Back in 2019, we discussed the trend of ethical investing and highlighted some of its specific characteristics.
In the years since, more and more investors around the world are looking at how their investments can be profitable while also meeting a range of non-financial criteria.
There has been a significant increase in responsible investing, and the global financial industry estimates one-quarter of assets under management fit this definition.
Today, we take a closer look at ethical investing and consider its performance.
Understanding responsible and ethical investing
As society becomes increasingly focused on certain ethical concerns, so too do pockets of the investment market. For many investors, their decisions are no longer simply based on risk and return analysis. Non-financial factors are becoming more important and people are selecting investments that align with their own personal values.
As discussed in our previous article, the main origin of responsible and ethical investing lies with religion. The premise dates back several centuries and was to avoid investments in industries that harmed fellow human beings, such as the slave trade.
In the 20th century, this moved away from being driven by religion and became more focused on potentially harmful industries such as tobacco or gambling. And today, we see a similar shift as some investors depart from environmentally controversial industries such as fossil fuels.
The movement isn’t specific to a single event or industry… but is part of the ever-evolving landscape of collective attitudes. Environmental challenges, corporate scandals, global societal demands and extraordinary advances in technology all influence these dynamics.
During its infancy, few people actively moved toward ethical investing and it was slow to build in popularity. Many felt it had too many additional costs while also having considerable limitations on investment choices.
But thanks to consistent investor demand, many have now embraced the shift. There is a global commitment to responsible investments and asset managers have recognised the need to cater to these demands.
“A 2017 study estimated that more than one-quarter of assets under management (AUM) globally are now being invested in responsible investment strategies — the Global Sustainable Investment Alliance’s 2018 trends report put the figure at $US30.7 trillion.
While Australia is small in terms of responsible assets under management compared to Europe and the US, our participation rates are high. In 2018, Australia’s responsible investment market grew 13 percent to $980 billion, or 44 percent of total professionally managed assets ($2.24 trillion in total). Retirement assets play an important role, with four out of five Australian superannuation funds committed to some form of responsible investment.”
With such impressive growth, there has been debate around whether the financial return provided adequate performance. And while initially it was assumed that ethical investments would have limited returns and experience slow growth, recent research suggests the opposite. The Responsible Investment Association Australasia’s Benchmark Report from 2020 states,
*chart sourced from RIAA’s Responsible Investment Benchmark Report
“Australian and multi-sector responsible investment funds outperformed mainstream funds over every time horizon.
International responsible investment share funds outperformed the Morningstar average mainstream international share fund over every time horizon except one year (based on a weighted average performance over 10 years, net of fees).”
These research findings are a clear indication that responsible investing could provide positive returns. Plus, we are witnessing many traditional business models finding new opportunities to meet responsible definitions. There is mounting community pressure on company boards to embrace ethical processes within their operations, so overall more and more mainstream organisations are shifting in this direction.
Understandably, this transition takes time and some asset classes will evolve more slowly than others. But it is a worthwhile growth area to monitor and examine in the years to come.
Research over the last few years clearly highlights that ethical and responsible investing can provide financial returns that are on par with the broader investment market. But it is also important to be able to demonstrate that this investment strategy has a positive real-world impact.
Unfortunately, we haven’t seen the same amount of research into this aspect of ethical investing. So, while investors are motivated to support social and environmental change, we are unable to be certain that we are actually tackling the issues we are concerned about. There is no absolute proof that we are helping to reduce poverty or minimise greenhouse gas emissions or combat plastic pollution. Ideally, to continue on a similar growth trajectory and to become a truly mainstream investment concept, people need to see evidence of the non-financial impacts.
Seek professional advice
Ethical investing can be complex and there is a lot of information to digest before you make your decision.