The pointlessness of ethical investing

Ethical investing is one of those areas where I was totally blinkered. I used to strongly support it and berate myself for not doing it. That shouldn’t have surprised me. In almost every way I’m your normal middle-class Guardian-reading liberal. Making sure that I invest in ethical funds fits as neatly into that demographic as drizzling single-estate balsamic vinegar over my homemade pomegranate and quinoa super-pot. Of COURSE I want to invest ethically.  It fits my journey to happiness.

This post is about my journey into considering ethical investing and about why I decided that it was pointless.  Specifically that it failed in my goal to make the world better through investing

Three things to say before I get into it. Firstly, I should say that checking if my funds could be more ethically invested has been on my list for a while but my inherent idleness has pushed it down the list.  But, I was prompted to look into it by a post by Mindy a few weeks back.  In one of those odd coincidences she has just written about ethical investing with a very different perspective to mine so make sure you check it out.

Secondly, I’m not making any judgments about what anyone else has done.  I’m definitely also not giving any kind of advice.  This is about my journey of discovery into ethical investing and I would love to hear alternate views (including why I am entirely and embarrassingly wrong) in the comments.

Thirdly, I’m going to warn you now, you may get disheartened after you read this post, but don’t worry. My next post is going to be about how you can save the world and get richer at the same time.

Why people invest ethically

I 100% get why people want to invest ethically. When I think about the health impacts of tobacco, the lives that are ruined by land mines, the clothes made in sweat shops and many other areas it makes me angry and sad. I don’t want companies to exploit the weak and ruin the environment. Even more so I don’t want to be part of enabling those companies to do those things.

The other side of this is that I want there to be more companies that are developing affordable renewable energy. I want there to be sustainable alternatives to plastics. The more companies that are developing delicious alternatives to meat products the better. (As an aside we discovered jackfruit ‘pulled pork’ recently. A. Maze. Ing). If I can be part of helping companies like that grow and thrive that that would be great.

While those are things that I care about everyone is different so you’ll have a different list of things that you’re bothered about. That, I think, is what motivates people to look into ethical investing. For some people ethical investing will mean avoiding investing in companies they disagree with, for others it will mean only investing in companies that they support. While I believe that those are the two main themes I’m sure that there are also many variations you can play on that.

Unfortunately I’ve come to the view that, as an individual investor, investing in ethical funds and the like doesn’t make a jot of difference.

Ethical investing means you don’t understand investing

My biggest problem with ethical investing is that it’s based on a wrong headed understanding of investing. I don’t mean in terms of understanding P/E ratios, or dividend yields, or passive vs. active investing or being able to read a set of accounts or the other stuff that people talk about when they talk about understanding investing. No. What I mean is that most people don’t understand (or, more charitably, think about) what happens to their money when they buy a share in a company.

Let me explain. Say I go log onto my online broker and buy shares in an exciting company called Sainty-Saints Corp. They are a gooder than good company. By buying their share I’m doing a good thing right? I’m helping them grow and expand. Frankly I’m amazing.

Well I may well be amazing (and I am), but not because I bought into Sainty-Saints Corp. When I bought my shares in Sainty-Saints Corp the money went to the person that sold that share. Importantly the money doesn’t go to Sainty-Saints Corp. Not even a bit of it. It doesn’t fund their research, or marketing, or CEO’s salary. Nothing. They don’t see it.

When you stop to think about it that’s kinda obvious isn’t it? If you bought a coffee shop you would pay the money to the owner who would take it and ride off into the sunset. The coffee shop itself wouldn’t see a penny of the sale price.

Similarly, when it comes to buying a share in Sainty-Saints Corp it has no impact on the company itself. It only affects the seller – and if you’re worried about ethics, you could be handing over money to a seller that’s a hero or a villain, or anything in between. You’ll never know.

What happens after I’ve bought into super-ethical Sainty-Saints Corp

So anyway I’ve bought my shares in Saints Inc. I own part of the company. Surely that has some effect? Well let’s look at what might happen to that share. Having bought into Sainty-Saints Corp, as an investor I’m expecting two things. The price of that share to change and/or that share to pay out a dividend.

While the share price may be linked to some of the company managers’ incentives the company itself doesn’t care what the share price is (for simplicity I’m ignoring things like financing covenants). The share price is essentially an issue for the owners of the company, i.e. people me. Sainty-Saints Corp will continue to do the good things it does regardless of the share price.

Dividends are an interesting one. Say I’ve now bought shares in the highly unethical Horrible-Sinners plc and I take a dividend. Am I encouraging Horrible-Sinners plc to carry out their dastardly activities? Well no. There are many reasons why a company pays out dividends and shareholder expectations are definitely included in that. However, whether or not the shareholders think that what they company is doing is ethically good or a bad isn’t relevant in that (I’ll come onto activist investing in a bit).

What I would say though is that regardless of whether owning the shares encourages that activity I do have sympathy with those who feel uncomfortable with the idea of profiting from those activities. That may well be enough for you decide that you don’t want to invest in unethical companies – I would just say that you need to make up your own mind as to whether it will change what that company does one way or the other.

But if everyone stopped investing in unethical firms they would go bust right?

