As more and more private investors turn towards ethical investing, there is debate arising over building responsible portfolios. Alexander Whitmore investigates whether profit maximisation and sustainable finance can converge.
The Intergovernmental Panel on Climate Change (IPCC) concluded earlier this month with “greater certainty” that humans have been the dominant cause of climate change in the 20th century. As the political debate intensifies, it is clear that we must also look to the private sector to reduce anthropogenic climate change. For some, the poor environmental record of many oil and gas companies and the urgency to reduce carbon emissions means that there is a move away from investing in these areas. This has led to a trend known as the ‘divestment’ movement.
What is divestment?
The financial services industry uses the umbrella term ‘sustainable and responsible finance’ to describe financial products that include considerations other than monetary returns. The most common set of considerations are environmental, social and governance (ESG) factors. Some investors, rather than just focusing on the greatest returns, are beginning to move their capital away from oil and gas companies towards more ‘ethical’ (or at least less damaging) investments.
Earlier this year, the government of Norway reviewed the share of fossil fuel companies in their sovereign investment fund, and more recently Glasgow University voted to divest away from fossil fuel companies. The divestment movement is a prominent example of some investors seeking to marry their finances to their ethics.
Advertisements for personal investment platforms have dotted the London Underground in the last few months. Demand for private investment management is up, driven by a recovering and relatively stable economy and the growing market of self-invested personal pensions (SIPPs). Research by one of the largest sustainable banks in the UK reported that “three quarters” of investors would like their pensions and investments to be invested more in environmental and social sectors. Yet 64% are unsure of how ethical their investments are. This information gap means many people are unaware of the externalities that affect their financial decisions and available options.
But does ‘ethical’ investment make financial sense? A common perception is that investments with ethical criteria necessarily underperform traditional portfolios. Private investors are generally unwilling to risk their money for anything less than the most stable or greatest return. Ethical investments are perceived to exchange a degree of monetary return for social good, and are often considered more volatile than their traditional counterparts.
This view is challenged by new evidence. In one piece of research by Moneyfacts, a financial product cost-comparison site, so-called ethical funds outperformed non-ethical funds in 2013. Inclusion of ethical criteria does not mean ethical funds necessarily outperform non-ethical ones. However, it does mean that such funds may perform differently. Ethical funds often invest in smaller, more specialised companies whose activities are different to larger, integrated multinationals. This leaves room for growth by innovative companies, but some may consider this a riskier investment than a firm with an established pedigree.
However, companies with a genuine commitment to sustainability and corporate responsibility may be less likely to receive disciplinary measures or government intervention as a result of their actions, and typically have a long-term outlook for their business. These companies are therefore often more suitable for long-term investment.
Sustainability in particular is a driving force behind the divestment movement. If, as the governor of the Bank of England believes, the “vast majority of [fossil fuel] reserves are unburnable”, then oil and gas companies will be left with ‘stranded assets’ (inaccessible deposits of fossil fuels). These companies may therefore be overvalued in what is known as a ‘carbon bubble’. International action to limit climate change could cause the value of oil and gas companies to drop dramatically. This provides the financial case behind the divestment movement.
Not just investors
In October of this year, the Good Money Week campaign aimed to raise awareness of sustainable and responsible finance. Sustainable finance isn’t just about investment; it also includes things like taxes, pensions, savings and current accounts. Banks use deposits to fund loans to businesses that engage in a variety of different practices; some of which you may disagree with.
Sustainable and responsible finance often makes good financial sense, even if you are not concerned with ethics. For those that are, it is possible to make money and make a difference by investing in successful companies that promote social good. Individuals affect the world through their financial choices; so the next time you consider opening a bank account or making an investment, take a look at The Life of a Fiver and see the difference even a small amount of money can make.
The views expressed in this article are those of the author and do not necessarily represent the views of Development in Action.
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