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Ethical Investing

An investment strategy where the investor’s ethical values are the primary objective along with good returns

What is Ethical Investing?

Ethical Investing is an investment strategy where the investor’s ethical values (moral, religious, social) are the primary objective, along with good returns. With suspicious and illegal investment deals on the rise, many investors are starting to insist that companies make socially responsible investments. It would mean treating their employees with respect, creating healthy products, and services and keeping away from unethical business practices.

 

Ethical Investing

 

Who Will Ethically Invest?

Ethical investing is for investors who want to invest their money to noble causes. For example, if an investor thinks tobacco is bad, then they would avoid companies that produce tobacco or own investments in tobacco-manufacturing companies.

 

Types of Ethical Investments

 

1. Socially Responsible Investing Funds (SRI Funds)

SRI funds avoid investing in controversial areas such as gambling, firearms, tobacco, alcohol, and oil. Here, the investor’s moral value is given more importance over financial returns.

 

2. Environmental, Social and Governance Funds (ESG Funds)

Unlike SRI funds, ESG funds consider in their decision-making how environment, social and governance risks and opportunities can cause material impacts on a company’s performance. They can invest sustainably while maintaining the same level of returns as they would with a standard approach.

 

3. Impact Funds

Impact funds place equal importance on fund performance. Hence, they aggressively look at creating ethical changes with the products and services. Impact funds are suitable for investors who are socially responsible but also want good returns.

 

4. Faith-based Funds

Faith-based funds only invest in stocks that follow religious values and strictly exclude investments that don’t fit the category.

 

Advantages of Ethical Investing

  • The investor feels happy when an ethical holding company performs well. They benefit emotionally and financially when the company shares their values.
  • As more people invest in ethical funds, the investments can grow substantially in the future.
  • Since ethical investing is gaining importance, it will give other businesses the chance to improve their ethical practices to attract funding.

 

Disadvantages of Ethical Investing

  • As ethical investing is not a passive strategy, it involves a lot of research to ensure that it aligns with the investor’s values and beliefs.
  • Ethical investing will not likely provide optimal returns; hence, the investor can be sacrificing financial gains for an ethical approach
  • The fees for ethical investing can be higher due to the research involved in identifying the right investment.

 

Famous Unethical Scams

 

1. Enron Scam

The Enron scam cost the stock market $78 billion due to massive accounting fraud. The Sarbanes-Oxley Act (SOX) was introduced in 2002 to combat such scams. The law requires every company to comply with certain internal controls that need to be audited.

 

2. The Ponzi Scheme of 2008

Bernard Madoff was the mastermind behind the $65 billion Ponzi scheme. In 2008, the former money manager was responsible for the largest fraud ever committed by an individual. This scam forced the Securities Exchange Commission (SEC) to give more importance to Ponzi and investment advisor fraud-related cases.

 

3.The $600-billion Bankruptcy of Lehman Brothers

During the 2008 Global Financial Crisis, Lehman Brothers, which previously owned $600 billion worth of assets, went bankrupt. It was the biggest bankruptcy ever and led to the financial crisis. Investigators accused its top executives and its auditor, Ernst & Young, of the fraud.

 

Does Ethical Investing Work?

One key aim of ethical investors is to avoid investing in companies that produce products that are against the social, moral, and religious values of the investor. However, boycotting an evil company by not investing in it doesn’t mean that money is not going to the company.

When an investor purchases a stock, the money goes to the seller of the stock, who is an individual investor and not the company. The company only makes money when it issues new stocks like an initial public offering (IPO). Hence, ethical investors are not punishing the evil companies.

Also, by boycotting a company, the investors are doing nothing but reducing the prices of the stocks, which will make it more attractive to unethical investors in the market to buy the stock at a lower price.

Ethical investing is beneficial to society; however, it needs to fulfill certain elements that it usually doesn’t.

  • First, a successful business idea needs to be identified, which will help the world. For example, solar panels are good examples of ethical investing. However, funding solar panels will not help do any justice to the cause if the company puts its competitors out of business or fails to perform.
  • Secondly, if the investor is able to identify a business opportunity that will result in a positive impact on the planet, then there needs to be “additionality” – a path by which the business can lead the company to grow substantially. However, it is difficult to achieve such an objective in the stock market.
  • There are many investors in the market seeking a higher expected return. If the ethical investment is providing a good return, the investors will be attracted to seek higher returns. It means that the ethical investor is only helping when the company is not giving a good return.

 

Should Investors Stop Ethical Investing?

Ethical investing isn’t a bad thing. It does help companies gain access to capital to grow and fund their CSR (corporate social responsibility) programs. If an investor is more concerned by the world compared to the returns, then investing in an ethical company will help them in their cause.

People often try to compare the expected returns of their investments in ethical investing to normal investing. However, if they are willing to lose money to make a difference, then the comparisons shouldn’t matter.

 

Conclusion

An investor chooses to ethically invest when they want to make a difference in society. Their primary goal from the investment is to meet their moral, social, and religious values, while returns are secondary.

While ethical investing is good, it is an expensive strategy, as thorough research needs to be done to find an investment that meets the investor’s primary goal. Also, boycotting companies will not impact them since driving down the prices will not attract unethical investors to buy the stock at a lower price.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Corporate Social Responsibility (CSR)
  • ESG (Environmental, Social, and Governance)
  • Ethical Dilemma
  • Moral Hazard

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