Ethical investing can add value if you avoid Jekyll and Hyde trap

I have recently come to realise I no longer believe unfettered capitalism is, to misquote Winston Churchill, the worst form of economic system apart from all the others.

I used to think a free market, where businesses compete without restraint for resources, labour, intellectual property and capital to make profits for shareholders, was the best way to increase wealth for all. But seeing the effects of the ongoing experiment that is full-on free-market capitalism, I now realise every business has a responsibility to act in the interests of all its stakeholders. Shareholders, yes, but also employees, suppliers, customers, and the taxpayer.

Ethical dilemma A growing minority of clients are concerned about the effect of their investments. To truly act in their best interests and respect their values, we must be able to respond to these concerns, which presents a problem.

Ethical investments are expensive (done properly, screening is phenomenally expensive), risky (removing stocks from a market portfolio reduces diversification), and riven with contradictions (if you are unhappy to invest in tobacco stocks, how can you be comfortable investing in their bankers, or their shipping companies?) There is some truth in the saying that ‘you can be ethical, or you can invest’.

At Navigator (and, to generalise, the wider profession) we have dealt with this up to now by not asking the question or, if it comes up, by persuading clients, using the ‘risky, expensive and contradictory’ argument, that it cannot be done.

We are parking it in the ‘too difficult’ box, and this has to stop.

Jekyll and Hyde One approach, let us call it Jekyll and Hyde, is to place the majority of a client’s invested wealth in a market portfolio, without any consideration for its impact. Their conscience is then salved by placing a small amount in an investment designed around ethical considerations, without worrying too much about the return, or perhaps giving it away to charity.

It is better than nothing, but it does not get away from the fact that the unbridled Mr Hyde portfolio is having negative social and environmental effects, which are not being offset by the Dr Jekyll part of the equation.

And it is unnecessary. Research now indicates that companies with good environmental, social and governance (ESG) metrics have better long-term growth than those without.

Some would argue if they do not invest in so-called ‘sin stocks’, someone else will, so their actions will not affect the companies themselves. Indeed, a study from the turn of the century showed that sin stocks outperformed the wider market.

Given that tobacco, alcohol and arms companies are some of the largest in the various indices, and one would expect them to have returns similar to large companies, surely that says something.

Investment returns and cost of capital are two sides of the same coin. If a company’s cost of capital is higher than the general market, investors are having some sort of an effect.

Change the world I have never really been one for New Year’s resolutions, but for 2017 I am making an exception.

By the end of this year, I want to be able to give my clients a choice: you can invest your money in an unfettered market portfolio, or one that has less of a negative social and environmental impact. The cost, the risks, and the expected return will essentially be the same. Which would you prefer?

The alternative solution will not be perfect, it will not suit everybody, and it will not be squeaky clean. I am tempted to call it the ‘half-fat’ solution. But it will be a start, and we can build on that.

Archimedes said: ‘Give me a place to stand, and a lever long enough, and I will move the world.’ Slowly but surely, we will build the place to stand, investors’ capital will provide the lever, and together we will change the way the world invests.