Tim Price puts the case against ethical investment, while below Mark Mansley springs to its defence.
Ethical investing is a fad. Avoid it at all costs
By Tim Price
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The financial services industry is prone to fads. Internet and technology-themed funds are probably the most devastating recent examples, but the damage they inflicted on fad-following investors (and on the credibility of fund-management companies that stepped up to meet public demand for them) was sector-specific. Ethical investing could be more dangerous yet, in that it represents an entire philosophy of money management that sits uneasily with the principles supporting a free capital market.
What precisely constitutes "ethical investing" is not clear. The onlinencyclopedia Wikipedia defines ethical investing as investment that decides not to fund arms manufacture and sales, questionable labour practices, or laenvironmental standards. Most investors would concede that profits from death, exploitation or pollution are difficult to swallow. But investment firm Domini Social Investments, which manages more than $1bn in assets for those "who wish to integrate social and environmental criteria into their investment decisions", goes further they avoid tobacco, alcohol, gambling and nuclear power. Does this mean that Big Oil and Big Coal (both inherently filthy businesses with an acknowledged track record of occasionally killing workers) make it in? Ethical investment starts to look worryingly subjective. As at 31 March 2005, some of the largest holdings within the Domini Social Equity Fund, one of the larger "socially responsible" funds, were shares in Microsoft and American International. Evidently, market-abusing monopolists and firms under investigation for improper accounting are perfectly "ethical".
The beauty of investment markets is that they constitute a self-perpetuatinmechanism that rewards success. Anything that impedes the free flow of capital such as a subjective assessment of presumed ethical superiority is, all things being equal, likely to result in sub-optimal returns. The investment markets are not motivated by fuzzy concepts such as inclusion' and social justice. What drives them is greed and fear the expectation of profit and the avoidance of the prospect of loss. Any financial market, like life itself, operates on Darwinian principles. Investing solely on the basis of ethical issues amounts to crippling oneself and one's opportunities. But perhaps the biggest reason to be suspicious of ethical investing is that it doesn't work. According to Bloomberg, since 2000 the Domini Social Equity Funhas lagged the S&P 500 (which has itself fallen by 14%) by more than 8%. There is a word for proactively pursuing investment losses: folly. To add insult to injury, a rival fund that is the polar opposite of Domini has performeswimmingly. Mutuals.com's Vice Fund, run by Dan Ahrens, has delivered totareturns of 61% since inception in September 2002, outperforming the S&P 500 index by more than 12%. Unlike Domini, it embraces the arms business, alcohol, gambling and tobacco. You may not like these sectors, but they are legal and do generate good returns.
Let's face facts. We live in an environment of low nominal returns. Globainterest rates are slender, bond markets look overvalued by most standards and a number of G8 economies are on the brink of recession. Finding profits is difficult enough, without hobbling yourself with ethical' investment.
Tim Price is senior investment strategist for Ansbacher & Co
Ethical investors make money and do good
By Mark Mansley
After years of being seen as a rather esoteric and minority activity, ethicainvesting and its traditional concerns are increasingly entering the mainstream a growing number of institutions are offering ethical' products. Still, this wider acceptance hasn't stopped the criticism rolling in from many quarters.
For example, some argue that it is impossible to apply ethical principlesensibly. This may be because companies are interdependent, the issues involved are complex, or because it is seen to be the role of governments, nobusinesses, to intervene if necessary. What this view fails to take into accounis the nature of most ethical investors: they are reasonably pragmatic and seethical investment as a way of contributing to a better world', not as aattempt to create a perfect world'. They recognise that sometimes it idifficult to draw a line between acceptable and unacceptable behaviour, and that the issues are complex. But they also feel that some activities arindefensible, that some action is appropriate, and that it is better to attempto do something than simply to ignore the issue altogether.
Another common criticism is that there is no common ground for ethics as ethics are purely subjective. This, however, is not a fundamental problem. Many ethical issues and concerns are broadly shared tobacco and arms, severe environmental damage and human-rights abuses, for example. This makes it possible to develop funds that appeal to most ethical investors. Furthermore, these broadly shared concerns can generate real opportunities for business, precisely because addressing them can give the business a good reputation.
More recently, ethical investment has faced another criticism: that followingood corporate governance and supporting ethical principles is what any good fund manager should be doing anyway, so the ethical' label is merely a sales gimmick. For many in ethical investment, this criticism feels more like compliment. True, many ethical concerns good corporate governance, thsignificance of non-financial risks, the importance of ethical issues to firmwhose value is intangible are now widely recognised by other investors, anthat is a big endorsement. But ethical investors will continue to be differentUnlike mainstream investors, they won't demand extensive evidence beforaccepting the validity of a particular concern and will be prepared to act ouof principle.
Interestingly, this may well enable them to win a financial advantage too. Bbeing more ready to respond to new or developing issues, ethical investorshould remain ahead of the curve. For example, Parmalat was excluded from the Rathbones Ethical Bond Fund because inconsistent responses to our enquiries highlighted its labyrinthine nature. We may not have known the specific reason for its failure, but we got an insight into Parmalat's internal accountability that other investors would have been unlikely to pick up on. This level of diligence when choosing stocks gives us an extra layer of research that helps unearth potentially harmful, unethical corporate problems that could lead to damaging litigation and weaker credit ratings. Finally, those who criticise ethical investment should recognise that ethical investors are in fact more demanding than most they demand not only financial performance, but also an ethical return. This poses a challenge to those of us who provide ethical investment services, but it's one to which we are happy to respond.
Mark Mansley is strategy and communications manager at Rathbone Greenbank Investments
The top ethical performers
When ethical funds first emerged in the early 1980s they were nicknamed "Brazil funds" because they were only for nuts, says The Sunday Telegraph. And despite good growth in assets under management over the last few years, they remain a niche business for most fund providers: only 1.95% of the £78.4bn invested in UK All Companies sector funds is invested in ethical funds. Traditionally, ethical investment has excluded firms involved in industries such as gambling, tobacco, armaments and alcohol. It is no longer that straightforward. Today, a fund's ethical commitment is categorised in different shades of green. Dark-green funds have more rigid criteria than light-green ones. They would not, for example, dream of investing in an oil firm. Light-green funds will invest, but will choose the best of breed within a sector for example, they will choose the most responsible of the oil firms rather than excluding the whole sector on principle.
In recent years ethical funds haven't underperformed. Standard & Poor's told The Times that while the average FTSE 100 tracker has returned 1.92% over three years, the average ethical fund has returned 4.19%. The top-performing ethical fund, F&C Stewardship Income, one of the darkest green funds, returned a very impressive 41%, making it the fourth-best performer in its peer group (the equity income sector, which includes non-ethical funds). It is not alone, says The Times. Insight Investment European Ethical has returned more than 30% over three years and Morley SF Corporate Bond 27%. "Ethical funds will have their ups and downs," Philip Chapman at Holden Meehan, an advisory firm that specialises in ethical investments, told The Sunday Telegraph. Some have suffered from low or no exposure to surging oil shares, for example. "But, over the longer term, investors should be able to ride out these ups and downs"
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