Thursday, 13 September 2018

The ethics of ethical investing

In recent years, there has been a trend towards the launch and promotion of 'ethical' funds, that forbid investment in companies engaging in various activities considered unethical. Common exclusions include 'sin' stocks involved in industries such as gambling, tobacco, and alcohol, and companies considered to be occasioning harm to the environment (such as coal miners). In addition, even outside of 'ethical' funds, it is sometimes argued that it ought to be incumbent on investment managers to take into account the ethics of the activities undertaken by the companies they invest in, and avoid companies engaged in 'unethical' activities.

Is this approach justifiable or merely and another way to try to promote supposedly differentiated investment funds to investors? And even outside of 'ethical' funds, how should investment managers take ethics into consideration when selecting investments? Should they amorally focus on making money - period - or should they try to make money 'with a conscience'?

My view on this is quite clear: what is ethical or unethical - at least as far as it concerns the business operations of the vast majority of listed companies - is generally not black and white, but is instead often simply a matter of perspective and politics, and it is not my role as an investment manager to force my politics/political beliefs onto my investors. To do so would be, ironically, unethical.

Is selling alcohol, for instance, unethical? Some people would say alcohol has a toxic effect on society, and promotes violence, obesity/liver disease, drunk driving, and in a minority of cases, alcoholism that can wreak havoc on peoples lives. However, a lot of other people would argue that they enjoy having a relaxing cold beer on a Friday evening after a hard week's work; that it adds value to their lives; and that it should not be anyone's right to deny them that pleasure. A ban on alcohol would seem, to this latter group, more unethical than allowing its sale. It would undermine their civil liberties; deprive them of choice; and compel them to conform to the same values and morals as other groups in society. And if no one produced and sold alcohol (or invested in those companies), such a ban would be the de facto outcome.

What about tobacco - the most universally despised 'unethical' industry. As a society, we have agreed to keep tobacco legal, but to heavily regulate and tax it. Health warnings are mandatory; punitive excise taxes are in force; sales to minors are illegal; and tobacco marketing is prohibited. Society has agreed that tobacco sales on these terms are allowable. So why should it be unethical for tobacco companies to sell products on these generally agreed terms, compliant with all regulations? Most people are not smokers, so they disregard the rights and interests of smokers in the same way anti-alcohol advocates disregard the rights of drinkers. Smokers believe they should have the right to smoke, should they so choose, and would consider it unethical for non-smokers to deny them that right, and who can say they are wrong? What is ethical is often a matter of perspective.

And if smoking is not ok, what about sugar? Excess sugar consumption is known to cause diabetes and obesity, which in combination reduce life expectancies by levels not too dissimilar to tobacco use. Should we therefore ban the sale of Coca-Cola? And is investing in the company's stock unethical, because it contributes to the premature death of millions? Or do we want to live in a world where people are free to engage in unhealthy indulgences if they so choose? Is allowing people to enjoy such unhealthy treats unethical, or is unilaterally forbidding them from doing so unethical?

How about coal mining? Burning coal releases a lot of carbon into the air, and contributes to global warming - no doubt. But it also provides affordable and reliable electricity to billions of poor people in developing countries, without which many could not afford electricity. Is it ethical to demand poor people live without electricity to reduce carbon emissions? Is it ethical for environmentalists in rich countries, that are living in countries that often became rich on the back of decades of burning cheap coal, to then turn around and deny similar affordable energy abundance to the world's poor?

I could go on, but you catch my drift. My point is not to defend various 'sin' industries, but instead to highlight that what is ethical is often a matter of debate and perspective, and in my view, the correct forum for this debate is the electoral/political process, not in the domain of picking stocks. Society needs - after due debate and consideration of alternative interests - to make the rules about what is generally agreed to be acceptable behaviour, and companies then need to comply with those agreed upon rules. And if companies are complying with rules that are established through democratic consensus, in my view it is not unethical to invest in such companies, even if your own moral compass clashes with what the company sells, because that's just your perspective. You could be wrong, and in any case, denying other people legitimate choice is every bit as morally conflicted as supporting the industries that supply those questionable choices.

