of August.

Risk is being structurally and wildly mis-priced within a range of relatively mainstream investments such as soft commodities

Sir Ronald’s engaging address focused on the impressive ground made in rolling out a series of ‘social impact bonds’ that offer fixed income-like returns from government coffers from savings made if a given socially and economically-beneficial objective is achieved, such as reducing recidivism among young offenders.

Following a pilot he himself pioneered in the UK when the Big Society Bank was first set up, there are now 19 such bonds in existence globally - 13 of which are in the UK - with more to come.

The truth, however, is that the sums involved are currently extremely modest in the grand scheme of things.

Beyond that, more traditionally structured ethical investment vehicles clearly continue to reside on the periphery. Big name managers seldom put their names to such funds and advisers rarely recommend them to mainstream clients.

One reason for this was highlighted by Mr Slipaczek during the conference in a “plea” to the room during the Q&A panel: the regulator still maintains an anachronistic view that everything in investment can be boiled down to a simple risk/return analysis that rejects notions of emotional engagement in investments.

Operating against this backdrop, what chance do advisers have?

Another speaker at the conference, Social Investment Business Group chief executive Jonathan Jenkins, admitted that the sector does not have the performance history to give some the requisite confidence that the tide really has turned in favour of SRI.

“If you want 10 to 20 years of performance track record, I’ll see you in 10 to 20 years. We are not there yet,” he said.

Mr Jenkins did, though, proclaim a small victory with the regulator, citing Retail Distribution Review guidance which offered a brief acknowledgment that an investor may seek to make investments where the pay-off is not entirely pecuniary in nature.

A long way to go, but a start at least.

More worrying, perhaps, than the regulator’s backwards attitude presenting an obstacle to ethical investing is the tacit approval of an existing paradigm that actually fundamentally undervalues risk and poses a threat to client returns in the longer term.

In what I found to be the most illuminating presentation of the afternoon, ODI chairman and Climate Change Capital non-executive chairman Mr Cameron issued an alarming warning over the way risk is being structurally and wildly mis-priced within a range of relatively mainstream investments such as soft commodities.

He explained that there is no pricing benchmark for water - at all, anywhere in the world - and that as such pricing for almost every soft commodity is essentially meaningless.

Similarly, fossil fuel companies are not properly factoring in the incontestable risks to their businesses in the short, medium and longer-term and so they, too, are fundamentally mis-priced.

“One day a prospectus is going to land that will say nothing about any of this and it is going to lose clients a lot of money,” he stated.

Responsibility for ensuring that our markets operate fairly and transparently falls at the regulator’s door and in this respect, as in so many others in relation to these issues, it is failing.