How ethical funds can help de-risk your portfolio

Ethical investing was once considered a fringe area within financial markets. But now, investors are starting to understand this approach can help de-risk a portfolio and generate sustainable returns over time.

Let’s take a look at the rationale behind ethical investing and one new option for investors to achieve a cost-effective, ethical allocation to the global equities component of their portfolio.

Many companies and investment funds are starting to take a more ethical approach to doing business and allocating capital, recognising a focus on environmental, social and governance (ESG) issues isn’t just about making them look good, it’s also about ensuring their long-term survival.

As such the word ‘sustainability’ isn’t just about being clean, green and ethical – it’s about ensuring a business or investment’s long-term survival and ability to support future returns. This requires boards and management to take a view about whether a company or investment can continue in its current guise. This includes examining its ability to maintain a social license to operate, whether it contributes to or alleviates environmental degradation and how it may be affected by future legislation designed to protect the environment.

When it comes to investing, research shows a responsible approach outperforms a standard approach. According to the Responsible Investment Benchmark Report 2018 Australia, “core responsible investment Australian share funds outperformed the average large cap Australian share funds over three, five and ten-year time horizons” and “core responsible investment international share funds outperformed large cap international share funds over one and three-year time horizons and matched the ten-year performance.”

Not all ethical investments equal

It’s important to consider the commercial realities of any decision taken to invest ethically. The vehicle battery swapping business Better Place is a good example. In 2008, it started rolling out battery swapping stations across Israel. But the business went bankrupt in 2013 because there wasn’t yet sufficient demand for its products as electric vehicles had yet to reach critical mass and investors lost their money.

The message to investors is that business ideas with an ethical focus only work when there is a sensible and truly sustainable commercial rationale behind them. This business may have potential now, but five years ago there wasn’t the underlying demand to make it work. As such, investors must be cautious and ensure ethical investment ideas have genuine scale.

It’s also important to examine the fees associated with any ethical investment. Often due to their smaller scale, some ethical investment funds charge fees that are higher than the cost of a standard managed fund, especially compared to passive structures such as exchange-traded funds. These higher fees can erode returns. So, assess the fees and charges attached to ethical funds to ensure they are capable of generating a sufficient return.

Responsible investing in action

Ethical investing is becoming more mainstream, as evidenced by the fact more fund managers are creating products with an ESG focus. Vanguard is one of them, with its Ethical International ETF.

We have chosen this fund as our default global equities component for client portfolios. The fund stacks up commercially and ethically and is a cost-effective way for investors to align their personal and ethical investment goals.

As ethical investing has become more mainstream, more investors are choosing to align their personal goals with their investment goals. For instance, many people are living more consciously when it comes to all aspects of their lives. For instance, we think more about where our food comes from and, if we eat meat, how the animals are raised.

The same approach can be taken when it comes to investing. So, contact us today if you would like to further explore the benefits of ethical investing and how you can align your personal goals with your investment goals.