At its simplest, ‘ethical’ or ‘responsible’ investing can be described as not just seeking positive financial returns, but also ensuring that those returns are generated in a way that is consistent with your personal beliefs and values.
This can take a number of forms. The process known as ‘negative screening’ refers to looking at your options and electing not to invest in certain companies or sectors because you don't want to support the products or practices involved.
Negative screening can take environmental, social, humanitarian or animal cruelty points of view into account. It will depend mainly on what the investor – either an individual or an institution – cares about and what their ethics are.
Beyond the decision to avoid certain investment options is ‘positive screening'. This is about actively allocating your money to areas that you want to support and which you believe can provide a positive financial return by doing so, whether that is investing in renewable or sustainable energy, healthcare or some aspect of social enterprise.
There is a third aspect to ethical investing, which large institutions can pursue, that is known as 'advocacy'.
Advocacy is about engaging with companies that a fund manager already invests in or wants to invest in and encouraging even better behaviour, or changes that would potentially include them in an 'ethical' investment bracket.
How do you invest ethically?
There are a number of choices available to investors, from checking if your super fund offers ethical options, to applying ethical principles to your own direct investment portfolio.
You can also find financial advisers who specialise in providing research to help you make an informed decision about what options might be best both in the financial and ethical sense, while some fund managers apply ethical screening to their investment decisions.
If you decide to go it alone, the degree to which you want to embed ethical investing into your portfolio will dictate the ease with which this can be achieved.
There can be a lot of research involved in trying to understand how companies perform in relation to these issues. While it might be easy to identify certain types of companies you might choose to avoid, such as tobacco or coal producers, it could be much more difficult to ascertain whether a company is avoiding questionable labour practices in its supply chain.
There can be some grey areas, such as uranium. Some fund managers might have an exposure to it as a clean energy source, but other investors might not want to be involved in uranium mining.
There are a lot of environmental, social and corporate governance issues that don’t show up on the financial statements, but that are critical to a company’s enduring value.
Returns are one part of the story, but risk is another. Remember that the same rules for ordinary investing apply to ethical and responsible themes.
After you work out what your objective and timeframe is and then think about what you want from your investment in terms of income or growth, you could then identify the type of areas you’d like your money to support and the areas you’d like to avoid. It's important to then match that up with your risk and return requirements.
Revenue and profit figures can be easy to ascertain and are regularly published by listed companies.
The way a company conducts itself, however, is hard to quantify.
Some benchmarks that can be used are environmental, social and governance (ESG), sustainable practices and corporate social responsibility (CSR), which attempt to measure a company’s behaviour against the impacts its business has on communities.
Index providers such as Dow Jones and MSCI build indices containing companies that pass supposedly stringent sustainability assessments based on CSR and ESG practices, and these indices serve as guidance for those adopting a 'responsible' approach to investing their money.
Given that different people have different ethics and standards on CSR and ESG practices, the evaluations can be subjective and the inclusion of so-called sustainable companies may be inconsistent from one index to another.
Dow Jones Sustainability Australia Index
The Dow Jones Sustainability Australia (DJSA) Index, introduced in February 2005, represent the top 30% of companies in the S&P/ASX200 based on long-term economic, environmental and social criteria.
Companies that are included are assessed based on their long-term economic, environmental and social record. All industry groups are considered, including mining and gaming and the index is reviewed annually.
Criteria such as climate change strategies, energy consumption, human resources development, knowledge management, stakeholder relations and corporate governance are reviewed, according to the index fact sheet.
MSCI Australia ESG Index
The MSCI Australia ESG Index “provides exposure to companies with high environmental, social and governance [ESG] performance relative to their sector peers”, according to its fact sheet.
The index is made up of large and mid-cap companies in Australian markets.
It aims to offer investors a broad, diversified sustainability benchmark and the selection of companies is based on data from MSCI ESG Research.
Investing in green corporate bonds
Investing in corporate bonds can be a way of diversifying your portfolio, but deciding which companies to choose can be difficult if sustainability is your focus.
Exchange traded bonds, or XTBs, trade on the Australian Securities Exchange (ASX) and some of those available have a 'green' label.
This means the bond issuer is committing to using the funds for purposes that meet the requirements of the Climate Bonds International Standards and Certification Scheme.
The standards present investors with information, guidelines and greater transparency regarding what should and should not be considered in assessing the credentials of the bond to help in the decision-making process of choosing where you feel comfortable putting your money.
There is no perfect way to measure how responsible, ethical or sustainable a company is.
Not only do companies have different standards in managing their ESG issues, individual investors also hold different beliefs as to what makes an investment ethical or responsible.
Regardless of the different approaches, intangible assets such as CSR and ESG practices may be very important when it comes to assessing a company's long-term growth prospects.