The minefield of ethical investing

Sonnie Bailey

1 November 2019

We all want to be ethical people, right?!

Well, at least most of us, right?!

In which case, investing in an ethical way is likely to be in line with our values and priorities, right?!


The idea of ethical investing seems to be becoming more popular.

(For reference, I'm going to use the term "ethical investing" as a blanket term to include SRI (socially responsible investment), ESG investing (investing with a focus on environmental, social, and governance factors), and "impact investing").

Of note, a lot of KiwiSaver providers have made changes to their investments recently, filtering out investments that invest in tobacco or weapons.

My views

If you're interested in ethical investing, I like you. It means you care about the world we live in.

And I'm sure you're the sort of person who appreciates that there are often shades of grey and room for good faith debate on topics like this.

In that spirit, you might want to buckle up 🙂

Personally, I'm ambivalent about ethical investing.

I think socially responsible businesses probably have better future prospects, and are exposed to less regulatory and reputational risk than other businesses.

But I don't think it's a given that investing in these types of companies will result in better returns, because these factors are already built into their share prices.

More importantly, investing in an ethical manner might feel good. But there's a risk that by investing ethically, we are "conscience laundering", when my sense is that there are other steps we can take to make the world a better place.

From a practical perspective, we all have different ethical views and finding an investment manager that aligns with our values (and continues to invest in according to our personal value) is likely to be very difficult.

I'm also not convinced ethical investing makes a big difference in terms of influencing how businesses operate.

I think there are better tools for ensuring good corporate conduct. If we're going to vote with our dollars, our consumption decisions will have a bigger influence.

Even more important is supporting, and agitating for, effective regulation and enforcement that creates consequences for bad corporate behaviour.

I don't believe we should invest in "vice funds" (more on that later). I also support investing in exclusion-based funds which remove some industries. But beyond this, I'm not sure there's much more we can do from a traditional investing viewpoint.

What are your ethical concerns?

Before we begin, I want to recognise that everyone has different views on ethics. Although the idea of learning or talking about ethics often induces eye-rolls, it often results in the most vibrant conversations you ever have.

When it comes to ethical issues, there are often no "wrong" or "right" answers. There's a lot of room for good faith debate. And those debates usually touch on fundamental beliefs and values. That's heady, interesting, fertile soil for conversation.

So - an ethical investment for you might be very different to an ethical investment for someone else.

Some examples, to get your mind moving:

Nuclear power? Adult entertainment? GMOs?

Some investment managers exclude investments in nuclear power and adult entertainment, on the basis that they are unethical industries.

I know quite a few people who would debate for hours about whether this is the case or not.

The same goes with GMOs: in fact, I know several people who say that avoiding GMOs is unethical.

Very different perspectives, each held in good faith.

Facebook and other social media companies?

Most investment funds and managers don't consider social media companies like Facebook to be unethical. Yet I've had multiple clients tell me they think Facebook is the most dangerous and unethical company in the world.

(In fairness to Zuck, Many people would say the same about Twitter, too.)

Although there are good things about these social media companies, there are definitely aspects about these companies which are unsavoury.

(I would love for New Zealand to be a world leader in introducing appropriate legislation for organisations like Facebook to adhere to if they want to operate their business here. Including allowing people to export their "social graph", and providing greater transparency about "shadow profiles" which are held on people who aren't even Facebook users. I'd also like to see a public registry of advertisements that are published on Facebook's platforms, and to whom these advertisements are targeted. But I'm getting ahead of myself.)

Amazon, and other companies with big societal impacts and debatable employment practices?

What about Amazon, with the way it disrupts traditional mum-and-dad companies and industries, and the way it treats many of its workers (including contractors) poorly?

Uber and other blitzscalers?

Is Uber an ethical firm? A lot of news reports about its internal processes and culture suggest otherwise.

What about other companies that blitzscale, profitability and their impact on established industries (and the people whose livelihood depends on them) be damned?

Pharmaceutical companies?

