Ethical Investment – Big Business But What Does It Mean Exactly?
When push meets shove, that’s for individual investors to decide
An Ethical by any other name
Ethical investment is big business. How big, we’ll take a look at shortly. But for sure it’s an important consideration for publicly listed companies these years. The acquisition of ‘ethical’ status opens up the company to a wider range of prospective shareholders, from institutional to private retail, giving it more robust fund-raising options going forward. And it adds cachet to the company’s name and its brand or brands, making it easier for the company to recruit. There would hardly be a listed company today which doesn’t consider itself ethical, and proclaim as much on its corporate website, whether or not the market agrees.
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But what is an ‘ethical’ investment? Who decides, and by what yardsticks, that company A is ethical but company B, well, isn’t? If a company you have shares in doesn’t feature in a high-profile Ethicals index, does that mean the company is ‘unethical’ and should you be dumping it as soon as?
And in addition to the adjective ‘ethical’, publicly traded companies are increasingly being categorised as ‘socially responsible’, for the purposes of inclusion in SRIs – Socially Responsible Indices, or Investments. Or is that ‘sustainable and responsible investment’? Or ‘sustainable, responsible and impact’ investing? Actually the same acronym is used for all these labels, which is not helpful.
Is it irresponsible to not be socially responsible?
So is being socially responsible – or sustainable and responsible, with or without an impact – any different from being ethical? If a listed company isn’t included in a Socially Responsible Index, is it socially irresponsible?
And can you be ethical and/or socially responsible if you’re not ‘green’? To be sure, to be green you have to be ‘sustainable’. But do you need to have living walls at your corporate HQ, with bike racks in place of (some) car parks, and solar-powered hot showers available to your sweaty bike-riding workers?
If a corporate is providing such sustainably thoughtful amenities, the chances are that it’s got an enlightened and forward-thinking board and management, in which event it probably rates highly in another acronym – ESG – which of course stands for ‘Environmental, Social and Governance’. Are you keeping up?
The Big Bang in Ethical Investment
It’s hard to say for sure where it all started, though the blacklisting of companies because of the way they do business goes back at least to the American Civil War era, when slave-labour enterprises in the south were boycotted by northern capital. In the modern era though, and again in the United States, investment advisor Amy Domini can legitimately claim to have been at or near ground zero in the big bang of the ethical investment movement. The stock index she created in 1990, as the Domini 400 Social Index, lives on today – as the MSCI KLD 400 Social Index, now a prominent part of MSCI’s vast inventory of global investment decision tools. It was relatively small change back then but last year US SIF – the Forum for Sustainable and Responsible Investment (aka the ethicals industry trade union) – published its latest study of the worth of the SRI/ESG industry in the United States and the numbers are impressive.
According to that study, ‘sustainable and responsible investment’ under professional funds management of some type in the US last year amounted to $3.74 trillion, an increase of 486 percent on 1995 when the calculation was first undertaken. This, according to US SIF, accounts for over 11 percent of all professionally managed investment in the US, some $33.3 trillion as tracked by Thomson Reuters.
And in global terms? That’s a stat we’ve found hard to track down and in their report just mentioned US SIF say only that ‘the tally of the global assets of the US money managers and institutional investors engaged in or exploring SRI strategies is many times larger’, which suggests they didn’t have any more luck than we did.
Picking Ethicals – Negative and Positive Lists
So if you’re an equities investor – or into bonds for that matter, because they also play the ethical game – with a highly-developed social conscience and of a mind to put your money only into socially responsible, sustainable, environmentally aware and responsibly governed public companies, how might you go about it? You could of course go the funds route and let someone else do all the legwork – for a fee naturally, and ethical funds fees are typically higher than mainstream funds on the footing that more work is involved in composition and monitoring.
