Good Honest Dollar $$

Ethical Investment Anyone?

Is it possible to invest ethically in casino operators, tobacco manufacturers, weapons manufacturers, fast food chains or makers of alcoholic beverages?

One school of thought says no – given the negative social impact of the operations of such firms, it is impossible for funds directed toward them to constitute socially responsible investments.

But another school of thought adopts a different perspective, and instead selects ethical investments based on a ‘best of sector’ approach.

Those who favor such an approach typically would not exclude firms in the above industries altogether. Instead, they would consider only the best (or least worst) behaved firms from such sectors.

A fast food chain, for example, may be considered if the firm in question has taken proactive measures to promote public health – such as the introduction of healthier menu options, the elimination of harmful ingredients from recipes and the sponsorship of health education programs.

So too might a manufacturer of alcoholic beverages which had been active in the promotion of responsible drinking behavior and/or taken measures to reduce the alcoholic content of its beverages.

 
Introducing the ‘Best of sector’ approach
Under the more traditional approach toward the construction of socially responsible investment portfolios, investors or fund managers seek to specifically include stocks from industries whose impact is considered to be positive from a social or environmental standpoint and/or specifically exclude those whose impact is considered to be negative.

In contrast, under a best of sector approach, fund managers typically select companies from a broad range of industries or sectors, sometimes regardless of the social impact of the industry or sector concerned. Instead, investment selections are restricted to individual firms whose corporate reputation is amongst the best within their industry or sector.

Under this approach, the critical factor which determines the suitability of an individual firm for inclusion in the portfolio is not so much the sector in which it operates, but rather the firm’s individual performance relative to its peers within the same industry.

 
The key advantage of  the ‘best of sector’ approach
The key advantage of the best of sector approach is that it provides an incentive for individual firms across all sectors to improve ethical performance, regardless of the industry or sector in which they operate.

Any industry, any sector – firms which adopt the most responsible corporate behavior are candidates to attract the ethical investment dollar – and the resultant benefits in capital markets (refer post).

Investors who adopt this approach believe that positive corporate behavior should be rewarded across all industries, not only those which are favored by the traditional SRI approach.

 
Arguments against
In my view, there are two key arguments against this approach:

• Any investment dollars which are allocated toward industries whose social impact is negative help to stimulate growth of such industries – not a desirable outcome no matter which firm is involved.

• Firms which are not sufficiently motivated to adopt positive corporate behavior due to other factors (e.g. public relations, government regulations) are unlikely to do so simply to appease the ethical investment community.

  
So, which approach is best?
In my view, the optimal approach toward SRI would involve a combination of the more traditional selection process as well as the best of sector approach.

Ethical investment portfolios should certainly be weighted to some extent so that more weight is given to industries or sectors whose social impact is positive, with less weight given to those whose impact is negative.

However, the performance of individual firms relative to their sector should also be considered, and any firms which demonstrate a proactive approach toward mitigating any negative social impact from their operations need not be excluded from SRI portfolios altogether.

Nevertheless, I do believe there are some industries where no particular firm has demonstrated sufficient behavior to warrant inclusion in SRI portfolios. These include the tobacco industry and the worst parts of the adult entertainment industry.

Firms in such industries have no place in SRI portfolios.