What about pharmaceutical companies which rely on artificial monopolies so they can charge thousands of dollars for medications which cost cents to make?

(Of course, I'm simplifying; any industry where the first unit costs $1 billion and the next unit costs 1 cent is going to require tricky economics and unique regulatory treatment in order for significant R&D investments to be made. It's better than having billion-dollar Breaking Bad-type operations!)

Energy companies with big carbon footprints?

And any other companies with big externalities?

This is perhaps more relevant in other countries: for example, in Australia, a lot of energy is generated by burning brown coal, which creates enormous CO2 emissions.

Big financial institutions?

In light of the Australian Royal Commission findings, do you think the big Australian banks are ethical?

Is it ethical to invest in rental properties?

I've met people who've made passionate moral arguments against investing in rental property.

If it weren't for lots of mum and dad investors wanting to invest in rentals, demand for residential property wouldn't be so high, and housing affordability might not be such a big issue.

All else being equal, demand increases price:

And the change in price is exaggerated when supply can't rapidly adjust to these changes in demand... ie, when the slope of the supply (S) curve in a chart like the one above is steeper.

On all of these points, we might all think we have the "right" view, but most of the time we're really talking in shades of grey.

And even if our ethical intuitions aligned, we are likely to prioritise our thoughts and feelings in different ways.

On top of this, companies in "ethical industries" can also conduct themselves unethically

To complicate matters, even with companies that are in "ethical" industries, people working on their behalf can conduct business unethically, mistreating staff and suppliers, misrepresenting consumers, etc.

Consider your own experience. I'm sure you've worked in organisations with a number of employees. Even if you're working in an organisation, it's hard to know whether everyone is acting appropriately in the organisation. That's the case even if you're a very senior person.

Of course, most people and organisations put their best foot forward and want to make it look like they're doing their bit. They will paint that picture. But is that picture accurate? How can you know this for sure?

It's hard enough to know from the inside. Do you think external fund managers will have a clearer picture?

By focusing on investing ethically, are you conscience laundering? 

Warren Buffett's son, Peter Buffett, refers to "conscience laundering", or the "charitable-industrial complex". He uses the term "conscience laundering" in the context of billionaires like his father using philanthropy to feel "better about accumulating more than any one person could possibly need to live on by sprinkling a little around as an act of charity", while keeping "the existing structure of inequality in place".

(Anand Giridharadas takes this argument further in his book Winners Take All: The Elite Charade of Changing the World: he has a great conversation on this topic with Preet Bharara on the Stay Tuned podcast.)

I think the term "conscience laundering" can be used when it comes to ethical investing as well.

A lot of people feel a little uncomfortable with the fact they've accumulated (or inherited) wealth when they are aware that there are many people who don't have wealth. These same people often have significant concerns about the world we live in.

I am empathetic to this. I feel an affinity to people who want to make decisions that will make the world a better place.

The problem is, I'm not convinced that using ethical investment as a major criteria with our investing decisions is an especially effective way to do a lot of good in the world.

Does ethical investing make much of a difference?

At the end of the day, I don't think investing ethically makes a big difference.

For one thing, when you buy or sell a share, it doesn't have a direct impact on the company in question. The money you pay to buy a share, for example, goes to the person who previously owned the share, and not the company.

Share price might impact the business in some indirect ways - for example, possibly its ability to get additional finance, or the attractiveness of share options for senior executives.

From my perspective, systemic issues aren't going to be addressed by whether you decide to invest in a particular company or not.

Systemic issues come from drawing attention to bad practices, and taking steps to ensure these bad practices stop.

We might be able to do this with our decisions as consumers.

But I think the biggest impact we can make is by encouraging good policy and regulatory action to ensure good behaviour.

For example:

  • By internalising externalities - such as putting a price on greenhouse gas emissions.
  • By supporting policies and enforcement that stops companies from being opaque or misleading with respect to its representations to consumers.
  • By being engaged in local and national politics, especially the areas where you might have the knowledge and ability to make a genuine difference.

