What are ethical investments?

Ethical investments have been a drive for profound change in the way society thinks about investing. In banking and investments, the reward of an investment is normally linked only to profit returns in monetary terms. As long as the assumed profit meets or exceeds the expectations of the investor and falls within acceptable risk parameters, little regard is given to where the money is being invested.

Ethical investors prefer to support businesses that meet their personal moral or ethical values- Sandro Baluci and Kenneth Genovese

However, there could be additional criteria from which investors may also benefit by taking them into account. The global ethical investment movement upholds that besides seeking financial reward, investors may also have peace of mind by putting their money to “worthy causes”.

The first ethical investments developed to their present form in the 1950s and 1960s and have now become very conventional. Ethical funds have grown considerably and nowadays account for €5 trillion in Europe, while in the United States it is estimated that one out of every $5 is invested with an ethical mandate.

This ethical investment approach looks in detail at where the money is being invested to ensure that social and environmental returns are added to the investment return without compromising on profitability.

Given that two investment selections promise a similar financial profit return, ethical investors prefer to support businesses that meet their personal moral or ethical values. Financial profits are not necessarily lower because one is supporting an ethical investment decision. Indeed, in mature economies, the risks are higher for businesses that do not meet the environmental, social and ethical concerns of society, so ultimately it also makes financial sense to include these values into the equation.

A company that has repeatedly paid a very high price for its poor environmental record is British Petroleum. BP was one of the highest dividend-paying stocks in the FTSE 100 index, accounting for nearly 10 per cent of all dividends paid by the index. The stock distributed more than £7 billion in dividends in 2009, more than 40 pence per share. It was widely held by individuals and institutions, and as much as these had reaped rewards in the past, they were also the ones to ultimately bear the brunt when things went wrong.

On April 20, 2010, while drilling at the Macondo Prospect in the Gulf of Mexico, an explosion on one of its leased rigs killed 11 crewmen and ignited a huge fireball. The fire lasted two days until the Deepwater Horizon rig sank, leaving the well gushing at the seabed and causing the largest offshore oil spill in US history. It later emerged that a safety audit report carried out a few months earlier had identified that the rig required over 3,000 hours of maintenance, which had been postponed indefinitely to avoid halting the expensive drilling operation.

This type of reckless decision ended up costing BP over $45 billion, with the final price tag likely to exceed $70 billion. No dividends were paid in 2010, affecting pension plans, funds and individual investors. The following year less than 20 pence per share were paid in dividends – a 50 per cent drop from 2009. BP is currently in the process of selling substantial parts of its US operations to fund the liabilities caused directly or indirectly by the spill.

Only last August, the company lost a very lucrative contract for Arctic exploration and BP’s partners in other production wells are requesting further assurances about the company’s operations and it may very well cost BP more profitable contracts in the future. That leaves the shareholder holding onto a stock that could underperform for many years, with depressed dividends and at a discount to BP’s peers.

This is not a singular episode seen only in energy investments, but it clearly illustrates the risks involved with companies that act with short term vision to protect their bottom line. Considering this, it seems sensible to invest in companies which choose to do the right thing, rather than take the fastest route towards profitability.

Responsible environmental credentials are just one of the factors that are considered when evaluating ethical investments. Other aspects include sustainability in terms of social considerations, labour market strategy and corporate governance, and to favour industries that set the standard for future generations and penalise those that provide negative social returns.

The integration of environmental, social and governance (ESG) factors are intertwined into the investment decision making process. Socially responsible investing collectively evaluates three broad criteria.

The first is environmental strategy. Each organisation is assessed on its environmental impact according to the industry to which it belongs. In assessing environmental strategies, the environmental impact and management of the company’s operations are considered and how this may affect biodiversity. Companies testing products on animals are clearly excluded. The usage of potentially harmful chemicals and their disposal and the effects of manufacturing on climate change are examined.

The second is social and labour strategy. Companies are responsible to provide fair, safe, and fulfilling and attractive working conditions, providing equal opportunities without discriminating on grounds of race, ethnic background, marital status, age, sex, disabilities, health status or pregnancy. Companies that adopt family- friendly policies by offering part-time work, flexitime, job-sharing, career breaks, childcare facilities and a commitment to effective training and personal development of their employees are favoured.

Organisations are also examined for good corporate governance. Promoting good governance ultimately protects and promotes the investment being made in the company. Factors such as pay equity, a clear and positive code of ethics and adherence to human rights principles in stakeholder dealing are considered to be attractive features when selecting ethical investment opportunities.

Ethical investments are based on decisions that account for both financial rewards and other criteria. They aim to reward investment decisions that cater not only for instant financial gain but also for longer term objectives.

Therefore, the interest of future generations and a healthier natural environment are also included in the decision-making process.

Mr Baluci is head of asset management at APS Bank Ltd. Mr Genovese is manager private clients at APS Bank Ltd.