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The inconvenient truth about ethical investing

I thought long and hard before I wrote this article.

Frankly, I don’t want more investment (at a corporate or national level) in efforts that unduly harm our environment or society. So speaking out against the push toward ethical investing could see me lumped (pun only partly intended) in with the coal, forestry, arms and cigarette pushers, among others.

I’m going to make my case anyway, and trust you to read to the end.

Straight off the bat, I have no problem with ethical investing, per se. I think it’s great that people invest with both their heads and their consciences, if it helps them feel good about how they’re investing, and there’s little true downside.

But I think most of the time, the ‘ethical’ component is little more than well-meaning window dressing when it comes to having a meaningful impact on the environmental and social issues that those investors care about. (Yes, yes, the numbers show that ethical investing outperforms. I’ll get to that, so bear with me.)

The first mistake investors make is to confuse where their money goes when they buy shares on the ASX. To avoid pedants getting caught up in the examples, let’s use a fictional company: Coal, Guns & Gambling (ASX:SIN). When you buy shares in CG&G, you’re not ‘supporting’ the company.

You’re not giving money to the company. You’re simply exchanging an existing ownership interest with someone else.

Whether you buy those shares or not, they’ll still exist. The company doesn’t know, or care, whether or not you own it. It’ll mine the same amount of coal, sell the same packets of cigarettes and own the same number of pokies, regardless of who is on the share register.

The second mistake is to suggest that ethical investing produces superior returns. Now, to be clear, some ethical investors have beaten the average, but that’s confusing correlation and causation.

If you invest in a company for ethical reasons, but it succeeds for reasons unrelated to its ethics (for example, if it’s in a growing market, or has a breakthrough product), it’s not successful because it’s ethical.

The company could (and should) have been owned by ethical and non-ethical investors alike, because it was simply a better business, not because of its ethical position.

Investing in companies or funds just because they are ‘ethical’ might make you feel better, but that’s unlikely to have a tangible impact on the world.

There are some ways you can, as an investor and shareholder, have a positive ethical impact on the world, though.

You can pressure companies in which you own shares to operate ethically. Ironically, it wasn’t shareholders who avoided wood-chipping companies who made a difference, but investors and consumer groups who pressured the large Australian banks to avoid funding the sector.

Here’s an uncomfortable possibility: bank shareholders may have had a bigger ethical and environmental impact — if you used your position to add your voice to the campaign — than passively owning shares in a solar or wind farm business.

Where owning — or not owning — unethical companies matters, is if and when they seek to raise more money (as opposed to just buying and selling existing shares on the ASX).

If a coal company wants to raise equity for expansion, the act of not participating, if done at scale, does influence that company’s ability to raise sufficient, cheap, capital.

And the existence of ethical investment funds might well help these issues take a higher place in the public’s consciousness. If you believe those causes are worthwhile, then it’s a useful role.

Foolish takeaway

I don’t want to take away from those companies and funds who are trying to do the right thing. We can definitely do with a little more corporate responsibility from our business leaders and leading companies. Indeed, in my opinion, they should do the right thing just because it’s right.

I don’t want to take anything away from people who are investing according to their consciences, either. But simply avoiding investing in existing businesses that you consider unethical isn’t enough. It’s barely going to make a dent, unfortunately.

Indeed, there’s a decent argument that the best way to positively impact some of the causes you hold dear is to invest not in the most ethical businesses, but the businesses that offer the best returns. You can then use those dividends or capital gains to help make a bigger difference.

Now that’s an inconvenient truth.

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