What is Ethical Investing?

By, Robert J. Moss

As the issue of climate change has grown more prevalent among the international community, corporations across sectors have increasingly come under scrutiny for their environmental policies. Often the onus is on corporations to reform from within, ignoring the larger role investors can play in enacting change through ethical investing policies.

Like ethics itself, ethical investing looks differently to different people. If you’re concerned about climate change and invest in an oil and gas company, can you call yourself an ethical investor? Would your opinion change if the company was a leader among its peers in minimizing their carbon footprint and developing renewable energy technology? To understand how investors make these decisions, the Chartered Financial Analyst (CFA) Institute identifies three approaches to ethical investing: exclusion, integration, and impact-based investing.

An exclusion-based approach screens out companies with problematic environmental, social, and governance (ESG) issues. Faith-based institutional investors were the first to publicly develop this approach, requiring their portfolio managers to exclude investments in so-called ‘sin stocks’ associated with, “alcohol, tobacco, and gambling,” according to the CFA. If a current investment was found to breach the investor’s ethical investing policy, they would divest.

The Yale Endowment Fund, seen as the standard bearer for university endowment funds after consistently achieving phenomenal long-term returns, uses an exclusion-based approach. In their Ethical Investing Policy, the concept of preventing social injury, the, “injurious impact which the activities of a company are found to have on consumers, employees, or other persons,” is the cornerstone of their policy. In 2006, they divested from an oil and gas company based in Sudan because of the genocide in Darfur. While divestment occur more often than not, institutional investors like the Yale Endowment Fund would argue shareholder engagement with management is often more effective in achieving change than divestment and proxy battles.

An integration-based approach uses ESG issues to determine what investments to include. Fundamental ESG integration examines these issues qualitatively whereas a systematic ESG integration approach would quantify an ESG score for the company. Often a hybrid of these two methods will be used. Both methods supplement the decision-making process. Of course, how much emphasis a portfolio manager would weigh ESG compared to other factors would vary across asset management firms. In addition, this approach may be more difficult given wide variation in ESG reporting across public companies.

McMaster students can use the systematic ESG integration method with the help of Reuters Eikon. The Gould Trading Floor’s Reuters Eikon terminals provide their own ESG scores of public companies based on publicly available information. In addition, students can see these scores broken down by their individual components.

The impact-based approach is the most proactive. Adherent investors seek out investments that have a positive impact on an ESG issue.

Canada Pension Plan Investment Board’s (CPPIB’s) investment in green bonds is a perfect example of an impact-based approach. Last January, they issued €10 billion, 10 year, fixed-rate green bonds. What makes a green bond different from a regular bond is the use of proceeds. Proceeds from the green bond will be used exclusively by CPPIB to fund green projects in, “renewables, water, and real estate.” Buying a stake in a German offshore wind farm is one such way the pension plan is making an impact on the environment.

As concern mounts over corporate social responsibility on issues like climate change and many others, the demand for ESG information will likely grow. However, the question about how to invest ethically won’t be answered any time soon. As shown, there are many approaches and the growth of ESG information will help investors make more informed decisions.

Featured image by veeterzy on Unsplash.

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