Does investing ethically generate better returns?

Some people think that ethical investments will outperform other types of investments.

The rationale seems fairly strong: companies that are socially responsible, and that have sound environmental, social, and governance arrangements, are likely to be more sustainable in the long-run.

All else being equal, ethical companies are likely to be subject to less regulatory and reputational risk than other companies.

My intuition is that these are the types of characteristics that are likely to result in companies that thrive in the future.

On top of this, there's probably some correlation-causation involved: high-performing companies can probably also afford to prioritise these factors, even if they are a cost to the bottom line over the short-term.

The issue with this, however, is that these characteristics are probably built into their share prices already.

From my perspective, any argument about better or worse returns are moot. Sure, ethical funds could generate better returns than funds that aren't ethical. And vice versa.

But to the extent that anyone can make a good prediction about this, these factors are probably already priced into the share prices of these investments.

I'm a big fan of index-based investing. One of the reasons for this is that I don't think anyone can reliably pick an investment strategy that will outperform others over the long-run.

If I focus on ethical investments, this is simply another domain where I think I can pick the market. That's antithetical to the point of index-based investing, and my (in)efficient market hypothesis.

(Interestingly, there is a fund in the US called the "Vice Fund". It has been operating since at least 2002. It invests in companies that are associated with tobacco, gambling, defense/aerospace, and alcohol industries, presumably on the basis that some people think these types of investments will outperform others - especially since there tends to be lower demand for these types of investments. (Mary Holm wrote about the fund in 2010.) In at least one year, I believe it was one of the best performing funds in all of America. And since 2002, it has outperformed an S&P 500 index in 11 of 17 years. (Having said this, this doesn't appear to factor in fees. Long-term performance seems to be below the S&P 500 index.))

If you still want to invest ethically...

Of course, in this article I'm setting out my own views and you're welcome to your own. As with many things, there are no "right" and "wrong" answers.

If you're still interested in investing in ethically, I'll share a few breadcrumbs to get started.

A good place to begin is's KiwiSaver Fund finder, in particular the "Ethical funds" section. Although it's oriented towards KiwiSaver, most providers who have ethically-oriented KiwiSaver funds have similar non-KiwiSaver funds.

At the time I write this, the Fund funder identifies 17 investment managers which "have a framework in place to filter out investments that could be considered unethical, such as tobacco or weapons". In other words, they do a "negative screen" but don't do a "positive screen" like the following funds. More on that later.

Sorted also identifies six funds which go beyond this and are specifically oriented towards ethical investing. They include:

  • AMP Responsible Investment Balanced Fund
  • Booster Socially Responsible Investment Balanced Fund
  • Craigs Investment Partners Quaystreet Balanced SRI Fund
  • Superlife Ethica Fund
  • Booster Socially Responsible Investment Growth Fund
  • ANZ Sustainable International Share Fund

Another breadcrumb: Mary Holm periodically write about ethical investing, and she usually has a good idea about what's available. It can be worth checking out her website for her writings on this topic.

Based on Mary's articles, I understand there are a couple of other providers not currently on the fund finder:

  • Amanah KiwiSaver Plan (which is Shari’ah compliant - it doesn't, for instance, invest in banks, which are in the business of lending)
  • Koinonia KiwiSaver Scheme (membership of which is fairly limited, and notably requires applicants to "express a Christian faith and have a commitment to Christian community involvement").

Another resource is the Mindful Money website. This site lets you delve into how specific funds are invested, across ethical dimensions.

Even if you don't go ahead with the fund or funds the site recommends, it will provide you with some food for thought to help inform your investment decisions.

You can also go through the "Find a fund that fits" exercise, It lets you to identify priorities, and also to determine which industries or activities that concern you the most.

The Responsible Investment Association Australasia also has some interesting information and resources. Its mission is "To promote, advocate for, and support approaches to responsible investment that align capital with achieving a healthy and sustainable society, environment and economy". It's worth noting that it's an industry association, and most of its members are financial institutions who might benefit from having some alignment with the organisation.

