Ethical Investing - Part 1

Courtesy : Investopedia

What is ethical investing? The definition depends on your personal beliefs. Ethical investing is highly subjective because each individual investor has different ideas about what constitutes ethical behavior by a company, and different priorities that they want to support with their investment dollars.

Broadly speaking, however, ethical investing is a way of earning returns in the financial markets by supporting companies that are creating positive change in the world, or, in some cases, that aren't creating positive change; but aren't making the world worse, either. Ethical investors want to reach their financial goals in ways that coincide with their values. Their investing decisions are usually part of an overall strategy for ethical living that includes making values-based decisions about work, housing, transportation and shopping, among other concerns.

 

Ethical investing is still a niche investment style, but it has gained popularity.

According to the Forum for Sustainable and Responsible Investment (US SIF), "From 2007 to 2010, social investing enjoyed a growth rate of more than 13%, increasing from $2.71 trillion in 2007. Nearly one out of every eight dollars under professional management in the United States today, 12.2% of the $25.2 trillion in total assets under management tracked by Thomson Reuters Nelson, is involved in socially responsible investing." Furthermore, socially responsible investing "encompasses an estimated $3.07 trillion out of $25.2 trillion in the U.S. investment marketplace today." These figures were as of 2011.

Ethical investing isn't just for individual investors. Institutional invsetors also practice ethical investing. After all, many institutions, such as universities, are largely supported by individual donors, and the donors want their funds used in ways they approve of. Institutional investors are actually "the largest and fastest growing segment of the socially responsible investment (SRI) world," states US SIF.
Active Investing
Ethical investors are heavily involved in their investment decisions. They take their roles as part-owners of the companies they hold shares in seriously. They read annual reports and prospectuses, vote proxies and submit shareholder resolutions. They care who manages a company and who sits on its board. They are concerned about corporate transparency and accountability. They also want to know how companies are behaving with respect to the environment, social issues, human rights and workers' rights. Some ethical investors care about all of these issues; others choose to focus on just one or two. It's often difficult to find investments that meet 100% of an ethical investor's values and financial goals.

From a financial perspective, ethical investing has historically been considered a subpar investment style. However, it isn't true that socially responsible funds consistently underperform. Social investors don't have to sacrifice investment gains in the name of doing good. But, just like any type of investment, there are winners and losers in the ethical investing universe. It takes thorough research to find the investments that meet both ethics criteria and have the potential to meet desired performance goals.

Unethical Investors?
Of course, the idea that some investors are "ethical" doesn't mean that individuals and institutions that don't pursue ethical investing are unethical. Many people don't have the time, or the confidence, to make the active investment decisions required of ethical investors. Others simply don't like investing and want to put minimal effort into it. Chances are that these people are putting at least some of their money toward ethical causes whether they intend to or not. Investing for your family's future? That's ethical. And if you simply put your money in a Standard & Poor's 500 Index (S&P 500) fund, you can't help but have funds invested in a number of good companies.

What's more, people who consider themselves ethical investors often have to make compromises. A company that produces an ethical product might have some questionable business practices. A company that performs well on environmental issues might not perform well on social issues. A company that donates a percentage of its profits to the community might use sweatshop labor. Ethical investors are faced with the challenge of not only uncovering these complex issues, but deciding where to draw the line with their investments. Sometimes they will even invest in companies they are unhappy with and use shareholder activism to force the companies to change.

Even people who aren't particularly interested in the social, environmental, humanitarian or governance issues, that ethical investors support, can benefit from incorporating ethical investing principles into their investment strategies. Companies that treat people and the environment with respect are less likely to find themselves distracted by or burdened with lawsuits. Companies that have a positive image in the public eye are more likely to generate high sales levels. Ethical business practices can generate better profits and better returns for investors, especially in the long run. As Amy Domini, founder and CEO of ethical investment firm Domini Funds, puts it, "To pollute, to discriminate, to violate basic human rights, is just not good for business."

Ethical investing goes by a number of names, which will be used interchangeably throughout this tutorial. The most common is socially responsible investing; others include morally responsible investing, impact investing, mission investing, sustainable investing and triple bottom line investing (the triple bottom line being people, the planet and profits).

