GREEN IS GOOD: What Is Ethical Investing and Is It Profitable?

Delwin Graham - Jan 27, 2021
Ethical investing holds out the possibility of making money while following your conscience. It is the practice of selecting investments based on religious, ethical, or moral principles.

In the 1987 movie “Wall Street”, Michael Douglas as Gordon Gecko gave a famous speech where he said, “Greed, for lack of a better word, is good.” He went on to make the point that greed is a driver that “captures the essence of the evolutionary spirit. Greed, in all of its forms: greed for life, for money, for love, for knowledge has marked the upward surge of mankind.”

On the one hand, the profit motive (or “greed”) certainly seems to be the animating spirit behind capitalism. Investors are motivated by profit – “Without profit, there is no stock market, no Wall Street, and no financial system.” (Cf., Kimberly Amadeo, “Greed is Good or is it?”, www.thoughtco.com, August 21, 2010)

On the other hand, the pursuit of commercial self-interest has traditionally been viewed with ethical or moral distrust. For example, St. Jerome said that “a man who is a merchant can seldom if ever please God.” His claim was that the choice to enter business didn’t necessarily deprive someone of their salvation, but it certainly was a risk to their soul. (Cf., John Paul Rollert, “Greed is Good: A 300-Year History of a Dangerous Idea”, www.theatlantic.com, April 7, 2014)

Ethical investing holds out the possibility of making money while following your conscience. It is the practice of selecting investments based on religious, ethical, or moral principles. But there is no industry-standard definition of “ethical investing”. There isn’t even an agreed-upon name – terms for it are used interchangeably, even if there are subtle differences. These include socially responsible investing (SRI); environmental, social, and governance (ESG) investing; sustainable investing; impact investing; values-based investing; socially conscious investing; and green investing.

Of course, ethical investing based on religious tenets has had a very long history. The earliest recorded instance of ethical investing in America was by the 18th century Quakers, who restricted members from spending their money in the slave trade. During the same era, John Wesley, a founder of Methodism, preached the importance of refraining from investing in industries that harm one’s neighbor, such as chemical plants. Another example of a religious-based ethical investing regime is seen in Islamic banking, which shuns investment in alcohol, gambling, pork, and other forbidden items. (Cf., Will Kenton, “Ethical Investing”, www.investopedia.com, August 17, 2020)

More recently, however, ethical investing has focused primarily on its impact on society and the environment. Ethical investors typically avoid investments in “sin stocks” – that is, companies involved in stigmatized industries like firearms, tobacco, gambling, alcohol, and even fossil fuels. Another approach is to focus on companies that actively and measurably seek to have a positive social or environmental impact. For example, investors might look for companies that develop alternative energies or retailers that are model employers or engage in “fair-trade” practices.

But can you have your cake and eat it too? Because ethical investors are screening their investments on criteria other that the simple maximization of profit, we might expect suboptimal returns. An ethical screen reduces your potential return by reducing your investment universe. However, a report by Morgan Stanley in 2019 has shown that in an analysis of over 10,000 mutual funds active in any given year from 2004 to 2018, there was no real difference between the returns of ethical and traditional funds. This was despite the fact that 53 percent of investors believed that investing ethically required a financial trade-off. (Cf., Adrienne Tanner, “The Case for Ethical Investing”, www.cpacanada.ca, March 9, 2020) What does this tell us?

We all want to feel good about our money, and marketers know this. Even by early 2014, ethical investment funds reached an estimated worldwide value of US$22.72 trillion (cf., Sarita Harbour, “What is Ethical Investing?”, www.sunlife.ca, March 30, 2017). There is little to suggest that this trend has slowed. In Canada, the first Canadian fund for ethical investing was created in the mid-‘80s. Since then, all of the big five national banks have introduced SRI-type mutual funds or managed accounts. Research shows that 80 percent of Canadians are aware of ethical investing (although a smaller percentage actually practices it). (Cf., Michael Allen, “What is Ethical Investing & Why Do It?”, www.wealthsimple.com, January 16, 2021)

Perhaps the fact that there is little difference between the returns of ethical and regular funds is because there is little difference between the two – that is, the selection criteria used by ethical funds has been watered down to compete with regular funds in a case of “greenwashing”.

On the other hand, perhaps the social and ethical selection criteria that the modern ethical fund operates upon has come to reflect the “social license” that every company is expected to operate within. Business does not happen in a vacuum, and companies are rewarded or punished by legal and political structures. For example, companies that operate illegally or unethically (e.g., the Enron scam, Bernie Madoff’s Ponzi scheme, Lehman Bother’s bankruptcy) are typically not good for investors. It is simple prudence for a money manager to run a social or ethical screen for any investment. As a result, ethical and everyday portfolios start to look the same. This is a good thing.

Perhaps it’s no surprise that capitalism and ethics are not mutually exclusive. Please contact me at dgraham@cgf.com or 780-408-1518 for a few opportunities to make you feel good about your money.