Niall Kennedy: Five myths about ethical investing

Niall Kennedy is portfolio director at Cazenove Capital in Edinburgh.

Sustainable investing is growing in popularity, but many misconceptions remain. Here are five myths to debunk.

– Sustainable investing is just avoiding “sin stocks”

The phrase “sin stocks” emerged to describe firms linked to industries perceived by some to be unethical, such as tobacco, alcohol or gambling.

Sustainable investment funds will exclude these stocks or screen them out. But each investor has views on what is and isn’t ethical.

Rather than merely screening out certain stocks, sustainable investing is about closely evaluating a range of environmental, social and governance issues, known as ESG.

This could be analysing a company’s track record on pollution from its factories, or how socially responsible it is in the communities where it operates.

– Returns will be hit if you invest sustainably

Isn’t there a cost to investing sustainably? There is mounting evidence to the contrary. Studies by Friede, Busch and Bassen (2015) and Morgan Stanley, to name but two, found that companies focused on ESG, had on average, enhanced financial performance.

A study by Empirical Research, which has been evaluating and monitoring 60 ESG factors since 2014 for US stocks, found that those companies with higher ESG scores outperformed those with lower scores.

By examining ESG issues, investors may gain a better understanding of not just what companies do but how they do it.

– It’s all about green investment

It would be easy to assume that the “e” of ESG dominates the other two. Most of the thematic investment funds focus on environmental issues, from water shortages to new technologies. And environmental issues, especially after the COP 21 climate change talks in Paris last year, are at the forefront of investors’ minds.

However, social and governance issues are of increasing importance. Rising inequality and cash-strapped governments have led to the introduction of the Living Wage in a number of regions, putting pressure on costs.

Changing consumer tastes and new regulation have seen the introduction of sugar taxes and ongoing declines in sugary drinks consumption.

– It only works in the most developed markets

The bulk of the ESG data that we have is disclosed by large companies operating in developed markets. However, this does not mean that ESG considerations are not pressing for those in emerging markets.

A 2013 report by UBS, analysing the World Economic Forum Corporate Governance Index and emerging market equities valuations, concluded that companies that score well on governance are valued more highly and had lower volatility.

Evaluating how companies manage stakeholders, as well as environmental and social change, is relevant in every market. With emerging markets, it may just take more digging.

– It only works for stocks

We tend to think mostly about equities, but it doesn’t end there. With bonds, for instance, ESG analysis helps identify risks to a borrower’s ability and willingness to repay debts.

Put simply, a well-managed company should be less likely to stumble into value-destroying disasters and be better able to repay investors who lend them money.

In conclusion, it should be remembered that investments do not operate in a vacuum. Global industries are having to face social, economic, environmental and industrial changes on a larger scale and at a faster pace than they have ever seen before.

The gap between the values of companies on the right or wrong sides of those fast-paced trends may grow ever wider as a result.

However, by investing in various types of sustainable businesses, investors may increase their chances of success.

Niall Kennedy is portfolio director at Cazenove Capital in Edinburgh.

Nothing in this article should be deemed to constitute the provision of financial, investment or other professional advice in any way. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

This article appears in the AUTUMN 2017 edition of Vision Scotland. An online version can be read here. Further information about Vision Scotland here.