Ethical investments’ objectives and implementation tools
Pooled investments known as Sicavs, investment funds or mutual trusts are nowadays the most popular vehicles for collective investment. Fund managers pool the funds raised from their various different clients into the same investment portfolio, to benefit from economies of scale, which allow for lower trading costs, diversification and professional money management.
Each fund is governed by a prospectus which lays down how the fund will work. Terms and conditions such as exposure limits, investment limits and other conditions and limitations are normally covered in the prospectus. These investment parameters are an expression of the fund’s theme and it is the theme that describes the overall approach and scope of the fund.
An ethical fund operates exactly like a traditional fund but besides the traditional financial analysis one finds in the prospectus, the manager of an ethical fund also undertakes an additional level of analysis which is of a non-financial nature.
The rules and themes of this non-financial analysis are usually included under a separate policy appendix to the prospectus known as the ethical policy of the fund.
Financial reports alone do not demonstrate the full profile and risks associated with a company.
Adding a deeper, non-financial analysis helps in highlighting future risks such as possible employee unrest, suspicious business dealings, environmental misdemeanours and other undesirable repercussions which might not be identifiable under standard financial analysis.
The policy can change significantly across different ethical funds depending on the fund’s theme. For instance, certain ethical funds invest according to Christian principles; others are guided by Muslim Sharia and others by environmental or other considerations. This broad range of themes and values ensures that one can choose a fund according to one’s values and beliefs.
On the other hand, this very broad range makes choosing an ethical fund consistent with one’s convictions a more complex task. A number of specialist rating agencies certify that these funds are consistent in their adherence to the specific ethical policy in the same manner as a credit rating agency would rate an organisation based on its financial strength.
The fastest growing area in the ethical investments field is funds which support a number of themes concurrently. The reason for these funds’ popularity is that similarly to traditional funds, the larger pool of eligible investments allows the fund manager to deliver more consistent return over time, while minimising risk.
A typical ethical fund having multiple themes would have issues such as climate change, environmental damage, adult entertainment, stakeholder management, animal testing, life termination services, weapons manufacturing, corrupt governments, tobacco and alcohol in its ethical policy.
Besides the financial analysis, there are three main tools which would be applied to select the appropriate investments.
The first is called ‘screening’. By applying negative screening, the fund manager would avoid investing in companies which manufacture or distribute products in any of the themes outlined earlier.
Inversely, by applying positive screening the fund manager would invest in companies which produce positive initiatives in any of the themes. The fund manager would take these decisions by relying on the reporting provided by the ethical rating agencies. The rating agency will closely monitor the issuer and hold regular meetings with all stakeholders of the company.
The second technique is called ‘engagement’. This is used where the fund holds shares in a company. Under the engagement process, the fund manager would use his power as a shareholder in a company to ensure that initiatives presented will adhere better to the company’s corporate social responsibilities. Examples of such actions might be a change in manufacturing processes to minimise the carbon footprint or a change in employee relations leading to happier and more productive employees.
The third tool, ‘community investing’, may be exercised in two ways. The fund manager can either invest directly in local projects which apart from having investment potential also produce a positive social return for the local community; or else employ part of the profits into projects which are of benefit to the local community.
Examples of community investing in a local scenario would be investing in a company operating a reverse osmosis plant which benefits farmers or donating part of the profits generated by the company towards the building of an outdoor gym to encourage more active lifestyles and reduce obesity.
It is important to highlight that investments in ethical funds are not charitable donations. It is iexactly the opposite as there is an extra layer of risk analysis and the assurance that one’s hard-earned savings are not used for the benefit of companies which are producing a service or product which goes contrary to one’s values. Ethical investments provide the opportunity for investors to align their personal beliefs and values with the way their savings are managed.
Ethical investments try to avoid nasty surprises as investments are made in companies that are less liable to fall foul of their country’s laws or to engage into actions that may prompt consumers to boycott the company’s products. An example would be a company using child labour to manufacture its products in another country. While engaging a child worker may be legal in that part of the world, such action would surely induce prospective clients to divert their purchases to competition.
Abortion would be a typical example in Malta. In most surveys it emerges that a high percentage of the population does not support abortion, but only few investors question if their savings are being invested in companies that are involved in life termination services.
Specialist rate agencies are used in the selection process of the investments. Apart from normal financial analysis, the fund is also subject to supplementary assessments in order to guarantee to the investor that the ethical values are not overseen.
Mr Baluci is head of asset management at APS Bank Ltd. Mr Genovese is manager private clients at APS Bank Ltd.