Ethical Investing: Environmentally-Conscious Investing

Ethical investors who care about environmental issues want companies to minimize their negative impact on the environment. When choosing which companies to invest in, they commonly focus on the following aspects of a company's operations: energy, waste and pollution; natural resource conservation and treatment of animals.

Energy, Waste and Pollution
All companies need to use energy, and all companies generate waste products. When we think of energy use and pollution, most of us probably think of manufacturers, but even the smallest operations need electricity to power their lighting and computer systems. Some ethical investors seek out companies that don't pollute much in the first place. Others seek out companies that have purposefully minimized their environmental impact, while still others seek out the worst offenders and plan to change their ways.

One way companies can reduce their energy use is to operate out of green buildings. Green building features, that reduce energy use, include windows that let in enough natural light to make overhead lighting unnecessary; window coverings that reduce heat penetration so air conditioning use can be minimized and solar panels. Companies that transport goods can reduce their use of gasoline by decreasing packaging - lighter loads require less energy to haul. They can also permit workers to telecommute or to commute at off-peak times; options that might not reduce a company's own costs, but might have a positive impact on the environment. What's more, workers who can avoid traffic jams or work from home are likely to be happier and more productive.

Companies can reduce waste through methods such as minimizing packaging materials, using recycled materials, implementing company-wide recycling programs and making products that are designed to last for years that have serviceable and replaceable components.

To avoid polluting, corporations can work with waste management companies to properly dispose of items they aren't sure what to do with, rather than practicing illegal dumping. Instead of discharging toxic wastewater, companies can invest in processes that clean the wastewater before it reenters the natural environment. They can also use nontoxic production processes to minimize the amount of toxic waste they have to process. 

Natural Resource Conservation

Ethical investors concerned with natural resource conservation are focused on preserving what we have by using resources more efficiently or switching from the use of scarce resources to the use of abundant resources.

Companies can conserve resources through everything from company recycling programs to their choice of faucets in the bathrooms (if the company owns the building). They can purchase products that are made from recycled materials and are able to be recycled after use. They can minimize their paper communications and maximize their electronic communications. Some credit card companies, for example, offer customers an incentive, in the form of bonus reward points, for choosing electronic statements over paper. Companies that provide bottled water for employees can, instead, offer reusable water bottles and install water filters to encourage employees to use tap water.

Companies that extract natural resources, including oil and natural gas companies, seafood purveyors, mining companies and forest products companies can choose to extract resources in a responsible manner.

Treatment of Animals 

Some investors (vegans) don't think it's ethical to use any animal products whatsoever, and some vegetarians might find companies that are involved in meat production to be unethical. Other investors do consume animal products, but believe they should be produced in a humane and sustainable way.

Any company that is involved with animal testing or expressly prohibits it might attract attention from ethical investors. Some cosmetics companies and household products companies test their products on animals for "skin or eye irritation, skin sensitization (allergy), toxicity (poisoning), mutagenicity (genetic damage), teratogenicity (birth defects), carcinogenicity (causing cancer), embryonic or fetal genetic damage and toxicokinetics (to study the absorption, metabolism, distribution and excretion of the substance)," according to the animal rights advocacy group Go Cruelty Free.

Ethical investors are also interested in food companies that bring nutritious and safe products to the market. These include companies that use organic and natural ingredients, that don't use pesticides, minimize processing, use little to no artificial additives, use seasonal and locally grown ingredients and produce healthy and nutritious foods. Ethical investors may want to avoid companies that practice factory farming and heavily use pesticides, fertilizers, hormones and antibiotics. Instead, they may want to invest in companies that grow organic, produce grass-fed beef and dairy products and raise free-range chickens. Ethical investors may also seek out companies that engage in fair trade practices with international suppliers

Why Environmental Policies and Practices Matter

Whether you consider yourself an environmentalist or not, there are good reasons to care about the environmental policies of any company you invest in. Companies that pollute may face regulatory fines which will reduce shareholder profits. Many environmentally friendly changes save companies money and increase their bottom lines. And companies that employ environmentally responsible policies may be more likely to have a positive public image and generate consumer loyalty.

Ethical Investing: Socially Responsible Investing  

         

Numerous issues make up the social constellation of the ethical investing universe. Many of these issues have to do with a company's relationships with outsiders (we'll cover relationships with workers and with shareholders in later sections). Let's begin by examining the kinds of relationships companies can choose to have with their suppliers.

