7 minute read

Ethical Investing: Profiting from the Common Good

A Better Way?    7 minute read

Ethical Investing: Profiting from the Common Good

For John Wesley, a founder of Methodism, a person was defined by what they invested in. He was acutely aware that buying shares meant that an investor owned a slice of its business and, crucially to Wesley, its activities, whether they were ethical or not.

Quakers restricted members from investing their time or money in the slave trade in the eighteenth century. This was the earliest recorded instance of ethical investing. When investment decisions depend on one’s ethical principles, it follows logically that one becomes an ethical investor. Parameters such as community welfare, the effects of a company’s activities on health and the environment, workers’ rights and corporate governance could all be considered while selecting a security.

The list of parameters is endless, but there are three clear screening methods. Firstly, one might favour a company that makes a positive contribution to society. Second, companies could be negatively screened for engaging in activities that harm society. Lastly, favouring one company because its activities are less socially harmful than another’s could also constitute ethical investing.

Facts and Figures

World’s Most Ethical Companies 2016 honourees included 131 companies across 55 industries and 21 countries. Of them, 99 were from the United States, four from the United Kingdom and three each from France, India and Japan. The list included companies like Capgemini, Cisco, Dell, Ford, GE, Intel, LinkedIn, L’Oréal, Microsoft, Ricoh, Starbucks, Tata Steel and Xerox.

According to a USSIF Report on US Sustainable, Responsible and Impact Investing Trends 2016, total assets under professional management in the United States as of 2016 were $40.3trn. Out of this, the size of Sustainable, Responsible and Impact (SRI) investing was $8.72trn. It also reported that SRI investing has grown 33% since 2014.

According to USSIF, SRI is an investment discipline that considers environmental, social and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact.

Ethical and Outperforming

MSCI World SRI Index and MSCI Emerging Markets (EM) SRI Index are two important indices that include large and mid-cap stocks across 23 developed markets and 23 emerging markets, respectively. These indices include companies having outstanding Environmental, Social and Governance (ESG) ratings and exclude companies whose products have negative social or environmental impacts.

Since their inception, these indices have outperformed the MSCI World Index and MSCI EM Index respectively (as shown below). Finance, information technology and consumer discretionary were the top three sectors dominating the indices. The top three companies in the MSCI World SRI Index were Microsoft, P&G and Cisco while Taiwan Semiconductor Manufacturing, HDFC and Banco Brandesco were the top 3 in MSCI EM SRI Index.

A Look at the Tobacco Industry

According to Campaign for Tobacco-Free Kids, over 5.5trn cigarettes were sold in 2015 across the globe. Of total sales, 65% were made in Asia-Pacific region. Over the last decade, tobacco consumption in this region increased by approximately 20%, while reducing in North America and Europe. The five largest cigarette consuming nations; China, Russia, USA, Indonesia and Japan accounted for 63% of the total volume.

According to World Health Organization, more than a billion people smoke and around 6 million people die every year due to the habit. Passive smokers account for 10% of total deaths. An ethical investor must ask, “Would it be appropriate to be an owner of a tobacco company?”

China National Tobacco Corporation (CNTC), Philip Morris International (PMI), British American Tobacco (BAT), Japan Tobacco Inc. (JT) and Imperial Brands controlled 84% of the global market. Even though smoking is injurious to health, it is one of the most profitable businesses in the world.

The market capitalization of the top companies has surged in the last decade. The 2008 recession had a short-term impact on these companies. These companies continued to flourish and, by proxy, kill people. Governments tax them at higher rates, which ultimately has a negligible effect on the demand for tobacco and only fills national exchequers.

Cigarette Giants

The Chinese government controls CNTC. It enjoys a near monopoly in China, and exports scarcely one percent of its products. The Chinese government could be lampooned for any of its anti-tobacco measures since it is the sole owner of the world’s largest tobacco company.

PMI is known for its world-famous brand Marlboro. It has increased its annual dividend every year since 2008. BAT is listed on the London Stock Exchange, New York Stock Exchange and Johannesburg Stock Exchange.

JT operates in 120 countries and 65% of its profits were on account of international sales. It had the largest growth in Central Asia. The company has also diversified into pharmaceuticals and food processing industries. Imperial Tobacco Group exists in 160 markets around the world and has acquired four US brands and a line of e-cigarettes after the merger of Reynolds and Lorillard was agreed.

Various anti-tobacco campaigns are carried out across the world and initiatives like ‘No Smoking’ boards in public places, pictorial warnings on the packets, ad bans and ‘sin tax’ on tobacco products have been successful to a limited extent.

It is time that financial markets also act to push an anti-tobacco campaign. Imposing a ‘sin premium’ for any deal by the company or ‘sin capital gains tax’ for investing in these companies might be worthy considerations.

Other Asset Classes

Ethical investing is not restricted to stocks, but also to bonds, mutual funds, ETFs, hedge funds and real estate. Various funds across the world already invest in SRI stocks and bonds.

Real estate investing is trickier. The classification of ethical and unethical depends on the land usage, location, method of construction and other parameters. An ethical real estate investor could use it for community development, education, hospitals and so on. One might use solar energy, rainwater harvesting and other such tools to reduce the impact on health and the environment.

Some countries have issued green bonds to finance environmentally friendly projects. Companies often take measures to reduce and reuse waste to keep the environment clean. Others invest in underdeveloped regions across the world to boost employment in that region. Some donate their incomes to various philanthropic activities.

Governments often give various concessions in the form of tax rebates and allowances to such companies. Investors must acknowledge these measures and extend their support to such projects, companies and countries.

Towards a Better Future

Whichever investment vehicle one chooses, the ground rules remain the same. Several reports prove that being an ethical investor does not hamper profitability. These investments give both long-term benefits and blessings in disguise.

Of course, such a style of investing might occasionally be disappointing too. Evil deeds, bad news and losses of the favoured company might necessitate a rebalancing of a portfolio at times. It might well be impossible for a company to meet ethical benchmarks at all times. In such cases, the comparative superiority method would play a decisive role.

One might also compromise ethics for profits, and a portfolio could be divided between ethical, not-so-ethical, and non-ethical instruments. Ultimately, investing is about personal preferences and choices. If choices such as these drive a healthy and ethical global market, they can only be small steps towards the common good.

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