If you’d prefer that your money doesn’t support destructive, dirty or morally questionable industries and practices — but you still want to grow your wealth — there is a way to invest ethically.
In light of the urgent need to address climate change globally, ethical investing has risen in prominence in Australia.
But what does ethical investing mean, and how can you eliminate the noise to determine the best investment opportunities aligned with your values? Read on to learn more.
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What Is Ethical Investing?
If you feel strongly about certain issues or moral principles, ethical investing is a way to ‘put your money where your mouth is.’
Any investment decision you make based on your beliefs about what is right or wrong — rather than solely on an expectation of financial gains — can be considered an ethical investment.
However, the term is typically used to describe investing in companies or industries that objectively do good by meeting certain standards.
There is a range of terms that encompass the concept of ethical investing, including:
- Sustainable Or Socially Responsible Investing (SRI). This also goes by names like ‘green investing’ and ‘responsible investing’. The approach primarily focuses on divesting from companies undertaking harmful activities with unacceptable downside risks for people and the environment (e.g., tobacco, weapons manufacturing). But it’s also about targeting companies that care about creating a healthy society and planet.
- ESG investing. ESG stands for environmental, social and governance. Many corporations report their ESG performance based on various voluntary frameworks and regulated obligations. Investors can use these to evaluate a company’s level of risk, accountability and ability to achieve sustainable growth.
- Impact Investing. Whereby investors direct their capital towards organisations, social enterprises and funds, making a positive difference to a specific cause, problem or non-profit industries that improve outcomes for both humans and nature.
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What Are The Upsides Of Ethical Investing?
The upsides of investing in ethical ventures may include:
- Being able to sleep at night knowing your money isn’t doing harm or is actively supporting companies focused on making the world a better place.
- Getting ahead of regulatory change and consumer trends, in recognition that governments and corporations are under increased scrutiny to act to protect the environment and vulnerable communities. Ethical investing could help to de-risk your portfolio.
- Superior resilience of ESG-focused companies in an increasingly volatile world where the risks of climate change (e.g., natural disasters and displacement) and other threats can have a tangible impact on a company’s capacity to remain operational and profitable.
Everyone has different ‘hard limits’, but ethical investors may seek to avoid owning a stake in companies involved in:
- Alcohol, big pharma, casinos, gambling, pornography.
- Fossil fuels, coal mining and mining of other precious minerals.
- Deforestation, water pollution and biodiversity loss.
- Weapons and ammunition, or links to armed conflict.
- Human rights abuses, human trafficking and slavery.
- Anti-competitive behaviour and corruption.
- Animal cruelty and unethical medical research.
(Related: How To Start Trading Commodities).
What Are The Downsides Of Ethical Investing?
The major dilemma for ethical investors is how to create a portfolio balanced between ethical concerns and the ability to generate profits and/or income to meet your investing goals.
Limiting the range of companies or sectors you invest in limits your opportunities to make returns.
Compounding this impact on returns is that ethical funds may attract higher management fees.
Other barriers to ethical investing can include:
- Lack of clarity about ESG performance and difficulty in gauging what will drive sustainability and societal benefits.
- Emerging ethical ventures may pose a higher risk of failure. For example, perhaps you’re keen to support zero-emission vehicles by investing in battery technology. As it’s unclear how the technology will evolve and which companies will become leaders, you risk capital losses.
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The Rise Of ESG Investing in Australia.
Above: ESG investing set a record in 2019.
With more companies in Australia and around the world reporting on ESG, it has become a valuable source of research and benchmarking for many ethical investors.
Companies who care about ESG principles might commit to:
- Reducing emissions, mitigating climate impacts and improving energy efficiency.
- Supporting environmental rehabilitation and biodiversity protection.
- Maintaining strong governance processes within its leadership.
- Operating compliantly, honestly and transparently.
- Avoiding suppliers that exploit workers or condone child labour.
- Hiring for diversity and gender equality within its own business.
By understanding how effectively a company manages ESG, and adjusting your portfolio accordingly, you can take a holistic approach to ethical investing.
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This would help you consider the company’s commitment to sustainability, how responsibly a company manages its workforce operations, and whether it contributes to the community.
