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  • Andrew Klamerus

It pays to be good

We are witnessing a new era in ethical investing. As societies worldwide are becoming more aware of the dangers of climate change, growing economic inequality between the developed economies and emerging/frontier markets and the importance of transparency when it comes to corporate governance, the funds that promise to invest your monies in an ethical way are entering the mainstream.

The idea of ethical investing, some say, goes back to 18th century and has roots in religious dogma. Back then, in North America, Quakers (one of the Christian denominations) restricted their followers from engaging in slave-trading or investing in companies that derived profit from slave labour. This idea has been adopted and soon expanded by other protestant denominations both in the New World and Old. Most notably a certain John Wesley, an English cleric who led a revival movement within the Church of England known as Methodism. In a truly Christian fashion, he pleaded with his followers to avoid companies that “harm one’s neighbour”, such as chemical plants – we have to keep in mind the non-existing environment regulatory framework back in that day. Interestingly, the religious associations of ethical investing led to a whole lot of embarrassment when in 2012 it was revealed that Vatican had a considerable holding in Beretta, an arms manufacturer.

Outside of our Euro-American echo chamber, perhaps the earliest example of ethical investing - also rooted in religion - is Islamic Banking with its restrictions on alcohol, gambling and pork.

All of the above were just guidelines, a moral compass announced by clergymen. Not much has changed until the Vietnam War which as we know led to a massive societal change in the USA. This is the genesis of Pax World Fund, the first mutual fund that promised its investors not to allocate any monies to arms manufacturers. The rest is, as they say, history.

Schroders conducted a survey in 32 countries and they’ve found that on average 61% of investors are now expressing desire for their funds to be managed in line with ESG (Environment Friendly, Socially Responsible and Transparent Governance) values. This increasing awareness resulted in an outpour of ESG funds. Morningstar reported in 2019 that the number of ESG funds increased by 50% compared to 2018. But it’s not only the number of new funds that is astonishing, the same Morningstar report revealed that the total inflows into ESG funds in the period between 2013 to 2018 were thirty times higher than 2009 – 2012. We are yet to see the updated data, but this trend is likely to continue.

This increase doesn’t come without any challenges. Companies that tend to adhere to ESG guidelines also share some other characteristics, like size, type of industry they operate in and geographical allocation. The reason why that can hypothetically be a problem is that instead of having a broad spectrum of global companies and industries being represented in say a Global Equity ESG fund, we can unintentionally end up with a portfolio concentrated in North American big tech companies. Not to say that they are not at the forefront of what ESG should be about, but this kind of concentration can eventually lead to over-exposure to these assets and the associated risks. This has not been the case so far, but one can imagine a scenario where stocks of these companies, being highly correlated, can deprive the investor of one of the most powerful risk reducing factors – diversification.

This has been recognised by the industry and various professional bodies and fund managers are trying to address this issue by opening up to less developed regions and smaller companies and also adopting a more nuanced approach to stock selection, such as ‘best-in-class’. ESG is evolving rapidly and we can only hope that one day these new ‘higher standards’ will just be the new normal.

However, for now, we at Schofield Money are recognising that ESG is on a certain level, just another investment style and we are approaching it with the same attitude that we apply to any other investment style: with no bias, investment style agnosticism and by looking at the hard data rather than fund managers’ glossy brochures. Currently, every client is to some degree invested with an ESG focus as investments such as the Royal London and Liontrust Sustainable series of funds have been core mainstays within our portfolios for a number of years now.

For those clients that have chosen to invest exclusively in ethical investments with us, rest assured that the rapidly increasing universe of options allows us to ensure we continually maintain effective diversification within your portfolios.

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