Ethical Investing  

Fund Selector: ESG myths and realities

Fund Selector: ESG myths and realities

The 19th annual World No Tobacco Day took place last month, on May 31. Organised by the World Health Organization, the idea was to raise recognition that the seven million annual deaths attributed to tobacco are a handicap to societal development. 

Passive funds continue to grow, winning market share as investors seek simplicity, low fees and alternatives to the average active fund. 

It received little media coverage beyond the news that a number of investment companies chose the day to encourage those invested in tobacco stocks to quit the habit.

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This raises the issue of how ethical/green/SRI/ESG considerations have started to spread from the periphery of the investment world into the mainstream. These are not ‘ethical’ funds per se, but ‘vanilla’ investment companies believing that what is good for society in the long run will also be good for shareholders.

This has come only a week or so since the performance of the now Wonga-free portfolio of the Church of England was praised to the rafters. 

It also coincided with a number of discussions about passive ESG funds. These, I confess, leave me much vexed.

Is it right that non-ESG portfolios can hedge their non-ESG nature by buying a passive ethical fund, just in case sustainable companies outperform? Does the ESG investor need to believe in what they do?

The questions are rhetorical. There is no reason why the ethical investor should hold the moral high ground over the uncaring, what-if-I’m wrong hedger. Capital allocated to businesses acting sustainably and ethically can surely only be for the better.

The caveat to this is money that flows into passives can just as quickly turn into outflows, with the threat of share prices of index constituents being whipsawed according to the whims of whether ESG is in or out of vogue.

There are two obstacles frequently thrown in the way of ethical investment strategies, of which performance is one. The argument is ethical funds are handicapped as they do not invest in tobacco, alcohol, oil nor bombs, and companies involved in these allegedly undesirable activities tend to do rather well.

There are snippets of truth here: yes, ethical funds on the whole limit their exposure to these activities, and yes, consumer goods companies have performed very well. But these are very short-term arguments and deeply flawed.

There are plenty of companies that make a positive contribution to society and the environment that have also performed extremely well.

Indeed, the performance of very many ‘ethical’ funds thoroughly scotches the myth of in-built underperformance. The performance cat is steadily coming out of the bag.

The second great myth is that of risk. It is argued that ethical funds must be riskier because of the smaller universe of stocks from which to choose. The logic is thin and can be turned on its head.

What, instead, is the risk of investing into firms that do not act in the best long-term interests of all stakeholders? Is this not dangerous short-termism? There is no right nor wrong answer to this, only opinions that can only be judged over decades.