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Getting ethical by default

30 July 2019
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Even ethical default funds are now available for company pensions, but ethical investing remains a very confusing area.

There is certainly nothing new about the concept of ethical investing, in which social, moral and religious values are applied to investment portfolios. Indeed, as long ago as the 19th century Quakers and Methodists sought to exclude investing in ‘sin stocks’ such as tobacco and alcohol.

The approach has even been available to private savers via collective investment schemes for as long as many of us can remember. The Stewardship fund, which was UK’s first ethical unit trust, was launched as far back as 1984 by Friends Provident – although mergers have subsequently seen its ownership pass to Aviva.

As with many investment trends, the workplace has tended to lag somewhat behind the retail market. But group pension providers have been catching up fast, and most now offer employees in defined contribution schemes the option of at least one ethical fund.

The most recent development has been the availability of the ethical approach as a default fund and, fittingly, the Stewardship fund has once again been the primary trailblazer.

This month Aviva launched a workplace pension default investment strategy based on the Stewardship fund range, which excludes companies that fail to meet certain ethical standards or that harm society or the environment. Obvious examples would be those heavily involved with pornography, tobacco or coal mining.

The Aviva team also engages with companies to improve how they conduct their business, and it monitors and reports on a range of environmental, social and corporate governance metrics.

A number of other providers also have ethical strategies linked to their default funds, and this bandwagon will undoubtedly continue to gather momentum. Indeed, I can’t wait for the day when all providers offer employers the option.

That is not to say that I think that every employer should actually implement an ethical default fund. The approach could clearly be suitable for organisations involved with a business area like recycling or providing solar panels, or for those which pride themselves on having an unusually strong ethical focus.

For others, simply offering a range of ethical funds as investment options may be enough. Indeed, because the performance of ethical funds often compares favourably with that of standard funds, this could be justified simply on grounds of diversification, risk management and portfolio performance – even without an ethical motive.

But don’t underestimate the importance of selecting the right ethical funds. Employees and potential employees are delving ever more deeply into companies’ ethical stances, and this can include detailed examination of the investment choices made by available funds.

There is now such a wealth of ethical alternatives available that the field can seem intimidatingly complex, so there is much to be said for seeking help from an expert adviser like Chase de Vere.

In particular, a great deal of confusion stems from the many different terms that are commonly bandied about in this area, such as socially responsible investing (SRI), environmental, social and governance (ESG) investing, impact investing, sustainable investing and green investing.

These terms are often used interchangeably, even though there are some quite subtle differences between them, particularly with regard to the degree to which they prioritise positive and negative screening.

For example, SRI seeks to consider social and environmental factors, both positive and negative. But the focus tends to be more on how positively a company is assessed, and the fund management team would also look to actively engage with company management.

The term SRI started to replace the use of ‘ethical’ for fund description, but more recently those seeking to use an all-embracing title have tended to refer to ESG. However, this isn’t technically correct because, although ESG incorporates the fundamentals of ethical investing, it doesn’t use negative screening.

A tobacco company, for example, may score highly on its ESG rating and so, as a result of that, it could be considered suitable for investment. But a tobacco company would never be considered for investment in a traditional ethical fund.

Content correct at time of writing and is intended for general information only and should not be construed as advice.

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