The shades of grey in ethical investing

Darius McDermott, managing director of Chelsea Financial Services, considers ethical investing ahead of Good Money Week which begins on 30 October.

The shades of grey in ethical investing

Smoking isn’t good for you, but it’s been very good for UK investors’ returns over the past decade. Depending on how comfortable you feel with this statement, you may or may not consider yourself an ethical investor. Good Money Week, which begins on 30 October, invites everyone to think about this balance.

UK-listed tobacco firms have delivered total returns of 351% in the 10 years to 21 October 2016. The broader market has done 73% (1). That’s quite a difference. Among tobacco’s better known advocates, from an investing perspective, are Neil Woodford, a top UK fund manager who runs Woodford Equity Income, and Terry Smith, the man behind Fundsmith Equity.

Objectively, tobacco ticks off several investment criteria. The companies don’t have to (and/or aren’t allowed to) spend big money on advertising. They have recurring demand and barriers to entry. And because they have strong cash flows and light capital expenditure, they tend to pay good, steady dividends that contribute significantly so investors’ total returns.

So you have to face it, tobacco companies are a ‘good’ investment, viewed in this light. Yet for most ‘ethical’ funds and people seeking ethical investments, they are a definite no-go zone. Fortunately, tobacco is not the only industry to have outperformed the broader market over the long term (although it is the stand out). Telecommunications has returned 168% over the same 10-year period. Healthcare is up 124% (2).

Not black and white

You’d think these two industries would be clear cut examples of ethical investments. But, as always, there are nuances. Healthcare, for example, contains pharmaceuticals which have varying reputations regarding socially responsible behaviour.

These quandaries occur not just in investing, but in our day-to-day lives, too. We buy a bunch of chocolate bars on the high street without giving the brands a second thought, yet stories of cocoa farm mistreatments are rife – how do we know what we are really buying? Clothing retailers are another prominent example.

Ethical fund managers make these kinds of background checks part of their core business. Sue Round, who has been managing the Elite Rated EdenTree Amity UK for more than 25 years, recently brought a couple of their preferred investments – in chocolate – to my attention. The fund currently has both Patiserrie Holdings and Hotel Chocolat in its portfolio and Sue emphasises that both companies have strong ESG [environmental, social and governance] credentials, while having also experienced impressive growth over the past decade.

Sue describes an ethical and responsible supply chain as “one of the most significant challenges to the food and beverage industry” and highlights how Hotel Chocolat is a rare example of a chocolatier that also grows its own cocoa to ensure better control over employees’ working conditions. So who says you can’t have your (chocolate) cake and eat it too?

Looking for the good

More broadly, Sue’s approach showcases what I think is a positive trend in ethical investing, which is to look for the good as much as to screen out the bad. This strategy might take an ethical fund into perhaps unexpected industries, such as basic materials, if a manager feels a company demonstrates best practice in one or more key ESG criteria and could be viewed as a leader in its field. Of course, these sorts of parameters should be made clear to investors.

Another fund I really like, which puts ‘positive screening’ front and centre of its process, is the Rathbone Ethical Bond fund. Its manager, Bryn Jones, won’t invest in a company unless it has at least one positive ESG quality. Bryn’s been running the fund for 12 years now and it has beaten the average corporate bond fund by 10% during his tenure (3). Because it buys bonds instead of equities, the fund also offers something different in the ethical investing space, with an income focus and a historic yield of 4.5% (4) – pretty attractive in our low rate environment.

So while ethical investing is indeed an area with many shades of grey, the most important thing to know is that there are options. Personally, I like the idea of not just avoiding the companies I dislike, but of putting my money into businesses that are trying to change the world, while also looking after my own financial future. I think that should be the definition of ‘good’ investing.

 

  1. FE Analytics, FTSE All Share Tobacco vs FTSE All Share, TR in GBP, 20/10/2006–21/10/2016
  2. FE Analytics, FTSE All Share Telecommunications, FTSE ALL Share Health Care, TR in GBP, 20/10/2006–21/10/2016
  3. FE Analytics, Rathbone Ethical Bond vs IA Sterling Corporate Bond sector, TR in GBP, 01/11/2004–24/10/2016
  4. Rathbone Ethical Bond fund fact sheet, 31 August 2016

 

Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest. 

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