Keen to be green? Find the shade that’s right for you

Editor’s note: Audacious Investing is pleased to run this comment piece from Australian Ethical Investment. We encourage informed comment from industry experts that will give greater understanding to you about how ethical and responsible finance works.

By Stuart Palmer – Head of Ethics Research – Australian Ethical

Stuart Palmer, head of ethics, Australian Ethical Investment

The rise and rise of responsible investing seems irresistible, with ’deep’ ethical investing doubling every few years and broader responsible investment making up around half of all Australian funds under management. As responsible investing grows, there’s little doubt that more investors, and their clients, want to be involved. However, as responsible investing (RI) becomes more mainstream, it’s crucial to understand what ‘RI’ means. Investors have many tools to influence the world, and they need to pay attention to each of them to meet clients’ objectives for individual financial security and a better future for all.

Investment screening and ESG integration

By being selective about where they will and won’t invest, responsible funds can support positive businesses like renewables and healthcare, and deny capital to unsustainable industries like fossil fuels.

Negative screens – a method of determining what a fund won’t invest in – vary greatly between responsible funds. Some ethical ETFs have very limited screens and exclusions (e.g. just tobacco), while other fund managers, like Australian Ethical, have much broader screens. Guided by our Australian Ethical Charter, we do not invest in anything that is unnecessarily harmful to people, animals, society and the environment which means our exclusions go far beyond tobacco to sectors like gambling, live export, fossil fuels, nuclear technologies and companies that disregard human rights.

ESG integration means investment decisions consider how companies are managing their environmental and social impacts, and also the quality of their governance. For example, the manager may reduce a valuation for a company if they are concerned about the risk of environmental claims against the company, or of workforce disruption. ESG integration is important, but on its own it tends to be ‘ethically passive’. It won’t stop a fund investing in a harmful product if the manager thinks the company’s share price has fallen far enough to represent good financial value. The problem with this approach is that it ignores the power investors themselves have to help shape the future. For example, if investors only choose companies which have strategies aligned to limiting warming to below two degrees, then they will help bring about a world which effectively limits warming. By shifting capital from fossil fuels to renewables, investors help to bring down the price of renewable energy, they encourage investment in more flexible electricity grids and storage, and they contribute constructively to a sensible public discussion about energy policy. This will be in their interests and the interests of their clients: risk-adjusted returns are going to be better in a low-warming world than a high-warming one.

Influencing better business

Responsible investors can also exercise positive influence through the special access they have to company boards and managers. Responsible investors can encourage companies to pay attention to issues which are sometimes overlooked by executives with a narrow, short-term focus. In the food sector, for example, investors have been asking how overuse of antibiotics can harm consumer health, animals, and the environment. In particular, investors have focussed on the use of antibiotics categorised by the World Health Organisation (WHO) as important to human health, where overuse can encourage bacteria that are resistant to these antibiotics. Following this recent scrutiny, Australian chicken companies have given commitments to eliminate (over time) the use of some of these antibiotics.

Better government

Responsible funds need to use their voice to influence government and voters. Investors like super funds invest for the long-term and in businesses spread across the economy. They bring a more balanced perspective compared to individual industry sectors and civil society groups, who often have a narrower and shorter-term focus. It’s that broader, longer-term investor perspective which is so urgently needed today, whether in discussing clean energy targets or modern slavery laws to eliminate forced labour. Last year, Australian Ethical made five written submissions to government policy consultations on climate, human rights, and infrastructure funding. We also appeared twice before parliamentary hearings for additional policy consultation.

Transparency

Investors and their advisors need to be careful when choosing an ethical fund. They need to make sure they avoid ‘greenwash’, that is to avoid funds which use superficial ‘green’ labels and marketing for so-called sustainable investment options which are little different to mainstream funds. They need to do the same amount of research about fund impact as they do about fund returns. To facilitate this, responsible funds need to be transparent and tell clients what they do and don’t invest in, and why. They need to explain the rigorous processes they have for achieving positive social and environmental outcomes, as well as financial outcomes.

This openness is important for client choice but also because of the role responsible investors play in the public square. Recent political volatility demonstrates that well-functioning democracies and economies rely on open, constructive discussion of the issues to help people make informed choices with their votes and money. At stake are the choices governments make on pressing environmental and social issues like climate change and human rights, and crucial economic questions about well-functioning local and global markets. It’s important people speak up on social, environmental and economic questions, and that these voices include people from different parts of society with a diverse range of expertise, experience, and perspective. This includes politicians, journalists, professional pundits, civil society voices, and investors. So, as well as sitting in private meetings with company executives, fund managers need to exercise their responsible voices in public for all to hear.

There is a significant and growing shift in investor and client sentiment toward ethical investing. Investors have many powers to create positive change in the world, leading to a better future for all. The challenge now is to make sure investment choices leverage all these powers – both public and private – so that the shift to responsible investment makes a real difference.