Red flags
For those investors who are adamant about adhering to a strict exclusionary ethical standard of investing, what are the associated costs?
“Those funds that apply an exclusionary screen will never garner the same level of assets under management, no matter what their performance is, as a broader mainstream type of product,” says Shaw. “You have to accept that your investable universe will be more restricted.”
Investors also need to keep in mind that investing in this type of ethical strategy is a long-term endeavour. The exclusionary nature of a dark-green strategy by necessity creates biases in the portfolio, so investors need to be willing to weather the highs and lows that come with that.
Shaw adds: “Ethical investors are willing to acknowledge they have benefited from a pretty strong bull run for equities. Certainly, being underweight oil and commodities was helpful in 2015.
“There have been other years where if you were underweight in those areas, that would have been hurtful in terms of relative performance. This year, for instance, has not been a good year at all for ethical mandates.
“However, all the managers we spoke to on the equities and bond side said they would not expect there to be a drag on performance in the long run due to the ethical criteria. They all accept, as do we, that in the short run you will be out of certain sectors and overweight some other ones.”
Funds that belong to the relatively nascent ESG sector, on the other hand, are likely to require investors to keep a closer eye on investment activities as the industry becomes more standardised over time.
But with the rise of the millennial investor, Abu-Habsa thinks it is only a matter of time before demand for regulatory change and greater transparency steers the sector to greater disclosure around ESG metrics.
She says: “As we have seen with the disclosure around fees and how that has evolved through the years, investors are more aware of the impact higher fees have on their portfolios. Over time they will be more aware of the impact controversies have on their portfolios and that will in turn drive regulation.”
Personal vision
Despite some of the issues with transparency, investing in an exclusionary ethical fund does not necessarily mean you are investing in sustainable companies that are environmentally friendly, socially responsible or concerned with good governance.
Many funds classified by Morningstar as SRI, values-based funds, including UBS Global Sustainability Equity and JPM Global Socially Responsible score below average or lower than their peers on ESG grounds.
Conversely, Hermes’ Global Equity ESG receives an above-average score from Morningstar from a sustainability perspective, even though it has an index weight in healthcare and an overweight in financials.
Abu-Habsa says: “As much as an investor is trying to align his/her ethical interests with what a fund manager is trying to do, that alignment is never going to be perfect. There are different acceptable ethical values that are applied across those funds by different fund managers, and these have evolved over the years.”
In the end, whether an investor favours a dark-green strategy or the flexibility of an ESG vehicle is down to personal preference.
Though their visions for the future of the ethical investment industry may differ, one thing both Abu-Habsa and Shaw would agree on is that the onus should be on empowering investors through information.