ii blog: Greenwashing, ethical investing and conflict

by Rebecca O'Keeffe from interactive investor |

A punchily titled report raises important issues that many in the industry have been grappling with for years.

The punchily titled report this week from SCM Direct, Greenwashing: Misclassification and Mis-selling of Ethical Investments, raises some important issues that many in the industry have been grappling with for years. 

The whole concept of ethical investment is awash with tensions that are not easy to manage. But far from being a hidden problem that has somehow just been uncovered, the reality is that the EU are already focuing closely on this issue, the FCA are well aware, and the industry hotly anticipates the results of the Investment Association's ethical consultation. 

As a starting point to any discussion of ethical investing, it is crucial to understand that ethical investing is extremely subjective. This makes attempts to formulate strict objective criteria for ethical funds a fool’s errand.  At what point a company stops being unethical and starts to become ethical is hugely open to interpretation and a matter of personal opinion and therefore there is immense scope for disagreement. 

The still maturing ethical investing sector is trying to navigate its way through all these issues, alongside the wider investment industry too. Using data alone to differentiate between investments runs the risk that people will play the environmental, social and governance (ESG) language bingo game, littering their prospectus with relevant terms.

This may be a cynical attempt to try and suggest a greater emphasis on ethical investing, but it could simply be that some of the terms that are more prevalent with ethical investing, such as sustainable, may not necessarily always just apply to socially responsible investing. 

This runs the risk of leaving investors and the industry somewhat confused about just how much an investment actively adopts ethical and ESG practices. In addition, investors may have very different views on investing in government bonds.

Some will look favourably on them as they fund schools, healthcare and other social benefits, while others may focus on certain aspects they may be uncomfortable with. We would suggest that investors also scrutinise so called 'ethical' launches and look closely at their heritage in the sector. Being slightly cautious and taking the time to investigate the underlying issues is essential.

It's right and proper to highlight the complex issues around ethical investing. But where does that leave investors who want to invest ethically? Just because something is hard, doesn’t mean it is not worth plugging away with. Just as investing requires investors to know their own individual risk profile, investing ethically requires investors to understand their own personal ethical profile, and be prepared to do their own research to back it up.

The inherent conflicts in the ethical investment industry is exactly why interactive investor sought independent expert advice from SRI Services so that we could try and avoid these pitfalls when we launched our own ethical iinvesting long list in September (and our ACE 30 list of rated ethical funds). We were acutely conscious of not wanting to rely purely on data driven sources, but at the same time wanted to provide a starting point for investors interested in investing in funds, investment trusts and exchange traded funds (ETFs) with some form of ethical consideration.

We came up with three simple ethical styles that were deliberately jargon free: 'Avoids', 'Considers' and 'Embraces.' However, at no point have we suggested that any individual style is a good fit for all. Strategies vary enormously and within our list there are a vast array of different approaches. For example, some funds will take a very limited avoidance, while others take a much more stringent approach and eliminate two thirds of the investment universe. We provide information that helps our investors to determine just how strictly to apply their own personal ethical criteria, so that they can help make good investment choices which fit in with how they want to invest.

Julia Dreblow, Founder, SRI Services & Fund EcoMarket, points out: "ESG ratings are very different from understanding policies and criteria as, for example a tobacco, oil, bank or pharmaceutical company can have excellent ESG strategies and be highly thought of by ratings agencies, but that does not make them 'ethical'. Having a high ESG rating typically means a company documents and manages their environmental, social and governance risks well - but this may rightly be of no interest to individual investors."  

Vanguard SRI European Stock highlights the tensions within the industry. It is in ii's ACE 30 and is highlighted in the SCM report, due to it having a small percentage of the fund invested in alcohol, gaming and defence stocks. The fund aims to exclude companies based on the UN Global Compact including human rights, labour rights environment, corruption and controversial weapons.

Julia Dreblow explains: "The Vanguard SRI European Stock fund is highlighted in the SCM report, due to it having 5.7% of the fund invested in alcohol, gaming and defence stocks. This fund has a limited negative avoidance strategy which excludes companies with significant UNGC (UN Global Compact) breaches only. Vanguard could do better in explaining this – but the strategy is not 'wrong' per se – indeed it is better than funds that invest in companies that ignore UN norms. The point is, investors really need to know their own ethical profile.

"Those who work within the industry have spent years trying to manage these moral and ethical conflicts. But let's not undermine a segment of the market that is vitally important - we need to raise standards without losing people along the way.  It is quite possible that this may mark a turning point where stronger, braver strategies gain real ground. Let's hope so."

We welcome the prospect that this report might help accelerate progress being made in this area, but it is not as simple as the report suggests.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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