The ethical investing spectrum

I don't think it's accurate to put investment funds into two categories: ethical or not. It's a spectrum.

At one end of the spectrum, we might have the Vice Fund, which goes out of its way to invest in "unethical" investments.

At the other end of the spectrum we might have a fund where the fund managers are focused entirely on investing only in companies that have a good social/environmental/etc footprint, with little to no regard to other criteria like investment returns.

Some funds may be completely agnostic about ethical dimensions. Even those I've listed above, which tout themselves as being oriented towards ethical investing, might prioritise the ethical dimension of their decision-making more or less than others.

Negative screening

Somewhere in the middle are funds which do a "negative screen". This means they filter out specific industries/investments, and then focus on other criteria for selecting investments from whatever is left after this filter.

This is my preferred approach, because it removes the majority of problematic investments. But it means that the investment managers can then focus on what they do best.

(It also happens that this is the approach most index-based funds use. In some ways, it's because they have to: it'd be hard to implement an index-based fund and then add other criteria.)

Even when it comes to negative screening, there are approaches that are at different points in the spectrum!

As I mentioned above, Sorted's Fund finder identifies 17 KiwiSaver providers which "have a framework in place to filter out investments that could be considered unethical, such as tobacco or weapons".

Many of these funds do this, at least with shares, by investing in Vanguard's International Shares Select Exclusions Index Fund. This is a fairly standard index fund, with the exclusions relating to "companies involved in the production of tobacco, controversial weapons and companies that manufacture nuclear weapons, components that were developed or significantly modified for exclusive use in nuclear weapons, and companies that provide auxiliary services related to nuclear weapons".

Some companies go a little further. For instance, Simplicity initially used the above fund, but has since switched to Vanguard's Ethically Conscious International Shares ETF. As per Simplicity's PDS, this excludes "investments in companies with significant involvement in the following activities:

  • Fossil fuels
  • Tobacco
  • Alcohol
  • Gambling
  • Military weapons
  • Civilian firearms
  • Nuclear power
  • Adult entertainment".

This is a slightly more comprehensive black list.

Positive screening

If you want to invest in a fund that goes above-and-beyond regarding ethical investing, the costs will go up:

  • For you, at the outset, in terms of finding which manager aligns most closely with your values.
  • For you, on an ongoing basis, in terms of monitoring the manager, to ensure they act walking the talk, and that any changes to their approach stay in line with your own values.
  • For the fund manager, which goes to the fees you pay, because it's another dimension which requires more work.

As I explained earlier in this article, there are lots of dimensions to consider when it comes to ethical investing. There's probably no individual who shares your exact priorities. That goes double for an investment manager.

It's also worth noting that New Zealand has a small investment market. It's one of the reasons that fees for managed funds are a lot higher here than in countries with larger populations. (Larger populations = more potential investors = more potential funds invested = more ability to spread fund management costs = lower fees.) In light of this, it's quite pleasing that there are as many ethical investment options as there are.

Another thing that is important to note is that if you opt for positive screening, you're opting for active investment management.

With all active investment, you have to give your fund manager a fair amount of leeway and discretion to make decisions. You're not going to sit in on investment manager meetings. You're not going to find out about their investment decisions until after they've implemented them. And even then, you're unlikely to ever have full transparency about what they're doing at any given moment.

You just need do your due diligence for each fund. An excellent place to start is their Statement of Investment Policy and Objectives (SIPO), which they need to prepare by law. In the words of the Financial Markets Authority (FMA), a SIPO is "a document that sets out the investment governance and management framework, philosophy, strategies and objectives of a managed investment scheme and its investment funds or portfolios".

"Shareholder activism"

If you're a shareholder of a company, you usually having certain voting rights relating to the business.

