Article written by InvestNow – 5th September 2022

Over the last decade or so the concept of ‘ethical’ investing has flooded the mainstream airwaves with even previously amoral financial institutions promoting products branded under various labels such as socially responsible, green finance or the go-to standard, environmental, social and governance (ESG).

And the NZ market has more recently caught on to the concept of making money by ‘doing good’ amid a surge of local investment managers catering to rising demand with a smorgasbord of ESG or ethical-flavoured funds built to match public tastes.

The expanded range of ethical-like funds on InvestNow also reflects the trend with ESG products on offer from index managers such as Vanguard (which follows a mechanical stock exclusion process) to more nuanced active strategies provided by local boutiques including Pathfinder and Mint that combine negative-screening with purposeful corporate engagement.

At the same time, InvestNow continues to offer unscreened funds like the Smartshares US 500 ETF, which simply invests in all large US companies regardless of whether they are ‘good’, ‘bad’, or otherwise labelled under the multiple, and often conflicting, ESG definitions.

Our platform is designed to provide investors with choices that match their investment preferences rather than to act as an ethical overlord.

Unlike traditional investing, where there is essentially one common goal of maximising returns relative to a specific level of risk, tacking on ethical principles brings additional layers of complexity in trying to appeal to investors who – individually – each have slightly different views or preferences about how their money should be managed.

While the ongoing active-versus-passive argument is lively enough for an industry dominated by middle-aged white guys, the debate about whether ethical investment will ultimately outperform is probably even more heated – albeit that taking a stance against ‘feel-good’ ethical factors can be a lose-lose position for those trying to mount an intellectual position on the long-term investment prospects for ESG strategies.

Nonetheless, on one side of the ethical performance debate managers like Pathfinder and Simplicity posit that in the long run clean ethical ‘industries of the future’ will naturally out-perform sunset sectors such as fossil fuels.

Team ESG appeared to be on the winning side of history in the post global financial crisis period where so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) – that were heavily weighted in ‘ethical’ portfolios – massively outperformed ‘legacy’ industries such as oil and tobacco.

The FAANGs were pushed even higher in the immediate aftermath of the COVID-19 crisis where work-from-home and travel restrictions played into the hands (and balance sheets) of the technology elite.

But for old-school investors, the valuation collapse of sectors with still-substantial fundamental return dynamics – oil, for example – actually offers the prospects of better long-term returns by buying such companies at a significant discount.

The traditional investment argument has won out in more recent times with massive outperformance from ethical outcasts such as listed US companies Occidental Petroleum (+183%), Marathon Oil (+127%) or Exxon Mobil (+77%).

Other ‘sin’ stocks have also fared relatively well since the change in market dynamics last year including strong returns from armaments firm Northrop Gruman (up 30%), fast-food franchise McDonalds (6%) while tobacco giant Altria sustained minimal losses of -10% as wider benchmark tumbled into bear territory (-20% or more).

Over the same one-year period a number of the FAANG stocks suffered much worse fates, including Netflix falling -61%, Facebook (now Meta) down -57%, and Amazon off -27%.

If the case that ethical or ESG companies will inevitably outperform seems to be built on shaky ground (in the short-term at least), traditional investment theory also suggests that strategies designed to restrict exposure to markets also come at the risk of losing the benefits of diversification.

Despite the strong historical evidence that diversification (across asset classes and sectors) remains one of the most important benefits for investors, the argument has been submerged in the current ethical tidal wave of ‘values-based’ strategies tuned to individual preferences.

For example, in a recently published joint report by the Responsible Investment Association Australasia (RIAA) and Mindful Money (MM), Kiwi respondents rated the translation of ethical investments into positive real-world impact as a high priority.

According to the RIAA/MM study:

• 73% of Kiwis expect their investments to be ethical or responsible;
• 62% of New Zealanders say it is important that their investment makes a positive difference in the world; and
• 54% of Kiwis would be more likely to invest in a fund that is independently labelled as ethical or responsible.

Many industry stakeholders including the Financial Markets Authority (FMA) and investment managers now lean on such statistics to bolster the case for ethical investing.

In fact, self-appointed industry watchdog Mindful Money appears to take the stance that ethical investment is the only way to go, which is oddly convenient given its business model relies on commissions for promoting and advising people to invest in these funds.

Some cynics in the industry point to the fact that if you ask a loaded question, you get a loaded answer.

It’s clear, for instance, that most people would say they are hugely concerned about climate change, and actively want to avoid doing harm to the environment – if you ask them.

However, the majority of the population doesn’t pay the additional cost of the carbon-offset when they fly, and readily drive their fossil fuel-powered cars when they could have easily opted for a more climate friendly transport option.

An equivalent disconnect can be seen in the investment industry where unscreened funds like the Smartshares US 500 ETF and NZX 50 ETF continue to be among the most popular choices.

In part, the preference for ‘non ethical’ options might be explained by costs, with ESG fees typically priced around 40% higher than unscreened counterparts.

True to form, the industry has also thrown in some confusing factors for investors to contemplate, pointing out quirks such as the exclusion of electric car manufacturer Tesla from the S&P 500 ESG Index that retains oil giant like Exxon Mobil: the apparent contradiction stems from various industry players placing different weightings on the importance of each of the  ‘E’, ‘S’ and ‘G’ factors.

And this brings us back to the most important stakeholder in the ethical debate – the individual investors who are looking for products that match their own investment objectives and beliefs.

The FMA is pushing the industry hard to supply better information to investors on products marketed under any sort of ethical label – with these types of funds falling into what are called ‘integrated financial products’ in regulator-speak.

Given the potential for confusion in this area, the FMA might have a point here, despite its typically annoying regulatory double-speaking way of approaching this issue!

Ultimately, there are no clear-cut right or wrong ways to invest sustainably, as success in ‘ethical terms’ is based on each individual’s personal beliefs and objectives.

Tilting your portfolio towards sustainable companies of the future, or investing purely to achieve an environmental objective, or simply excluding a few stocks that don’t align with your values via a passively managed ESG-screened fund, are all valid ways of investing ethically.

It is important to know that not all ethical (or similarly labelled) funds are built the same, nor do they effectively deliver the same ESG outcomes.

Just because a fund includes a few sustainable terms in the product name doesn’t mean it will automatically align with all ESG goals generally, and is certainly no guarantee of addressing an individual’s specific ethical goals.

As always in the investment industry, the devil is in the detail: proper due diligence and research into each manager’s ‘ethics’ goes a long way in helping ensure you’re investing in accordance with your personal ESG goals.

If you are not investing ‘ethically’, don’t feel like you are in the minority as many (if not most) people haven’t opted to do the investment equivalent of paying their carbon offset and are instead focused on gaining diversified exposure to markets via cost-effective traditionally structured funds.

For InvestNow the aim is simply to provide customers with funds that match their investment objectives and beliefs in a non-judgemental fashion: whether investors want ethical, or ESG or just plain old ‘investment’ our job is to ensure cost-efficient access to the high-quality, regulated funds.

We have a broad range of both ethical and traditional unscreened funds available, coupled with various educational tools to help investors figure out the best way to structure their portfolio to meet their specific investment objectives and preferences.

Click here to see our range of funds and further your sustainable (however you define it) investment goals today.