In recent years, people have taken an interest in supporting companies that focus on social responsibility alongside their business. This moral obligation has extended towards investors, as they engage with environmental, social, and governance (ESG) investing.
While socially responsible investments (SRI) were not seen as very profitable in the past, the recent spike in interest from consumers and investors has pushed large corporations to integrate ESG objectives into their investment decisions.
According to the Harvard Business Review, $1 of every $4 invested in the United States at the beginning of 2018 went towards ESG investment strategies, making a total of $11.6 trillion, compared to $3 trillion in 2010.
The growth of the ethical investment market allows more investors to choose which causes to support through ethical funds. However, before you put all your money towards ethical investments, investors should create a long-term plan that takes into account the benefits and risks that appear in these types of investments.
Benefits of Ethical Investments:
Investing in sustainable businesses helps to alleviate social and environmental issues.
One of the main benefits of investing in ethical funds is that investors can contribute their money towards socially responsible companies that are taking steps to improve society as a whole.
By aligning their own ethical values with the investments they make, investors will gain a sense of fulfilment knowing that unethical practices will be superseded by those they deem more responsible.
Companies that combat ESG issues will prosper in the long term.
Having noticed the profits that can be made from sustainable and ethical ventures, more and more companies will move towards a socially sustainable business model.
The growth of ethical investing might also nudge businesses to adopt socially responsible practices that address ESG issues head-on. In this way, companies that act ethically will gain considerable funding and further public support. Ideally, large corporations that are responsible for most of the damage will switch to less harmful practices.
Tax relief with ISA.
Investors can get an ethical ISA that solely consists of ethical funds. By placing up to £20,000-worth of ethical investments into an ISA, investors are eligible to pay no tax on returns. It is important to bear in mind that tax relief applies depending on your circumstances and are subject to change.
Drawbacks of Ethical Investments:
Lack of choice.
Even though the ethical investment market is growing, at the moment there are very few ethical funds to choose from that will bring substantial returns.
The stringent screening process for ethical funding may be the cause behind this. For companies to be selected, they must fulfil aspects from the positive criteria while avoiding practices in the negative criteria. Examples of positive criteria include adopting environmental protection policies and cooperating with trade unions, while negative criteria involve practices that damage the environment and relations with oppressive foreign governments.
There is also the added problem that even with investment backing, many ethical companies fail to grow sustainably and prevail in the long term due to commercial realities and trends, leading to bankruptcy.
This is what happened to Better Place, an electric car start-up that launched in Israel in 2008 with battery-swapping technology. The lack of demand for its products forced the company to go bankrupt five years later in 2013. Their goal was ‘to help end the global auto industry’s reliance on oil’ through electric cars, yet this noble cause wasn’t realised due to several reasons, from the inconvenience and unaffordability of electric cars to unexpected roadblocks that slowed progress down.
With very few options, investors still need to carefully consider each company they invest in to make sure they receive returns from their ethical investments.
Charging higher fees.
For the screening process to be effective for ethical funds, fund managers need to spend time and resources researching the business operations behind each company.
Ethical and SRI funds are divided into three shades of green – light green, medium green and dark green – with each category reflecting the levels of social responsibility companies adhere to:
- Light green is more relaxed – these funds invest in companies that engage with sustainable practices, but are still part of an unethical industry.
- Medium green is more focused – these funds only concentrate on particular areas for investment.
- Dark green is very restrictive – these funds rigidly comply with many if not all international ethical values.
With many companies trying to hide their unethical practices, especially larger corporations, this makes it much harder for fund managers to find out whether companies are behaving ethically or not. This cost for intensive screening checks is charged onto investors, who are forced to pay higher fees for their ethical investments, eroding returns for the foreseeable future.
Higher risk and lower returns.
By solely purchasing assets from companies that pass screening criteria, ethical funds typically generate low returns when compared to traditional investment funds.
With the tiered system implemented for ethical investments, investors will have to grapple with the fact that supporting dark green funded companies—that tackle more if not all ethical issues—bring greater risk and lower returns.
For risk-averse investors, they will have to prioritise which issues are most important to them and invest accordingly in either light green or medium green funds.
Many investors will find themselves sacrificing financial gains for sustaining an ethical approach to investing. Depending on how well funds are performing, you may gain sustainable returns over a longer timeframe than usual.
The rising popularity of SRI has enabled investors to take part in initiatives that positively impact society in the long run.
Ethical funds are experiencing higher charges, greater risks and lower returns. Investors will have to come to terms with the inevitable trade-off between supporting as many ethical practices as possible and receiving lower financial returns on your portfolio.
At the moment, ethical investing is an expensive endeavour, so investors need to focus on a long-term investment strategy to make it worthwhile. Speaking to a financial advisor can help you make better-informed decisions when it comes to ESG investing.
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For investors looking to contribute to ethical investments, our team at Count can assess your finances and help you calculate a long-term strategy that brings greater returns. Visit our website to find out more!