So far we’ve established that investing in, or holding a share in a company has no impact on what it does. But, am I thinking too small? What would happen if everyone decided not to invest in unethical companies and only invest in ethical ones. Let’s see what would happen at Horrible-Sinners plc if everyone started selling their shares.

The first order thing is that the share price of Horrible-Sinners plc would sink. This is a straightforward case of supply exceeding demand. The thing is, as before, it doesn’t make any difference to the day to day activities of the Horrible-Sinners plc. It will still carry on doing the bad things that it was doing before. There could be some impact on credit lines or debt covenants. But if we work on the basis that this is a company with no debt and plenty of cash then this doesn’t change anything.

What is even more interesting is the, likely, second order effect. If Horrible-Sinners plc is profitable and the fundamental business is sound then when the share price tanks, that’s going to attract the sharks. There will be investors (e.g. private equity type firms, or traders) that will look at this as a buying opportunity. In some situations, if the public markets are too problematic then they may even take Horrible-Sinners plc private.

The bottom line is that regardless of my decision to invest, or pull out, of Horrible-Sinners plc it’s going to carry on doing what it’s doing. My investment decision, or even the investment decision of many stock investors doesn’t change what the company actually does.

Ethical activist investing

Now I have one big exception to this: Ethical activist investing.

For those who haven’t come across activist investing that’s where someone invests in a company because they want some aspect of it to change. That could be things like its strategy or management. If the activist builds up a large enough holding then it can even get a seat on the board.

Now activist investing can work. Not all of the time, but it can work. After a certain point the management have to at least listen to the activist. Even with smaller holdings it’s possible for activists to disrupt annual general meetings or demand meetings with the management. They can also raise media or political interest in the issue to put pressure on management.

You can see how ethical activists can use activist investing to try to secure changes. But, I’m not sure that most of us have the resources (or interest?) to get involved at this level. It certainly doesn’t appear to be what most people are thinking of when they talk about ethical investing. Even more so, I don’t think that most ethical funds see activism as their focus. Rather, it appears, that most ethical funds just do their research up front and invest, or not, in companies that meet their criteria. If, for whatever reason, that company stops meeting their ethics criteria then it appears that the most likely outcome is that they just sell their holding. They don’t get involved in trying to effect change.

Ethical activist investing in practice

So does ethical activist investing work? Let’s look at a couple of examples. The Church of England has a £8.3bn investment fund. As you might expect, it also has an ethical investment policy, in fact it has an Ethical Investment Advisory Group. Most of what that seems to be is the sorts of things that you would expect i.e. committing not to invest in tobacco or gambling and that sort of thing.

Interestingly however it also has an active engagement approach – at least at times. So when the Church was debating whether it should sell its holdings in fossil fuels companies the FT quoted the Church Commissioners and its Pension Board saying:

“Our active engagement and collaboration with other investors are changing companies behaviour, providing greater leverage and influence than we could achieve simply by selling our holdings.”

So without commenting on how effective that is, they’re trying.

A more concrete example is the suggestion that Minnesota Board of Investment put pressure on KKR to look at providing severance payments for Toy R Us workers. While the direct cause and effect isn’t transparent it may be that the Minnesota pressure had an impact. I do wonder though if wider activist pressure, of which this was a part, was the real swing factor.

I suppose my concern with this as individual investor is that I’m not aware of many ethical investment funds that take an activist approach. The majority seem to take the approach of investing, or not investing, in particular companies.  And, as I’ve already explained I don’t think that has any affect on the company itself.

Please tell me if I’m wrong on that.

Final thoughts

So that’s my thesis: Ethical investing, at least the way that much of it is done today, doesn’t have an impact in the way most people want it to.

Just to reiterate I’m not giving any advice on how and where to invest (or indeed anything else). What I’m saying is that I don’t understand how or why ethical investing will have an effect.  As a result I’m not going to change any of investments I set up in my lazy rules.  I’m happy to keep investing in broad based trackers.

I also know that I have glossed over the issue of financing here.  This is mostly as I don’t know enough about it.  My understanding is that financing is provided mostly based on expectations of the company’s future growth and cashflow.  If that’s right then while customer behaviour can impact that then I struggle to see how investors can.

As I also said, I think that pressure groups and activist can have an impact. Companies are run by people, and most people don’t like being embarrassed in public. So, done right, I think that activists can make change happen.

Also, for a further alternative view check out Fugasaurus who talks about crowdfunded solar loans. (H/T to Triple Bottom Line FI who pointed it out in a comment to Mindy’s post) That’s not the sort of investing I’ve been talking about here and it’s well worth a read.

Wow. That was a but bleak wasn’t it? Fear not friends. This isn’t the end of the story. As I said at the start, my very next post is going to be about how we CAN save the world. Not only that, but we can do it in a way that makes us richer.

As always, do your own research.

Thoughts

Am I the fool here? Is it me that doesn’t understand how investing works?  Where does my logic or the facts fall apart?

Are you aware of activist investing working when it comes to challenging the ethics of a company?

What’s your take on ethical investing? Do you invest ethically?

Do you have any views on ethical activist investing?  Does it work?

Have I got “affect” and “effect” right in this piece…it’s one of my bête noires?

 

PS.  In case it wasn’t obvious Sainty-Saints Corp and Horrible-Sinners plc are entirely made up – any similarity to any real or fictional companies is completely coincidental!