Ethical investing has been around a long time – since the 18th century when the morality of slave-trading and workers’ rights were up for debate. It is, in my opinion, a very good idea. The problem is the approach is off track and not driving corporate behaviour in the way that is desired. This post is not here to extoll the virtues of ethical investing and to encourage people down that route; that is the choice of the individual. My aim is to challenge the conventional wisdom, critically evaluate the status quo and encourage people to think about whether their actions are achieving their goals.
According to USSIF - USSIF: The Forum for Sustainable and Responsible Investment – Formerly the Social Investment Forum (SIF) there are three main pillars of social responsibly investing (SRI):
Screening – That is essentially the selection of ethical companies and the avoidance of unethical companies in the investment portfolio
Shareholder advocacy – This is discussing with executives issues and putting pressure on them to adopt measure to help prevent adverse contributions towards them such as climate change or discrimination
Community Investing – The practice of investing in initiatives that help a community that ordinarily would not be able to raise funds
All of these make sense with a cursory examination, invest in companies you want to encourage, harass their CEOs to avoid help those who cannot raise capital with their worthwhile projects. In fact, community investing is a solid concept and I can see no issues with it in its current form. However, it does not seem like it will produce very good returns as there is a good reason these projects are struggling to obtain funding, so perhaps not the best choice for an investor that wants to have a social impact with their decisions but still requires a solid ROI. So let’s move on to the first two pillars.
Shareholder advocacy is a good idea, after all the executive management’s job is to represent the interests of the shareholders. If those shareholders are demanding specific social targets rather than solely focussed on financial targets then they will have to change their companies behaviour. Combine this with stock screening and you have a disaster.
Almost every ethical fund carries out the practice of stock screening – it seems to be the main determinant of whether you can put ‘socially responsible’ all over your marketing materials. The theory is by investing in the ‘good’ companies you are encouraging them, but does this hold up?
Take two hypothetical companies:
Angel PLC – A wind power company that takes social responsibility very seriously
Devil PLC – Provides coal power using child labour, unsound waste management and lots of generally unethical things
These two stocks have very similar fundamentals and their stock prices are identical at £5.00 per share. Our protagonist, SRI Investments, will think; ‘Excellent, easy decision to make for my energy stock, buy Angel and sell Devil’. Now if this fund was very large it could potentially have an impact of the share price by buying a significant stake pushing Angel up to £6.50. What has this achieved? Great! We’ve rewarded the good company with a higher share price. A week later, a standard fund manager is considering his energy stock selection. His investors have not specified a preference so he will choose the cheaper stock on fundamentals. So now you’ve rewarded investors that are ethically neutral for investing in a company you didn’t want to support. If you believe in efficient markets, any ethically neutral investors will switch investments and very quickly reverse any stock price impact anyway.
The AGM’s for both companies come around. The SRI fund manager will perhaps raise a few issue beforehand and then turn up to Angel PLC’s and vote on all issues as to encourage socially responsible behaviour. Of course Angel PLC is already best in class, so all this shareholder advocacy will have very little real world impact. Those decisions would have most likely been made by management anyway.
At Devil PLC’s AGM, management can announce their results and generally continue business as usual. The investors are interested in the earnings and have little incentive to look too closely at what is really happening behind the scenes as long at the profits are good. There is no reason why their management should change their behaviour.
Overall the only think that has been achieved is that the investors can feel good with themselves for ‘supporting’ good companies. Shareholder support is de facto standard for the vast majority of companies it is shareholder dissent that will raise eyebrows.
Following that train of thought now let’s explore the opposite scenario:
SRI Investments buys a significant stake in Devil PLC. Neutral investors are now encouraged to buy Angel PLC aligning them with the cause of wind power over coal. However the real impact is at the AGM. The executives at Devil PLC are not going to be sitting very comfortably knowing that a significant shareholder is clamouring for change in their working policies and practices. Suddenly they are forced to consider issues other than profits and this will begin to drive a change in behaviour.
With enough capital an SRI fund could potential buying a controlling stake in a company and force either a change in management or a change in policies. Rather than hoping that these companies will improve you are making it happen! This is what I would describe as bringing the private equity approach to SRI and almost completely absent in the world of fund management.
The current approach is at best ineffective burying your head in the sand, and the easy way. At worst it is actively detrimental to its own goals encouraging those neutral on ethical issue to align themselves with corporations seen negatively. Socially responsible investing should be seeking out the worst corporations, buying significant stakes and using this control to force management to change. Boycotting only works as a customer, it does not work as a shareholder.
To close, I finish with a quote from Albert Einstein: “The world is a dangerous place. Not because of the people who are evil; but because of the people who don't do anything about it.”
