Ethical Investing: The Benefits and Drawbacks

Ethical investing is a trending concept that has a series of benefits as well as several limitations that must be considered.

People have become more interested in supporting businesses that incorporate social responsibility into their operations in recent years. As investors engage in environmental, social, and governance (ESG) investing, they have a moral imperative to break through some of the social norms of the previous eras and establish better ethical practices. 

Related: Towards a Higher Shari’ah Compliance

What is ethical investing?

Investing in companies with moral ideals is known as ethical investing. Political, social, religious, moral, and other values are examples. These figures are then used to determine whether or not to purchase stock. 

Ethical investments attempt to make a profit while simultaneously having a positive impact on the world. It means you can make a profit without compromising your social, moral, or religious values.

This style of investing has only recently gained popularity. Until the internet, ethical investing was a solitary endeavour. Now, it has quickly gained momentum as a riveting movement that sets a pace for ethically inclined investors not just from the Islamic world, but across the board. 

Benefits of ethical investing

1. Ethical investing is a growing sector

Ethical investing is still a small part of the overall picture, but it is rapidly expanding.

According to Morningstar, funds that invest particularly according to ESG principles had net inflows of $71.1 billion between April and June 2020.

For the first time, the total assets under management in environmental, social, and governance (ESG) funds has topped $1 trillion.

ESG fund sales accounted for over a third of all fund sales in Europe.

2. The rise of Environmental, Social, and Governance

A more ethical investor would seek out companies that have exceptionally high standards in terms of the environment, society, and management. Environmental, Social, and Governance (ESG) criteria are a type of benchmark that socially concerned investors use to filter their investments.

Before selecting whether or not to invest in a company’s stock, investors examine its environmental and social impact. As a result, a more stringent definition of ‘ethical’ or ‘sustainable’ investing is formed because it considers all of a company’s major activities and how they affect the world on a large and small scale.

ESG investing has a lot more to offer than merely a moral appeal. Investors are also attracted by it since companies having a high ESG profile are thought to be more valuable. 

Organisations that are more sustainable, for example, have a better chance of long-term stability; companies that are socially responsible may attract the best personnel; and companies that are well-governed are less prone to corruption and disastrous scandals.

ESG fund managers that want to invest in a firm will look into its ESG credentials first, interviewing both management and employees as well as individuals connected to the company, such as suppliers, customers, and local communities. 

The inquiry looks for both problems and positives in order to provide a complete picture of the company’s overall impact. The fund may invest in the company’s shares if it meets the fund’s ESG requirements.

Related: Why Sustainable Investments Matter More Now

3. Companies that combat ESG issues will prosper in the long term

More and more businesses will shift to a socially sustainable business model after seeing the earnings that can be produced from sustainable and ethical activities.

The rise of ethical investing may also encourage companies to embrace socially responsible policies that directly address ESG concerns. Companies who perform ethically will receive significant financial and public support as a result of this. Large firms, which are responsible for the majority of the damage, should, in theory, convert to less destructive practises.

Limitations of ethical investing

1. Do ethical funds underperform?

There is a widespread belief that in order to invest ethically, you must sacrifice development. There is no indication that ethical funds perform poorly; in fact, many of them frequently outperform their non-ethically screened counterparts.

Many people, however, do not completely understand ethical funds and so misunderstand the pros and cons of ethical investing. The total performance of all funds is influenced by a variety of factors. There are a few things to keep in mind while investing in ethical funds that are actively managed:

Does the fund have a defined investment strategy? How long has the main fund manager been in the role? How does the parent group perceive this form of investing?

2. There’s more to consider

If you want to invest ethically, you’ll need to be willing to put in a little extra effort when choosing assets.

That’s because, in addition to selecting a fund with strong performance potential, you’ll want to choose one that is as closely aligned with your ethical ideals as feasible. Before you begin your search, think about what would please you on this front. Some ethical funds steer clear of companies with low ESG scores while keeping some exposure to industries like oil and gas, defence, and tobacco.

3. It’s critical to keep things in perspective

Ethical investors would do well to remember Voltaire’s maxim that “Perfection is the enemy of the good.” Because it’s doubtful that you’ll find a fund that exactly meets your ethical standards, the best fit is just a practical reality.

Ethical investors should also be realistic about what ESG investing can accomplish. It will take a long time for the global economy to shift to more ecologically friendly practises.

4. Fees incurred by investors

Fund managers must devote time and resources to researching the business operations of each company in order for the screening procedure for ethical funds to be effective.

Ethical and SRI funds are categorised into three categories based on the level of social responsibility that corporations adhere to: light green, medium green, and dark green.

Light green funds are more permissive; they invest in companies that use sustainable techniques but are still involved in unethical business practises.

Medium green funds are more focused, as these funds only invest in specific areas.

Dark green is a fairly restrictive colour, implying that these funds strictly adhere to many, if not all, international ethical standards.

Many organisations, particularly larger corporations, are attempting to conceal their unethical actions, making it considerably more difficult for fund managers to determine whether companies are acting ethically. Investors are obliged to pay greater fees for their ethical investments, diminishing returns for the foreseeable future.

How can you be sure you’re making ethical investments?

It’s important to make sure that a business or ethical fund delivers on its promises, especially if you’re investing for the long haul.

The more beneficial features of socially responsible investments can be over-hyped without addressing the more negative parts, a practise known as “greenwashing.”

While most businesses provide societal benefits such as jobs, this must be considered holistically. Is the company that is hiring treating its employees with dignity and respect, for example? Are any of the employees under the age of 18? There may be a long string of prerequisites to consider before identifying ethical investments.

Ethical investing is intrinsically a positive force that has entered the finance space as of late, but it’s always important to take note of the trends that are taking off and base your decisions on the apparent limitations seen in ethical investing.