Expert view: Ethical finance has wide implications

Socially responsible investing is increasingly finding its way on to the agendas of charity trustee meetings.

Investment policy statements are being rewritten to incorporate SRI, or at least mention that it has been considered.

The debate about SRI tends to centre on how a charity's investments should be consistent with its purpose and not risk alienating beneficiaries and donors.

When considering negative screening (avoiding so-called 'sin' stocks), trustees should focus on asking their managers how the exclusion of various sectors will affect performance.

It used to be assumed that excluding certain companies or sectors would reduce portfolio diversity and therefore damage performance. However, surveys by the European Centre for Corporate Engagement have shown that the returns achieved by ethical investment are neither better nor worse than those from the 'non-ethical' kind, and that it may in fact reduce risk. The debate has therefore moved on to look at the style tilt that can result from excluding sectors or companies.

As for impact on the corporate landscape, the theory is that if investors increasingly allocate capital away from tobacco, defence and sin stocks, then management's access to capital and ability to develop becomes more limited. In practice, where there are opportunities to make a good return, other investors will move in to pick up the slack.

Negative screens are particularly contentious in situations where capital is withdrawn from countries where human rights abuses take place, such as Burma. Which companies and investors move in to pick up the slack? They are usually names we would not recognise and do not have any social or environmental policies to speak of. And it is most likely to be the poor who suffer from the withdrawal of capital from a country. This minefield of unintended consequences is particularly difficult to navigate.

Finally, the definition of sin stocks is liable to change. A large number of funds used to avoid nuclear power, but it is now increasingly accepted as a potentially clean energy source, and it is estimated that 700 new stations are needed globally to meet future energy needs.

Instead of engaging in distracting debates about whether a company that produces safety equipment used by soldiers should be screened because it constitutes defence, trustees should focus on how negative screens affect the performance of the portfolio and, importantly, the environment and society more generally.

- Nicola Donnelly is an investment manager in the UBS charity team.

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