The art of throwing good money after bad

Most people want to invest responsibly. Recent research by the Defined Contribution Investment Forum found that 81 per cent of people said businesses had a wider responsibility than making a profit, while 61 per cent assume pension schemes follow responsible/sustainable investment principles. 

Most don’t, which is why the government said in June that trustees will have to factor environmental, social and governance (ESG) issues into their investment process. 

So, pension scheme trustees will face similar questions to private investors: how can we be sure that our money is being invested in line with our principles? This is tricky, as the Church of England demonstrated four years ago, when it emerged that it owned an indirect stake in Wonga, the payday lender. How can we avoid problems like this? 

A recent paper from the BlackRock Investment Institute is helpful: you can use exclusionary tactics (ruling out companies selling tobacco, fossil fuels, and weapons), a thematic approach (targeting specific opportunities such as low-carbon energy or transport), impact investing (seeking specific non-financial outcomes such as energy or water efficiency, or increased provision of affordable housing), and targeting ethically-minded companies. 

In practice, the last of these is likely to be the commonest approach. There is a growing number of indices that target high ESG performers, such as the MSCI Europe SRI Index, as well as many funds that offer an ESG focus. In addition, Morningstar publishes ESG-based ratings of just about every conventional fund on the market, enabling everyone to judge how responsible/sustainable their portfolio is. 

But ESG ratings do not necessarily exclude certain industries. They rate companies on their self-reported efforts to improve their environmental, social and governance impact. Unwary investors can be caught out: you might find your fund is investing in industries you think it should avoid, on the basis that the companies it has selected are the best performers in that industry. 

It is difficult for private investors in a fund to identify every holding it contains and we end up having to take a good deal on trust—if you want to know more you have to do your own research. 

It’s worth the effort—BlackRock suggests there is a big crossover between strong performance on ESG measures and the quality style of equity investing that tends to identify resilient businesses with a lower risk of mishaps and failures. Perhaps responsible investment is just another way of demonstrating that well-run companies that try to behave ethically make solid long-term investments. Who’d have thought?