Over the last few years, ethical investing has become one of the biggest trends in capital markets. The ever-increasing reach of the internet and social media has played a pivotal role in raising ethical issues, which have fuelled the rise of ethical investing themes, the most popular of which is ESG.
Due to rapid globalization, industrialization, and increasing global demand, major corporations worldwide have been focused on scale and cost above all else. Unfortunately, this has resulted in many issues such as regulatory arbitrage, lax environmental considerations, and human or animal rights violations. As a result, the news has been riddled with headlines highlighting unreasonable wages/working conditions and global demand over the past decade.
The confluence of these issues and events has led to a global shift towards ethical investing. Ethical investing involves shaping one’s investment decisions based on their ethical beliefs. These beliefs can include environmental preservation, human/animal rights protection, fair market behaviour, etc. There are various types of ethical investing themes prevalent today to address such concerns.
Not only have investors adopted such themes on an individual level, but major corporations such as BlackRock, the largest asset manager in the world, have also embraced ethical investing by committing to using its influence across the boards of major companies across the globe to drive environmental, social and governance goals.
Similarly, a slew of specialist hedge funds using their influence to woo investors and drive ESG goals. This year, a major news story was activist hedge fund Engine No. 1 pushing the Exxon Mobil board to commit $100 billion towards carbon capture and $3 billion towards the development of low emissions technologies.
Further, companies worldwide are also taking extensive measures to ensure that they meet ethical investing standards to avoid exclusion from these ethical pools of capital, especially as ethical investing inflows have been growing at a rapid rate over the past few years.
Types of Ethical Investing
While there are various types of ethical investing, the most prominent theme is ESG, Environmental Social and Governance, followed by SRI, Socially Responsible Investing, and Impact Investing. The events of the pandemic and the ensuing economic response led to a global environment of ultra-cheap capital and record inflows into capital markets. Such an environment-induced a massive global investment cycle.
However, this time the investing was driven by the relevance of environmental sustainability and social responsibility, which is why we are massive amounts of capital flowing into green tech, be it EVs or green energy production. Investments have also spilled over into green-tech ancillaries, e.g. materials that form crucial parts of the green tech supply chain, like lithium.
ESG (Environment, Social Responsibility, Governance)
As the name suggests, ESG consists of three components. The first is environmentally conscious investing. Climate Consciousness is at an all-time high. The focus on environmental sustainability has become a global mega-trend and led to a flurry of investments in green tech companies. However, this trend has also spilled over into public market investing, and this has caused large public corporations to rethink their stance and strategy. Companies worldwide are now actively making pledges to reduce their carbon footprint to zero over the next couple of decades as a way to win investor confidence and project themselves as climate-conscious. Companies are also actively assessing how to minimize their non-emissions-based environmental footprint by focusing on recyclability and impact on the environment surrounding their operations, such as waste disposal from manufacturing operations or annual plastic usage.
The second pillar of ESG is Social Responsibility. Growing public awareness through social media and mainstream media attention on the realities of how large corporations operate and their working conditions. As we mentioned above, rapid industrialization and globalization led to corporations resorting to scale and cost reduction above all priorities. This led to companies relocating manufacturing to cheap emerging economies desperate for economic activity and foreign investment. There were no strict laws or standards regarding human/worker rights protection or environmental regulation. The news has been flooded with headlines over the last few years about workers in factories in emerging economies of Asia being paid ultra-low wages and having to work in sweat-shop conditions. Child labour has plagued the mining industry, such as those of diamonds and cobalt, which is a core metal required for decarbonization. Increasing consciousness of such issues has put the spotlight on corporations’ social responsibility, and investors are now moving towards holding companies to social responsibility.
