Ethical investors cannot have their cake and eat it

AcademicS were making waves in the socially responsible investment (SRI) community this week, as a new study suggested that SRI funds offer lower returns than simple index-trackers. Conducted by the EDHEC-Risk Institute, the paper updates a study of French SRI funds by looking at 172 funds’ returns between 2002 and 2009. It shows that while the SBF 250 rose 4.67 per cent over the period, the SRI funds in the study rose just 1.32 per cent on average. Green funds performed better at 3.38 per cent.

The paper’s methodology is far from perfect, but it does raise the question of whether promoters of SRI are disingenuous when they claim ethical investment always makes the best business sense.

SRI, which aims to incorporate measures of environmental, social and governmental responsibility into investment decisions, has caught on in recent years. Many major asset managers and pensions providers have constructed funds that claim to invest only in low-carbon assets or good labour practices.

SRI advocates often suggest that, in the long-run, an ethical investment should be a profitable one. Barbara Evans, sustainability research analyst at RCM – a subsidiary of Allianz Global Investors – says: “You might have to wait a while but sustainability research should be an enhancement to stock-picking, not a detractor. I don’t see how it could detract from performance.”

But if this is true, why create special SRI funds? Shouldn’t financial imperatives

organically result in ethical investment?

Perhaps, but investors need to realise that “ethical investment” is not a monolithic ideal that one either pursues or ignores. Different ethical priorities often conflict with one another. Ashmore Group’s Jerome Booth emphasises that while none of Ashmore’s funds bear the SRI label explicitly, that does not mean they are not socially responsible: “There’s a negative way of interpreting it – ‘don’t do this or that’. Or there’s a more positive way: do invest in countries that need the investment. The best ethical stance is to encourage more people to invest in emerging markets, not to scare them off by saying they’re doing something terrible.”

For investors who want to help alleviate poverty, for example, investing in emerging market firms could be the best course of action. But for others who worry most about the environmental impact of emerging market development, investing in green tech could make more sense.

The key is that managers are transparent and systematic about how they deal with ethical dilemmas so investors can make an informed choice. Rather than simply ticking boxes or cutting out asset classes, investors must realise that all decisions require compromise, whether that means prioritising one ethical need above another or foregoing the very best returns.