But let’s say your inclination in investment decisions is to fly solo – how do you determine which companies qualify for your ethical investment funds? Like the funds, you have two basic approaches available to you. Your selection is either ‘negative’ – meaning you screen out all companies which fall into your blacklist and stand in the market for everything else – or you apply a ‘positive’ filter, in which case you actively seek out companies which operate in an SRI/ESG kind of way generally, or specifically in a way that appeals to you, and are therefore deserving of your investment.
In an explanation of the aforementioned MSCI KLD 400 Social Index in its modern form, MSCI explain how they do it. The index, they say –
… comprises companies with high Environmental, Social and Governance (ESG) ratings and excludes companies involved in Alcohol, Gambling, Tobacco, Military Weapons, Civilian Firearms, Nuclear Power, Adult Entertainment, and Genetically Modified Organisms (GMO).
So it’s a hybrid – there’s that blacklist but, with the players in those industries excluded, the companies actually selected for this particular index, some 397 currently by the way, must rate highly on ESG.
The problem with Negative Selection
One thing to keep clearly in mind in an ethical investments selection is that there is no single, universally accepted blacklist, or positive list for that matter. One investor’s shining green knight is another’s villain.
But using MSCI’s selection – curiously capitalised – of bad-guy industries, we could say, couldn’t we, that Tobacco is a no-brainer. There can’t be a more vilified consumer product used by a billion-plus people on the planet today. So the combined $418 billion of market cap amongst the world’s five biggest tobacco companies, allocated amongst nearly 8.4 billion shares held by hundreds of thousands, millions perhaps, of individual shareholders (either directly or through institutional investors), is the antithesis of ethical investment and no ethical investor would want to be seen in the same room as a shareholder in British American Tobacco (LON:BATS). Even though the tobacco companies are amongst the most ESG-conscious corporates in the world these days – and the most profitable.
We can likewise be comfortable with the blacklisting of Military Weapons and Civilian Firearms, both of which products – like tobacco – kill people, especially when in the wrong hands. Unless of course we’re amongst the legions of righteous investors who also happen to believe in the necessity of military might as a stabilising factor in a still-dangerous world and/or the constitutional right to bear arms. In other words, say, many tens of millions of Americans.
And what about Nuclear Power? The end product is undeniably clean and green, though the raw materials and by-products are neither, so should nuclear be on every ethical investor’s blacklist?
No easier with a positive approach
Turning now to the positive selections in the MSCI KLD 400 Social Index, which is as good as any other of the hundreds – thousands even – of ethical/SRI/ESG indices and funds to use for the purpose. As mentioned, there are nearly 400 listed companies in this long-standing ethicals index, with a combined market worth of $6.3 trillion, and at the top – weighing in at $275 billion – is Microsoft Corporation (NASDAQ:MSFT).
We’re here talking a company whose name has become more or less synonymous with antitrust violation, famously in the late 1990s in the United States but since the turn of the century in Europe, and pretty much every case connected with abuse of dominance in operating systems and browsers. Most recently, in March this year Microsoft was slapped by the European Commission with a fine of $732 million for failure to comply with undertakings given in a 2009 settlement undertaking to provide European computer buyers with alternatives to Windows. According to a NY Times piece of 7 March, Microsoft has shelled out around $3.4 billion in antitrust fines in Europe over the past decade.
Does persistent breach of the law matter when it comes to determining whether a corporate is or isn’t ‘ethical’? Ordinarily the answer would have to be yes, but perhaps the likes of Microsoft amount to special cases, on account of their sheer size or other innate propensity to run foul of laws which many investors perhaps don’t see as being ‘criminal’ behaviour (though antitrust violation most certainly is).
For whatever reason, Microsoft’s long, troubled relationship with competition regulators in the US and the EU doesn’t disqualify it from top billing in MSCI’s leading ethicals index, and no doubt many others. And the MSCI KLD 400 Social Index’s top 10 contains other major companies which for other reasons wouldn’t fit into everyone’s ‘ethical’ investment definition.
