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What are the pros and cons of ethical investing?

We are seeing a strong trend towards investors wanting to know that their investments are making a positive impact in the world with ethical or socially responsible investing. Here we discuss some of the pros and cons of ethical investing, so you can work out if it’s the right approach for you.

What is ethical investing?

Ethical or socially responsible investing is when you strategically invest in companies that have ethical practices. Of course, ‘ethical’ is a subjective term. For example, an ethical fund manager could define tobacco and gambling as unethical, yet consider alcohol to be acceptable.  Typically though, ethical funds tend to avoid investing in companies involved in weapons manufacture, alcohol, tobacco, gambling or fossil fuels; while favouring renewable energy companies, sustainable technologies or healthcare.  We go into more depth on what makes an investment ‘ethical’ here.

What are the advantages of ethical investing?

Socially responsible investing might enable you to generate sustainable returns and de-risk your profile. It may even help you sleep better at night.

You may enjoy sustainable returns

Many socially responsible funds have achieved good results.  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. 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.

You could de-risk your portfolio

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

You can live in alignment with your values

Who doesn’t want to make money and feel good doing it? By investing in a socially responsible way that is aligned with your values, you’ll sleep better at night knowing that you’re trying to do good in the world. But the most rewarding feeling comes if you start making a good return on your investment.  You’ll be making money and using your money to improve society as a whole.

What are the risks of ethical investing?

Socially responsible funds experience the same market ups and downs as any share-based investment.  Although many ethical funds have achieved good results, there are risks to be mindful of.

Limiting your investment options

It’s important to understand that when you limit your investment options because of ethical considerations, your return on investment could be compromised.  You may take on extra risk and volatility, or miss out on great investment opportunities. For example, one of the largest and most successful socially responsible funds doesn’t include shares in Microsoft because of the company’s “competitive dynamics” fail to meet the fund’s ethics criteria.

Not all ethical companies have potential

It’s also 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, Better Place 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.  At the time, electric vehicles had yet to reach critical mass and investors lost their money. 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.  Investors must be cautious and ensure ethical investment ideas have genuine scale.

You may pay more in fees

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 a standard managed fund.  This is especially the case when compared to passive structures such as exchange-traded funds.  These higher fees can significantly erode returns.  Carefully assess the fees and charges to ensure you can generate a sufficient return for your investment objectives.

Is a socially responsible investment strategy right for me?

When investing in socially responsible funds, the focus should always be on your long-term investment strategy. It’s worth speaking to a good financial adviser who can discuss the pros and cons of ethical investing relative to your own personal situation.  A good adviser will really listen about issues that are important to you.  They will work with you to develop an investment strategy where your heart is, as well as manage the risk associated with that strategy.

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