What is “Ethical Investing”?

Ethical investing is an investment approach, in which the primary objective in selecting securities is the investor’s ethical principles, for example, social or moral beliefs, instead of purely focusing on achieving maximum financial returns. Ethical investment strategies are rapidly gaining popularity both among retail and institutional investors. There is a clear transition in the market towards investing in “good” companies that value their employees, do not cause harm to the environment, and formally adopt CSR (Corporate Social Responsibility) practices.

Key Learning Points

  • Ethical investing is an investment strategy that first and foremost considers the investor’s ethical principles when selecting securities
  • It does not focus purely on gaining maximum financial return but seeks to invest in companies that align with their values
  • Ethical considerations include a broad variety of principles and practices, for example, companies that do not use child labor in their production lines, environmentally friendly firms, or those with a focus on supporting the society
  • Ethical investors typically avoid investing in stocks from particular sectors such as gambling, weapons-related activities, tobacco, and alcoholic beverages
  • As more companies are determined to improve their sustainable and responsible credentials, the investment universe for ethical investors is gradually expanding

The Basics of Ethical Investing

At its core, ethical investing offers investors the opportunity to align the allocation of capital to their personal values, but also potentially receive returns. One of the most popular ways to apply this strategy is by investing in ethical mutual funds. There are various products that offer different approaches to ethical investing.

For example, a fund manager may take an exclusionary stance and may avoid entire sectors considered harmful for the environment and the society such as oil & gas or military and defense. Others may go even further and avoid pharmaceutical or beauty companies that use animal testing for their products.

By avoiding such a large number of companies (there are many well-established “sin” stocks), investors become exposed to higher levels of risk, since diversification is limited. However, the proponents of ethical investing argue that the extra due diligence involved in the process could help investors identify better-managed and more efficient businesses, which in turn could offer exposure to stronger revenue streams.

Ethical vs. Impact Investing

While ethical investing could be considered more straightforward, impact investing is a more nuanced approach. Making a positive impact on society or the environment may involve investing in companies that aren’t necessarily always wholly good or bad. For example, an impact fund manager may hold energy stocks and use his/her shareholder rights to actively engage with the company and work towards improving its production practices by making them more sustainable and environmentally friendly.

Over the long-term, this steamship process may even evolve further and result in the company shifting its focus from traditional carbon-intensive production practices to cleaner energy and renewables. In addition, impact strategies also tend to provide transparency for investors by reporting on the impact they have made.

Ethical funds tend to take a more exclusionary approach and often set a specific threshold before an exclusion is applied. For example, should more than 5% of the company’s revenue derive from unethical activities, it would not be considered as an investment opportunity.