Are Ethical Investments Actually Ethical?

The increasing interest in ethical investments has caused the rise of environmental, social and governance (ESG) screens on funds offering global stock portfolios, making it easier to create an ethical investment strategy. However, this strategy raises concern about the true nature of its ethical impact as critics..

The increasing interest in ethical investments has caused the rise of environmental, social and governance (ESG) screens on funds offering global stock portfolios, making it easier to create an ethical investment strategy. However, this strategy raises concern about the true nature of its ethical impact as critics question the fluid definition of “ethical”.

Impact investing is a growing field, as investors demand a positive social outcome in addition to a strong financial performance. The increased demand has seen a corresponding increase in supply. Additionally, the field is attracting more women and millennials, both of whom value sustainable investing to a much larger extent. Millennials are increasingly concerned with their social and environmental impact on the world around them. Investing with sustainable goals allows them to combine their interests, resulting in profits with purpose. Mutual funds have found this to be an important growth area and are creating funds with a socially responsible orientation. The social aspect has led to a strategy of fund managers avoiding investments in industries deemed “unethical”, like alcohol, tobacco and guns. 

While impact investing is being lauded for its ability to combine finance with giving, critics take a different view. Sustainable investing allows people with wealth to improve the system but by ensuring an equal focus on financial performance, these investments reinforce the existing system of economic injustice. By evaluating a social cause for its ability to produce profits, the root cause for the broken system does not always get addressed. Using the very tools that have helped perpetuate inequality in the world to try and address this very concern can seem like an ineffective strategy. The idea that markets are primarily driven by fear and greed is fundamentally at odds with the objective of doing good.

Additionally, many critics point to the discrepancy in the understanding of an investments “ethical” impact as the definition varies for investors and companies. Investors seeking capital market investment opportunities are more likely to veer towards Scandinavian countries when considering the human rights track record of emerging countries like Saudi Arabia. However, this will continue to spur the growth of Scandinavian countries while failing to provide the necessary impetus for emerging economies to move out of poverty, thereby making investments in Sweden’s capital market less ‘ethical’. Judging markets by their peers is a much more reasonable way to create selection criteria and many ESG investors are now moving towards funds that focus on emerging economies.   

The counter argument is that emerging economies should be weaned off their dependence on foreign capital for growth. Developing countries need to develop their institutions to a sufficient level of quality before foreign capital can cause substantial growth. Even BRIC countries have yet to reach this level of quality, making it less advisable for ethical investors to invest in these regional capital markets.

Relying solely on the ESG selection criteria does not always result in the best investment options. For capital market investments, emerging markets should be evaluated for improvement against their peers, rather than compared to Nordic countries. Countries should also be evaluated for their ethical behaviour in relation to their economic size. Given America’s significant economic weight, the bar for its ethical impact should be equivalently high.

Currently, the lack of a clear definition of “ethical” remains a compelling challenge to sustainable investment strategies. As demand for ESG-screened funds rise, managers will also face pressure to clarify their criteria while increasing the positive impact resulting from their funds. Investors can ensure the trends moves in the right direction by continuing to demand funds and investment opportunities that more fully cater to their desire to cause an ethical impact. Investors who are cursory about their ESG needs will simply allow fund managers to coast with loose defined ethical impact. Funds can also improve their offerings by providing fewer supposedly amoral investment opportunities and emphasizing the potential to do good to their less concerned investors.

Funds and investors should collaborate to create more stringent ESG criteria while pushing for continued growth of ethical funds. Impact investments have shown their capacity for equivalent returns so there is no compelling reason to ignore the social impact of investments, especially as socially minded millennials start investing at unprecedented rates.  As ESG strategies expand from avoiding unethical industries to leaning heavily towards industries with a positive impact – like renewable energy – corporate citizenry is fast becoming a burgeoning orientation.