Apart from human rights, other social issues gaining attention are diversity and animal welfare. Growing reporting and research into companies’ pay and diversity metrics has led to them making efforts to diversify their employee pools in terms of ethnicity, race, and gender. All industry metrics show an under-representation of ethnic diversity and glaring gender gaps in employment and pay. Companies are now making efforts to project themselves as inclusive and multi-cultural. Corporations are also reacting cruelly to growing concerns about animals, especially in businesses that involve testing products on animals prior to human testing and those whose supply chains depend on products sourced from animals.
Lastly, the last pillar of ESG investing is Governance. Governance involves the evaluation of a company’s governance standards and shaping investing decisions based. The main governance issues range from treatment of people and employees, transparency, company policies, evaluation of top management/board of directors and their way of running the corporation, business ethics such as competitive tactics, and employee/management compensation. Growing disclosure requirements have scrutinized how companies operate and issues such as related party transactions or any actions involving principal-agent conflict. In addition, the increasing dominance of large corporations has led to growing industry concentration and anti-competitive behaviour, both of which might be at the customer’s expense. Increasing digitization has also exacerbated this criterion in the case of tech companies that hold massive amounts of data on billions of people. The presence of one or confluence of such factors might lead to a company being red-flagged as non-ethical, which can lead to a negative perception of its brand and decline in its stock price, which is why corporations are now increasingly becoming vigilant of these factors and addressing them.
ESG investing involves the evaluation of businesses based on the above framework and the assignment of an ESG score based on the same. The metric or score is then used to compare companies based on the ESG framework. While the pillars of the ESG frameworks are ethical, the primary purpose of ESG evaluation is to assess the financial or operational risk to a company posed by the ESG factors, such as human rights fines, environmental damage penalties, or losses/fraud caused by misgovernance or misreporting of facts by management.
SRI (Socially Responsible Investing)
Socially Responsible investing is in many ways very similar to ESG as it involves the use of ESG metrics or ethics metrics as a screen to determine a universe of investable securities by choosing a ranking methodology based on ethical factors. SRI investing only considers companies that rank above a certain threshold as eligible for investment.
The critical difference between ESG and SRI is that ESG is not a screening tool but a framework that gauges a company’s financial and operational risk based on ethical factors, thus allowing for comparability/risk assessment while SRI involves outright risk inclusion or exclusion based on the same factors.
Impact Investing is a form of thematic investing that involves investing in a company engaged in solving or addressing a cause or problem meaningful to the investing. While impact investing might not result in the best investment from a financial standpoint, it might accelerate the solution to a problem. Examples of impact investing include investing in a non-profitable development stage company engaged in biotechnology or green energy.
Other types of ESG investing include those that might hinge on businesses aligning with one’s religious or ethnic beliefs, such as shariah or catholic complaint businesses or businesses involved in sectors deemed as sinful. For example, religion or ethnicity belief-driven investing could include staying away from companies that engage in gambling or firearms/weaponry. Likewise, ethical investing based on immoral activities involves staying away from businesses that engage in alcohol, tobacco/cigarettes, or adult entertainment.
Risks of Ethical Investments
While ethical investing seems like the way to go, there are some risks involved that one must understand before deciding to commit to it, such as sustainability and the authenticity of a company’s claims about how it operates.
Sustainability here refers to the variability or competitive position of ethically driven businesses. As with all things in business and finance, ethical business decisions above industry norms usually result in a trade-off due to the extra costs incurred, which may put such companies at a competitive disadvantage. The truth is that most customers, especially in consumer-centric businesses, might be unaware of unethical practices of such companies, and cutting corners or engaging in unethical behaviour is usually incentivized by lower costs/higher profit, thus giving the company engaging in such tactics a competitive advantage. Further, the regulatory clout of corporations might result in no action against such tactics. Hence, investors must carefully understand the risks and disadvantages faced by ethical companies compared to their unethical counterparts.
Fortunately, there are plenty of ways today that make it easier for investors to evaluate a company’s ethics through ready-made metrics and their methodology freely available on the web today as far as public companies are concerned.
