More and more funds claim to follow an ethical investing, or “ESG”, mandate. Tim Bennett looks at some of the challenges when it comes to finding the right one.
Why Ethical Investing May Be Harder Than You Think
Welcome to this Kilic explains finiteness video this week why ethical investing is harder than you might think. Now the numbers certainly popular so in 2016 according to Boston Consulting Group assets under management following some kind of ethical mandate. And it does come with a number of titles. If your approach hit 23 trillion U.S. dollars pretty sizable number significantly that's up from 18 trillion in 2014. Not only is there a large pool of money out baffling some kind of ethical mandate but it would seem to be growing and at a reasonable rate on top of that 80 percent of high net worth millennials are insured in Sri approaches are socially responsible investing approaches ethical vs. 44 percent of all high net worth investors. So amongst younger generations this is certainly proving popular. So what is it and why is it harder to achieve and perhaps you might think first of all what are we talking about here. Well basically ESG is the current ways describes the popular acronym and that is essentially investment strategy based around picking stocks or falling funds which are driven by environmental social and governance concerns. In other words low environmental impact high social conscience and high quality corporate governance and the like and the approaches can be many and varied. So you can order pick individual stocks that say more about his new Lymon which follow the criteria you're looking at. Or you can simply take a broad basket of stocks and start to exclude companies that don't meet your mandate. So it sounds straightforward enough and it sounds sensible enough but there are some problems and thought having gone quickly.
First one the most obvious one is what actually do you mean by ethical investing. You'll see that actually what you mean. What I mean may mean two things in investing terms. Secondly once you know what you mean is there a product out there that meets your needs. How are you going to put together this portfolio which is SRI ESG. Well I think the best. And thirdly do you understand the implications for your broader portfolio and potentiate performance. Now the last year growth rate is what I called problem number one there. So what is on ESG failure now sounds a Blinov. I would invest on an ethical basis but actually on the right hand side here. Here are some of the criteria just some of the criteria which could be used to screen stocks to go in one of these portfolios. So while you're talking as many people are at the moment about low carbon non fossil fuel stopped as a popular one or are you avoiding vice stocks is no more about the moment or are you looking for non-military stocks or maybe screening out defense companies for example. Or is it religious values you want your portfolio to follow. So those could be Christian Catholic Islamic and so on. Or is it an interest in health stocks and therefore you want to screen out alcohol cigarettes non healthy foods may be popular. 70 years ago you became a known GM type stocks or maybe just renewables recyclables. You get the idea. The list goes on.
Or perhaps you're looking for only more holistic so only including firms that have sympathetic empathetic to the local economy to suppliers and newer employees and so on. So one Shafi'i about it you've got to think carefully about what I mean by ethical investing if you're buying a fund off the shelf is what you mean. Well they mean and so on. So next thing passive or active lets a thing right. Well basically a moment Bill by Ambu value that stocks reasons coming out I want to buy fog. Well what are the pros and cons that there are quite a few funds out there. Exchange traded funds for example which claimed the lives of ESG ethical or socially responsible investing probes. That's good. That cheap or cheap ETF tend to be. But you need to be careful so that naming names you look under the bonnet carefully one of the bigger S&P 500 ESG indices right which excludes all claims to exclude fossil fuel businesses. It's quite a popular moment. If you look carefully some of the companies in the index you'll find that actually it gets a bit gray around the kind of utility firms that are included and some of the banks which indirectly finance energy firms. So you've got to really look quite carefully in order to cover a portfolio within an index which is purely ESG driven active funds. You could take another break if you go big enough both earlier this year. Any people keeping up portfolios you could do one of those high net worth investors put together your own book value. Fuling your mind and criteria. That's always true. If you build a profile as an investment manager you've put together something which takes account of your ESG objectives whether your money's getting into funds or stocks or a mixture.
So are active funds out there that specialize in following ESG mandates. But inevitably you will pay a bit more usually to follow one of those two approaches or a combination than the pure passive approach that you might end up with something you're more comfortable with at the end of it. Then there's performance. Now there's some good news and bad news. It's good to be fat. Some ESG saying that the footsy for good Uganda index for example have returned around the same over the last five years as the Buddha FF6 to 100000 by focusing on firms that make globally recognized corporate responsibility standards. Over in the U.S. The Caille the 400 ethical index which is pretty well known as written around 100 9 percent of the last five years total return basis. By focusing on a broad spread of ESG firms if you like versus undenied the S&P 500 in the same period. So as always fair to say that ethical investors pay a penalty in performance terms. But it is true to say that voice can pay back but in a way so unethical actors have tended to be the ones that performed historically pretty strongly. All right. So if you looking at pure investment returns stocks in the alcohol tobacco gambling game and defense sectors not only offer pretty substantial total returns but actually income investors there are often some of the places they'll go looking and interesting in favor of way. Norway's sovereign wealth fund which is huge. How to go about excluding vice stocks completely as a screen for them over a period of 12 years from 2004.
And they reckon that annual returns suffered by around one point six percent. Now some reports I will. So what. I'm prepared to pay that price but just be aware that there might be a price to pay and then you get to be a little bit careful to make sure you're picking up an index on the S.G. focus. All right which is not the same as the broad index or building a portfolio options and the broad index. Watch out for tracking error under diversification where you bunch inadvertently sometimes into too narrow a selection of sectors and whether you are paying something the market lives for anyway. So the market for example raising the stock market has punished stocks in the US which cling to firearms. So names like Wal-Mart Kroger and Camping World are Remingtons gone bankrupt. So in other words as an ESG investor looking for the unknown Farnham's based firms you may be putting Atha in that the market is already kind of delivered in one way shape or form. Now to conclude so honest jest yes go for it. By all means if you think ESG investing is for you and you can find the right vehicle through today it is an alternative. So go grains of gold. The choice of the funds and investing options is growing. There are both passive and active styles of funds out there that try to achieve some kind of ethical mandates. All right. Returns can be certainly reasonable can be comparable to broader funds let's say as long as you're comfortable with the composition and as long as you're comfortable with the mandate matching your version of your definition of war. After investing is all about.
But some people would say why don't you keep investing simple and then achieve your ambitions elsewhere. One alternative approach will be just to recognize there's going to be very difficult to put together the perfect ethical portfolio given some of the constraints limitations I've just mentioned. So focus on his ongoing investment portfolio which will achieve your investment goals whatever those are at a tolerable level of risk for you. And then by all means fund things you are passionate about separately from the returns that you generate the day to email me on and has always just mentioned. Editor at Kilic dot com. Have you like watch videos related to this one click dot com forward slash nerd.