Ethics and American icons
Fourth place on the MSCI top-10 is Procter & Gamble Inc (NYSE:PG). It’s an American icon but it uses animal-testing. And like every other cosmetics manufacturer, it also uses a raft of very nasty chemicals to add shine, softness, suds and the like to its range of beauty and personal care products. And also lead – a 2007 study by the US Food & Drug Administration of 20 leading brands of lipstick sold in the US had Procter & Gamble products in three of the top five placings for lead content. It’s Cover Girl ‘Incredifull Lipcolor’ line was found to have had 34 times the lead content of the lowest in the survey and over three times the average content.
Then there’s PepsiCo (NYSE:PEP), in eighth place on the MSCI KLD 400 Social Index in terms of market cap, which makes dozens of food and beverage products that taken in sufficient quantity can make you fat, harden your arteries or even kill you. And which a great many green or socially responsible or otherwise ethically-minded investors wouldn’t touch, or allow their children to touch, with a barge-pole.
And not just American
So perhaps what’s coming through here is that once you start thinking about it, the separation of the world’s publicly-traded companies into ‘ethical’ and the rest is by no means cut and dried. Any major multinational you care to think of is likely to have issues with one or more aspects of the whole ethical/SRI/ESG template. Moving out of the US and into Europe, let’s take H & M (STO:HM-B), the Swedish flagship clothing retailer, the world’s second-largest and with a market cap of around $61.4 billion around three times the size of leading US chain The Gap (NYSE:GPS).
And being Swedish, it’d have to be ethical and socially responsible and responsibly governed and green, all at the same time, right? According to Greenpeace though, strike the latter tag. In a third report last year in its ‘Dirty Laundry’ series, entitled ‘Dirty Laundry: Reloaded – How big brands are making consumers unwitting accomplices in the toxic water cycle’, Greenpeace washed a sampling of new leading-brand clothing items to measure the proportion of environmentally hazardous NPEs – nonylphenol ethoxylates, a major source of water pollution – used in clothing manufacture which leached into the water cycle on first washing.
Tied for first place with a leaching of 94 percent of the NPEs detected in the new garment were an item manufactured and sold by H & M in China and one manufactured by Ralph Lauren (NYSE:RL) in The Philippines and sold in Italy. Adidas (ETR:ADS) and Nike (NYSE:NKE) products were not far behind at 90 and 88 percent respectively. Incidentally, the lowest first-wash NPE release was from a Kappa-branded tee-shirt, parent company Basic Net SpA of Italy (BIT:BAN), manufactured and produced in Thailand and which leached just nine percent.
Pragmatism the order of the day
The fact is, whether through conglomeration, scientific discovery, bias shift or some other reason, many – perhaps a majority – of the publicly-traded companies on ethical/SRI/ESG indices have some problematic element to their businesses. A degree of pragmatism is thus called for when making an ethicals portfolio selection. It’s certainly how the funds rationalise a stake in an attractive SRI/ESG- candidate even though it has a stake in some blacklisted industry. A cap on the investment, comparable to the extent of the naughty investment, is typically all that’s needed to get over that particular ethical issue.
To take a pertinent example. In eftchannel.com’s current ranking of the top 25 ‘Socially Responsible Dividend Stocks’, first place goes to NextEra Energy, Inc (NYSE:NEE), currently generating a yield of 3.05 percent. Based in Florida and formerly known as FPL Energy, NextEra has this to say in notes to its very healthy Q2 2013 earnings statement:
NextEra Energy Resources had a very strong quarter and the business remains on track to meet its development goals and strengthen its position as North America’s largest generator of clean, renewable energy from the wind and sun.
NextEra is indeed a major player in the North American renewable energy sector but what is not here mentioned is that NextEra is also into nuclear, owning 70 percent of the Duane Arnold Energy Centre, a nuclear power plant in Iowa, nearly 90 percent of the Seabrook Station NPP in New Hampshire and 100 percent of the Point Beach plant in Wisconsin.