The Rise of Ethical Investing
Data shows that capital inflows into major forms of ethical investing such as ESG or SRI has been growing at a monstrously rapid pace over the past decade as investors increasingly become socially and environmentally conscious.
Ethical Investing has become particularly popular in Canada as 2020 saw the launch of 41 new ESG products in the Canadian market, followed by a 50% bump to 61 new products by Q3’2021. Canadian funds enjoyed an average fund inflow run-rate of about C$2 billion per quarter in 2021. Bringing the total tally to about 200 products as of Q3’21, the bulk of which are in the form of ETFs.
In Canada, equities by far dominate the ethical investing vehicle holdings representing 76% of assets, followed by 18% in fixed-income securities and the remaining 6% in cash and other short-term assets.
Best Ethical Investing Funds in Canada
iShares ESG MSCI Canada ETF (TSE: XESG)
Assets Under Management – C$165.98 million
Expense Ratio – 0.17%
This ETF is operated by one of the biggest asset managers in the world. Jumping on the trend, BlackRock launched this fund in March 2019, and it has since grown very well. The fund boasts an extraordinary perfect ESG score and holds all assets in ESG friendly companies. The fund’s most considerable exposure by sector is in financial services, followed by energy, industrials, and materials. Its largest holdings are TD, Bank of Nova Scotia, RBC, Shopify, and the Canadian National Railway. The fund’s portfolio comprises 126 holdings.
Since inception, this ETF has delivered about 39%, while YTD performance has been about 24.6%. This excludes the fund’s annual distribution yield(dividend) of 1.88%.
BMO MSCI USA ESG Leaders Index ETF (TSX: ESGY)
Assets Under Management – $906 million
Expense Ratio – 0.22%
This ETF is focused on the US in terms of holdings, which makes it great for Canadians, both in terms of diversification and opportunities, as the US markets hold the biggest companies in the world. Unlike Canada-only ESG funds, this fund has exposure to the biggest tech companies globally, like Amazon/Microsoft/Google, which are very well placed in terms of ESG, growth, and business resilience. These companies are also extremely cash-flow positive.
This BMO ETF tracks the MSCI USA ESG Leaders Index, minus the expenses. This index comprises the USA’s best companies from an ESG standpoint based on a certain methodology available in the fund’s prospectus. In addition, the fund invests in companies with the highest ESG rating among its direct peer group, based on the aforementioned methodology.
Its largest holdings include Microsoft, followed by Alphabet, Tesla, and Nvidia, all of which have been top performers over the past financial year. In total, the fund holds 271 companies in its portfolio.
The fund has returned 21.92% since its inception in 2020 and 30% YTD. It also provides an annual yield of 1.22%.
We hope you liked this article and consider the ethical theme in your investing as it is bound to grow leaps and bound over the next few years, as seen by its spectacular growth last decade. Over the past decade, annual inflows grew from a net outflow in 2012 to a mind-bending $168 billion in 2020.
Overall, ethical investing funds (including ESG, SRI, and Impact) now constitute a north of $17 trillion in assets globally. In addition, a recent survey by BlackRock concluded that their clients, which cumulatively represent $25 trillion in assets, plan to double their ESG investments by the middle of this decade. This massive inflow into the closed club of high ethical standards companies should lead to a sizable return for current and new investors.
Green Mutual Funds for Sustainable investing
Given the explosion of consumer interest in this type of investment over the past decade, fueled by millennials “sensitivity and mentality, many investment management firms now offer ethical and responsible investments. Responsible investing in Canada is also easier than ever as Robo-advisers such as Wealthsimple offer ethical investment funds for SRI. In addition, growth investors increasingly recognize that a responsible investment portfolio in SRI makes financial sense and that these funds often perform better than their non-SRI counterparts.
The RBC Vision Funds are designed to meet the needs of investors who believe that social responsibility should be the first consideration when making investment decisions. These funds are ideal for investors looking for socially conscious investment alternatives and achieving long-term investment goals. ETFs offer a simple, practical approach that allows you to invest your money in SRI and ethical investment funds, achieve decent long-term returns with minimal risk, and pay lower fees than a passively managed investment fund.
