Investments

What is in a name? Ethical and responsible investing explained

If there is one thing that the investment profession loves, it is jargon. Are you an ethical or responsible investor; both or neither?

29 June 2022
4 minutes

The latest industry term to gain notoriety is ‘ESG’, which stands for environmental, social and governance. We often see strategies being referred to as ‘ESG funds’ and it can be lazily used to label those trying to do good or avoid doing harm.

In reality, ESG is a risk analysis tool. There is a growing body of evidence that ESG risks have the potential to do significant harm to long-term returns and that there is merit in managing these risks. Think of any corporate scandal that has embroiled a listed entity. What we tend to see is a steep decline on announcement and then a prolonged period where the consequences, both financial and reputational, weigh on share prices. Managing risks in these areas is vital to long-term returns.

So what terminology should investors be using? Mattioli Woods broadly classifies investors with an interest in this space as either ethical or responsible. Ethical investors typically take a ‘do no harm’ approach, avoiding companies with operations in certain areas such as exposure to weapons, nuclear power, alcohol and gambling, among others. We achieve this using an approach known as ‘negative screening’, which involves setting thresholds on the percentage of revenue that a company can derive from these sectors if they are to be considered as a potential investment.

Ethical investing is not a new concept, tracing its roots back to the 18th century. Quakers and Methodists set clear guidelines for members. Indeed, John Wesley (one of the founders of Methodism) outlined in a sermon the requirement for investments ‘not to harm one’s neighbours’. He implored followers to avoid industries like tanning and chemical production for the harm that they can cause to workers.

Ethical investing is not new to Mattioli Woods either. We have been managing multi-asset portfolios in this area since 2013. While we typically find that clients are often concerned by specific individual areas that are personal to them, adopting a comprehensive approach with 11 negative screens helps us to best serve a broad client base.

Responsible investing tends to take more of a pragmatic approach, focusing on positive aspects. That is not to say that responsible investing does not consider the negative implications of certain sectors. Indeed, it would be difficult for any investor in this space to justify investments in areas such as tobacco or gambling. However, there does not tend to be formal negative screens in place, as the avoidance of these areas is more implicit in nature.

Responsible investing has developed from the socially responsible investment (SRI) movement, which gained traction during the 1990s. Unlike ethical investment, the space is more conceptual and there is no agreed upon definition. We define it as ‘aiming to generate attractive long-term returns, while ensuring that the companies we own are behaving in the interests of their communities and wider society’. That is a key tenet of our Responsible Equity Fund.

In order to find companies that fit with this definition, we use the United Nations Sustainable Development Goals (SDG) to frame our thinking. These are goals that are long term in nature, very much in the interests of communities and wider society and can only be achieved with the input of corporates. The goals are diverse in nature, from No Poverty (UN SDG 1) to Climate Action (UN SDG 13). In total, there are 17 goals, with 169 sub-targets underlying them. We require all of our equities to be working towards at least one of the SDG sub-targets and typically find that they meet between three and five. We believe companies addressing these goals through their products, services or behaviours have the potential to benefit from structural tailwinds as governments and corporates pay increasing attention to the importance of meeting these goals.

Morality is highly subjective. However, we believe that we offer a range of opportunities to help meet client needs, from both an investment and moral standpoint. Our multi-asset funds integrate ESG considerations, which we feel is important irrespective of your feelings on any of those three areas. For clients concerned with avoiding certain sectors, Mattioli Woods Ethical offering provides access to our multi-asset ideas with negative screens in place. For those looking to target companies behaving responsibly and with the risk tolerance for equity investment, our Responsible Equity Fund offers an attractive blend of growth and value investment styles, to create what we believe is an all-weather strategy. So, whether you want to avoid companies, target companies or are indifferent, we believe we have an offering to suit you.

This article has been produced for information purposes only. It is not intended to be an invitation to buy or act upon the comments made. All investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. Your capital may be at risk and past performance is not a guide to future returns. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.

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