If you're a majority owner of a privately held company, for example, you're likely to have a lot of power over the company. Even if you're not a director setting strategic direction of the company, you probably have the power to add and remove directors, which in some ways is a superior form of power.

If you own a single share of a large, publicly listed company, the value of that voting right probably isn't very valuable. Most individual investors won't move the needle in terms of how a company is operated.

If you invest via a managed fund, one of the things you give up is your ability to vote at Annual General Meetings (AGMs). However, your investment manager can exercise votes on behalf of its members.

Different investment managers can wield this power in different ways.

Whether their approach to representing your vote can be an important factor.

Some companies take the view that there's not much they can do. An example is Vanguard. In its own words: "As a fiduciary, Vanguard is required to manage our funds and ETFs in the best interests of investors and obliged to maximise returns in order to help investors meet their financial goals. It would be exceedingly difficult, if not impossible, to fulfil these obligations while managing portfolios that reflect the social concerns of all of our investors".

One exception is for "companies whose direct involvement in crimes against humanity or patterns of egregious abuses of human rights would warrant engagement or potential divestment", which is a fairly high bar.

Arguably, the rights and obligations (or at least, the perceived rights and obligations) of a company will depend on the law of the land, including legislated or common law views of fiduciary duties, the degree to which shareholder primacy is enshrined in the law, etc. This might influence how a company exercises its voting rights.

But there is still room to move for organisations.

I'm not a shill for Simplicity, but I encourage you to watch the following TEDx presentation by its founder, Sam Stubbs, which touches on this topic:

It's also worth considering some of Simplicity's actions - such as its request for each of the top 50 listed companies in NZ to come up with a "diversity plan".

Lots of people vilify Sam Stubbs for "virtue signalling" and consider this to be a cynical way of seeking free publicity.

But a lot of people like the fact that there are people and organisations that care enough to take these sorts of steps.

Again, these organisations might not be fully aligned with your exact values. But the reality is, the best you can probably do is come up with an organisation that is somewhat aligned. "Good", isn't "perfect" but it's better than nothing.

At the very least, it's nice if they make an effort, and then bring this to the forefront of what they do.

Big, systemic issues require effective policy and enforcement

I am an advocate for capitalism and private market forces. I think Adam Smith's "invisible hand" is responsible for a lot of good in the world.

But it's important to remember that capitalism doesn't exist in a vacuum. It is predicated on a number of things that don't exist in the natural world, such as property rights and the rule of law.

In Economics 101 we learn about economic models and how they operate in the "perfect market". This theoretical perfect market makes all sorts of assumptions, like perfect knowledge and a lack of externalities.

As you progress through economics, you learn about public goods, such as certain types of infrastructure, and defence, which aren't suited to private markets and are best provided by central organisations. You learn about game theory and "the tragedy of the commons", where a locally optimal equilibrium might be inferior to other possible equilibria.

(The hard things about capitalism, and society in general, are often coordination problems. For more on this, I encourage you read this terrific article: "Meditations on Moloch".)

Good outcomes, especially when there are coordination issues, often depend on the rules of the game. And "the rules of the game" are usually determined by public policy, such as laws and regulations, and their effective enforcement.

None of these things are incompatible with capitalism.

In my view, if you really want good, ethical outcomes, you need to look at the rules of the game. You can do the best you can within the constraints of these rules. But real, systemic change, comes from the rules themselves.

If you're looking to do good by investing ethically, that's a great start. I recommend looking at funds that, at minimum, run a negative filter and preclude investments in industries you disagree with.

But if you want to make a bigger impact, you can probably do more by spending your time and energy elsewhere.

Other articles you may like:

My crystal ball is on the fritz (#AI)

My crystal ball is on the fritz (#AI)

How I money (2022)

How I money (2022)

“Market cap” can be misleading

“Market cap” can be misleading

Shares and hurricanes

Shares and hurricanes

Recessions, bear markets, and bananas

Recessions, bear markets, and bananas

Every asset class has bad years, even bonds

Every asset class has bad years, even bonds