Ethical Investing Explained: Screening, Engagement & Impact

Firstly, What Is Ethical Investing?

Ethical investing is the idea that our money can do good in the world whilst also bringing us a financial return.

For me, it focuses on our power and agency - and it’s exciting! It’s also a huge and varied field that allows (and requires) each individual to make thoughtful, intentional decisions which will have a ripple effect over our entire lives and communities - not just our individual money stuff.

Socially Responsible Investing (SRI)

This is the umbrella term which covers a range of approaches within the financial industry. It’s the financial industry’s attempt to answer: how can investment reflect people’s ethics?

I feel like ‘ethical investing’ is a term a lot of us use and we’re probably talking broadly about the same thing, but Ethical Investing has a specific meaning in the industry and is separate from Responsible Investment (even though the terms are often mixed and matched - we won’t!).

In the main, Ethical Investment refers to a process called screening and Responsible Investment refers to a process called engagement. Both are used by investors and fund managers to decide where their fund’s money should ultimately end up, but they’re quite different concepts - screening decides whether you invest; engagement decides what happens once you do.

Screening in Ethical Investment

Screening is about whether the money is or isn’t invested and then where it goes. There are two types: positive and negative.

Negative screening is the older of the two concepts - it means not investing in certain markets, trades or companies. For example tobacco, alcohol production, nuclear power/waste, pornography or trading in arms.

Positive screening is seeking assets which adopt good policies on the above issues but also focus on community involvement, the environment, sustainability, human rights etc.

This is sometimes called Impact Investing - investing with the intention to get measurable social and environmental returns as well as financial benefits.

It is possible (maybe even probable) that focussing heavily on impact could negatively affect profits. In reality, those paying better wages, investing in communities and the environment, following every regulation to the letter costs money - especially compared to companies which, frankly, don’t. But the data on ESG funds overall doesn’t really support the idea that ethical companies consistently deliver lower returns (more on that in a few days).

Engagement in Responsible Investment

This was the one that surprised and excited me when I first learned about it. The idea of board meetings and high level discussions between investors and CEOs kind of stresses me out - the old boys’ club. But what if that sort of influence was used for good?

So instead of avoiding investment in, say, fossil fuels, the fund manager buys enough in these assets to have a say in how the company is run and where it’s headed in the future. It’s sometimes described as ‘active ownership’.

JP Morgan gives the example of an investment manager with significant holdings in a US cement manufacturer who influences the company to reduce its reliance on a particularly environmentally damaging component. (They say it’s a real-life example and then later call it hypothetical, so who knows! But it illustrates the point clearly.)

Of course, the scale of the engagement effect is dependent on the scale of the investment. Not every fund or manager gets access to every inner sanctum. So you could argue that this influence remains largely symbolic until you get to the really big players, funnelling huge amounts of money into companies you may - or may not - believe in.

In Summary

I think most people reading will be quite taken by the concept of ethical investment - but when it comes down to it, how do we actually assess that and put it into practice? Especially if we’re not picking individual stocks ourselves (and frankly, most of us aren’t and shouldn’t be).

A grounding in the industry terms is a great place to start I think, and there’s more coming next week.

Please send me any questions you have about ethical investing - this week’s newsletter will take you step-by-step through what you might see when choosing an ESG fund, and next week’s newsletter will be a roundup of your biggest FAQs.

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Love Eleanor. xxx