Supplier Relations
Socially responsible investors want to know that the companies they invest in have mutually beneficial and respectful relationships with their suppliers. They want to see that companies are working with high-quality suppliers that don't cut corners and those suppliers are held to the same ethics standards the company holds itself to. It doesn't do much good for a company to claim that it doesn't use sweatshop labor if it buys merchandise from a supplier who does.

Some investors worry that powerful companies force suppliers' prices down and don't pay them fairly; other investors might argue that if a supplier agrees to do business, the relationship must benefit them, and that if it doesn't, the supplier is free to exit the relationship as soon as any existing contracts expire.

According to the Domini Funds website, "Information on supplier contracts tends to be anecdotal and usually surfaces for a relatively limited number of corporations that are exceptional on either the upside or the downside." Thus, investors may find themselves in the dark when it comes to a company's relationships with the members of its supply chain. If this information is especially important to them, they can take an activist position and try to get companies to disclose this information.
Community Relations

Every company impacts the communities where it operates. The question is whether that impact is negative or positive. Often, it's a combination of both. A new store might increase competition and give consumers lower-priced options, but it might take market shares away from existing businesses in the community. A new distribution center might create hundreds of jobs, but increase 18-wheeler traffic on local highways and roads.
Companies can make ethical decisions about the way they operate to maximize positive effects, and minimize negative effects on the community. They can also make charitable contributions to the community by donating a portion of profits, doing volunteer work, sponsoring the local little league team or helping out with community fundraisers. For example, Johnson and Johnson, in its 2010 Contributions Report, states that the company works with hundreds of community-based programs on initiatives such as disaster relief and maternal and children's health. The company also double-matched its employees' charitable donations, and gave a total of $603.3 million in cash and products. Newsweek ranked the company near the top at No. 4 in its 2010 environmental rankings of America's largest 500 publicly traded companies. 

Screening out Sin

One of an ethical investor's foremost concerns will be the nature of the product, or service, a company sells. Some investors want nothing to do with a company that sells a product or service that's harmful or addictive. The stocks of these companies are called "sin stocks," and the companies that most commonly fall into this category are those that sell products or services related to pornography, tobacco, alcohol, weapons or gambling. Such investors would avoid companies like Phillip Morris (the U.S.'s largest cigarette manufacturer), Anheuser-Busch InBev (owner of numerous beer brands) or MGM Resorts International (which owns several casinos).

Other investors don't see these companies as sinful. They think it's up to the individual to make responsible choices regarding products and services that have the potential for abuse. 

Government Interactions

Any company that is large enough to be publicly traded must interact with the government on a number of levels, from Securities and Exchange regulations to consumer safety regulations to environmental regulations and more. How the company chooses to behave in those interactions says a lot about the integrity of its managers and executives.

Some businesses lobby the government to win special treatment via subsidies, tax loopholes, regulatory loopholes and even regulations that punish competitors.

Financial journalist Charles Gasparino writes about a major instance of this problem in his book, "Bought and Paid For: The Unholy Alliance Between Barack Obama and Wall Street." Not only did the government bailout a number of Wall Street firms during the financial crisis, but when federal, state and local governments borrow money, they turn to Wall Street firms, so it's in Wall Street's best interest for government debt levels to remain high. All Americans, then, pay the price in the form of higher taxes. A socially responsible investor might want to avoid these firms.

Economist Bruce Yandle is well known for his bootleggers and Baptists theory, which explains how groups whose interests would seem to be in opposition often work together to achieve a mutually beneficial, but unsavory, goal. In his 2010 article, "We Want to Be Regulated," Yandle points out that while most people think big corporations want minimal government regulation, the opposite is often true. For example, a company that produces clean technology might lobby the government for tighter restrictions on a more polluting version of a similar technology. Why? Because regulations that not only favor one company but also make life harder for its competitors are likely to increase the favored company's revenues. Ethical investors must ask themselves if they want to profit from companies that lobby the government to help them earn their profits.

The number of social issues a company must contend with is too large to cover here, but supplier relations, community relations, customer satisfaction and government interactions are some of the key issues. In the next section, we'll examine how companies choose to interact with their workers.