These include responsible investment, SRI, environmental and social governance (ESG), sustainable investment, impact investment, value-driven investment, conscious investment and green investment. In addition, most Robo-advisers offer investment portfolios with a range of ethical investment concerns such as clean technology, gender diversity and a low carbon footprint. Finally, while each money manager has its criteria, there are many valuable resources, such as rating firms like Morningstar, that provide responsible valuations to mutual funds so that advisers and investment managers can recommend, package, and sell certain products.
There are several great investment options for ethical investors, including socially responsible investments and halal investment portfolios. Responsible investing, also known as Value-Based Ethical Investment, allows investors to use ESG data to align their values with their investment decisions. The United Nations supports the Principles of Socially Responsible Investment (PRI), and Openings provides a list of measures fund managers can follow to incorporate ESG principles into their investment practice.
Suppose you enter a few details, including age, comfort, risk and investment objectives (including a preference for ethical investment). In that case, a Robo-adviser recommends various low-cost, socially responsible exchange-traded funds (ETFs) that match your risk tolerance. Investment experts say sustainability is a crucial part of their investment process. They say their analysis includes an assessment of financial risks, environmental, social, and governance factors of the companies they want to invest in. There are various forms of responsible investment, from socially responsible investments (SRI) and impact investments to environmental and social governance investments (ESG). Still, all have certain similarities and can be tailored to different investors and fund selection criteria.
According to the Investment Funds Institute of Canada (IFIC), the assets of mutual funds and exchange-traded funds (ETFs) amounted at the end of 2020 to $201 billion, a 55 percent increase over the previous year. A report similar to the US Social Investment Forum’s Trends Report found that assets under management under SRI policies jumped from C $6.5 billion in 2004 to an astonishing C $50.3 billion in 2006. This represents 20% of the Canadian market for institutional investment funds. While most Canadians express an interest in their investment portfolios’ social and environmental performance, there is a considerable gap between what they want to pledge for their assets and what exists in the SRI account.
Canadian assets held in ESG funds in 2019 grew to $3.2 trillion, accounting for two-thirds of the country’s investment industry, said the Responsible Investment Association of Canada (RIA) in a report released last November. RBC Global Asset Management’s annual Responsible Investment Trends Survey found that in 2019 80% of Canadian respondents used ESG principles as part of their investment strategy, and in 2018 the number of people relying on ESG factors increased by five percentage points to 26%. In addition, the RIAs 2018 Canadian Impact Investment Trends Report shows that assets under management with an impact investing in Canada have grown to $147.5 billion since the end of 2017, up 81 percent from two years earlier.
Its banks have committed to support UN principles of responsible investment and have promised to integrate ESG factors into investment decisions. Corporate Knights research has found that they have invested billions in companies with sustainable solutions, billions in controversial weapons for profits, prisons for serious polluters and a range of other issues that are monstrous on the radar of many responsible investors. As a result, ESG, environmental, social and governance investing products are becoming mainstream. A study by SOM Desjardins has shown that socially responsible investment funds over three, five and ten years outperform traditional Canadian stocks, US stocks and global equity funds. After a slump at the end of the first quarter, when global stock markets plunged amid coronavirus concerns, the ESG ETFs in Canada are seeing significant momentum, and their investments are gaining potential as a signal that investors are sticking to their bets on socially responsible investing, says Rincon.
The official launch of Sri Canada came in 1986 when the Vancouver City Savings and Credit Union Ethical Growth Fund launched, the first Canadian investment fund to evaluate investments according to social and environmental guidelines. The Credit Union of Southwest Ontario went even further with Responsible Investing (RI), a growing movement that says that companies with robust ecological, social, and governance practices (ESG) will outperform the broader market in the long run.