Second and third spots in eftchannel.com’s top 25 ‘socially responsible’ dividend stocks are occupied by Microsoft and PepsiCo, considered earlier. And at number six is McDonald’s Corporation (NYSE:MCD). There are, it can safely be said, a great many retail investors around the world for whom a Big Mac Combo is the antithesis of ‘socially responsible’. Some of them quite possibly in Bolivia, where in May this year McDonald’s lowered the boom on its eight restaurants after 14 fruitless years of trying to persuade Bolivians to buy into fast-food.
‘Ethical’ – More of a concept really
So to recap, the label ‘ethical investment’ – whether or not it exactly equates with SRI or any other acronym – is much more a concept than it is a concrete parameter for shareholdings which tick every box for investors with a conscience. This because there is no set group of boxes. If your conscience compels you, say, in the direction of enterprises advancing the planet’s uptake of alternative energy, you will likely gravitate towards windfarms and solar (assuming that, unlike the aforementioned NextEra Energy, they are not also into nuclear). But you’ll want to satisfy yourself that, for example, your company of choice is not using rare earth minerals in its wind-turbine magnets which have been manufactured in an environmentally-disastrous process in the People’s Republic of China – which is where over 90 percent of such materials are in fact produced. Plus incidentally a huge proportion of the photovoltaic solar panels used throughout the world.
And if your concerns lie with the working conditions of low-paid labourers in Third World countries, you might think twice before investing in any of the world’s leading clothing and sportswear brands, since most are produced by such workers in such countries.
The role of shareholder activism
Or perhaps you’ll see your stake in the company as a means by which you can seek to influence its production values and practices in the future. This is where ESG in particular fits into the broader ‘ethical’ concept. Shareholder activism has become a major feature of corporate governance (the ‘G’ in ESG, recall) in the past decade or more, especially with American companies. And in principle every shareholder, no matter how small, has the right to file shareholder resolutions on governance or business practice issues for consideration at the company’s general meetings.Realistically though, the prospects are tiny for meaningful exposure of a resolution filed by a single small shareholder – there is only so much business a corporate can transact at its AGM. Much more pertinent is the opportunity for small shareholders to support governance-related resolutions put up by significantly-sized institutional shareholders representing ‘community’ interests – a practice which has become something of a growth industry in corporate America and elsewhere in recent years. And there’ve been some notable scores, with prominent companies being obliged by such shareholder activism to change the ways they carry on their businesses, especially in relation to their carbon footprints.
Getting back to the money
In the final analysis though, investing in equities is for the vast majority of investors a question of getting an acceptable return on the investment. There are undoubtedly many people whose primary objective is to support their particular ‘cause’ irrespective of the profitability of that enterprise but most mainstream investors will accord primacy to yield and capital growth. Those considerations may or may not – indeed oftentimes don’t – sit entirely comfortably with the pursuit of ethically and environmentally sound, and socially responsible, policies and practices.
The fact is that ethics cost and the aforementioned MSCI KLD 400 Social Index is probably as good an illustration as any. Whilst over the 15 years since it assumed its current form the index has outperformed the MSCI USA Index by a modest 2.2 percent, it’s actually lagged that main equities indicator in 11 of the 14 years since 1999. The fact that it’s in front overall is very largely due to a one-off blip, the 31.73 percent gain in 2009, versus the main index growth that year of 27.14 percent.
And the UK’s oldest extant ethical fund, which predates the founding of the MSCI KLD 400 Social Index by some years, is an even less compelling argument for the marriage of ethics and profit. The F&C Stewardship Growth Fund, launched in 1984, hasn’t out-performed the Footsie All-Shares index in a single year since.
There are exceptions of course, as there are to every rule, with some SRI/ESG-rated stocks doing very well for themselves, but in any event ethically-minded investors will doubtless be well aware that going ethical is by no means synonymous with getting the best return. More problematic surely is just what it means to go ethical. Ultimately, as with most moral issues, that’s down to the individual investor to decide.