Some argue that ethical business practices drive returns. What does the research say? Researchers from NYU Stern Center for Sustainable Business conducted a meta-analysis of over 1,000 studies into the relationship between ESG and financial performance. They found 58% of studies revealed a positive correlation between ESG and improved metrics, including return on equity and assets (ROE/ROA), or stock price — compared to only 8% showing a negative relationship.
How Is ESG Measured And Reported?
Companies commit to varying ESG goals, and may use multiple, differing methodologies to benchmark their reporting.
This can make it confusing for you to understand the comparative performance of a company within a market or the relevance of ESG progress to a company’s future prospects.
For example, Australian companies widely adopt the Global Reporting Initiative (GRI) standards.
Plus, around three-quarters of Australia’s top companies report against the Taskforce on Climate-related Financial Disclosures (TCFD) framework.
A PwC analysis of ESG reporting across ASX200 companies in 2022 found that:
- Around half disclosed a net zero target, but only 55% of those incorporated information about their transition plan or the activities that will help them achieve the target.
- 55% identified climate change as a current or emerging risk, but only 18% mentioned the potential impact of climate risks/opportunities on their financial position over time.
Reporting obligations for climate risks will soon become more standardised with new Australian Treasury mandates coming into effect from 1 July 2024. The new disclosure framework will require companies and financial/investment firms to show how they’ve evaluated their climate-related risks and opportunities and factored this into their business model.
How To Start Investing Ethically In Australia?
First, take stock of what matters most to you before building or rebalancing a portfolio in alignment with your ethics.
To critically evaluate whether an opportunity fits within your definition of an ‘ethical’ investment:
- Take a closer look at a company’s operations, including supply chains, partnerships, financial commitments and philanthropic efforts.
- Stay informed by reading a company’s official strategies and statements, following the news, and research from groups like Responsible Investment Association of Australasia (RIAA).
- Improve your understanding of performance measurement, disclosure and reporting processes that corporations adhere to.
Key investment products that offer exposure to ethical assets include:
- Individual shares in companies that match your moral code.
- ETFs focused on sustainability and ethical business.
- Thematic ETFs are funds that focus on health care, clean tech or renewable energy.
- Ethical robo-advisors like Stockspot’s sustainable portfolio.
- Ethical financial institutions and super funds such as Bank Australia and Ethical Super.
- Green Bonds issued by the Australian Treasury, scheduled for release in mid-2024.
Two Common Screening Methods For Ethical Investors.
Ethical investors typically screen potential investments in two ways:
- Exclude companies that don’t meet your desired standards and beliefs, based on poor ESG performance, past unethical behaviour, or inherent incompatibility with a sustainable, healthy future. This is also called a negative screening.
- Actively select companies based on strong ESG practices, or based on promising sustainability or impact results (aka positive screening).
If you have an existing portfolio, removing stocks or funds that don’t align with your ethics may be more convenient.
If you’re building a portfolio from scratch, you may take the time and effort to find and include only those companies or products that you deem highly worthy.
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Carefully Assess Ethical Funds.
Exchange-traded, managed, and super funds have varying approaches to selecting underlying holdings to provide investors with a sustainable or ethical option.
- Betashares Australian Sustainability Leaders ETF (FAIR) excludes fossil fuel exposed operations and also looks at each company’s alignment with the United Nations Sustainable Development Goals.
- iShares ETFs provide information on its product’s ‘sustainability characteristics’ based on measures of the underlying holdings’ ESG performance conducted by investment industry research firm Morgan Stanley Capital International (MSCI).
No matter how it’s marketed, the companies included in any fund may not gel with your views on what’s ethical or sustainable, so research each product carefully.
Consumer advocacy groups have criticised some sustainable funds for continuing to include major banks (who often finance fossil fuel projects), and for exaggerated or misleading green credentials (aka greenwashing).
The Bottom Line For Australian Ethical Investors?
It’s possible to grow your wealth and do good by investing your money thoughtfully.
Add an ethical lens when considering specific investment opportunities and risks, and the composition of your portfolio.
The key is: reflecting on what ‘doing good’ means to you, and taking the time to evaluate companies or funds for ongoing strong alignment with your ethics.