By contrast, if I as an investment manager were to state that "selling alcohol is unethical and so I'm not going to invest in it", I would basically be unilaterally declaring myself to be the supreme arbiter of virtue. I would effectively be saying, "my moral compass is superior, and so I'm going to force my superior morality onto my investors, regardless of whether they share my political beliefs or not." I don't do that, because in my view, it is not ethical. My investors appointed me their investment manager, not their morality policeman.



  1. In my experience, corporates that are highly explicit about "ethics" tend to be a bit like those that are highly explicit about "corporate governance" or "gender equality", or that place their mission statement on neon lights. They are almost always more about promotion and appearances than substance.

    I view a good corporate citizen a little like I view a good parent. If a parent spends more time pursuing "ethical" goals in his neighbourhood, than he spends with his kids, then he might be highly "ethical" (perhaps), but he is not as good a parent as what he could be, and he is arguably doing society as a whole a disservice (in the long run).

    Similalry, the best corporates, I would suggest, are those that focus on their knitting, with prudence and integrity, knowing that in the long run this counts for more than the promotion of any particular "ethics"of the day.

  2. It's an increasingly important conversation to have with both the investor and investee before a term sheet is signed. I tell founders they should ask for special control elements up-front if they have strong moral considerations. They should also expect to tradeoff some fundamental value as altruism can be negatively correlated with returns. I agree with you it isn't the manager's concern, but companies should have cultures.

    1. Culture is critically important in my opinion - so I agree there. However, cultures of substance tend to be the ones that walk more than talk.
      Ultimately its about substance over style.

  3. "if I as an investment manager were to state that "selling alcohol is unethical and so I'm not going to invest in it", I would basically be unilaterally declaring myself to be the supreme arbiter of virtue."
    This statement is not really supported by anything. Many people (such as myself) take a view, invest accordingly, and remain aware we could be wrong -- just doing my best mate.

    Last I checked no-one is forced to invest with a portfolio manager who invests according to beliefs they don't agree with. But just say people were forced to invest with you. And lets say some of them wanted you to avoid tobacco stocks. My ignoring that request because you consider it unethical to bend to the will of that minority, you would in fact be forcing your "superior morality" upon them.

    And for what it's worth, although I take a different view from you, I don't think it's unethical for you to take that view. To me ethical investing means that it is fine to think about the ethics of the business you invest in and take that into account. It doesn't mean the ethical decisions one makes are any more perfect than the investment decisions.

    1. Not really. If you're running a pooled fund and one investor says they don't like X stock, what do you do? If you have listened to one, you've imposed his opinion on the others.

      It's the problem identified by Taleb that the vocal minority are the ones who get to impose standards. Because it's easier for a manger to capitulate and mock up an ESG policy that n it is to articulate against it.

    2. My point is, if you believe smoking should be banned, the best place to express that view is to start an advocacy group, contribute to a public dialogue, and try to reach a consensus, through democratic means, that considers the perspective of all stakeholders.

      What you consider unethical might just be your personal perspective. If you don't want to smoke, that's great. It doesn't necessarily make it unethical to sell cigarettes to people that do want to smoke, and are educated about the risks.

      This is also not to mention the fact that whether or not somebody is a minority shareholder in a tobacco company, it's going to make literally zero difference to whether or not people smoke, how much they smoke, and government policy around smoking. Tobacco companies won't be raising capital from the public for a long time, if ever. So it's not even a practical objection. It doesn't accomplish anything. And I'm a moral pragmatist on these issues. Making yourself feel good or look good, in and of itself, doesn't make society any better off.

    3. Yes, I agree the best place to express the view is in the political arena. And I agree that what I consider unethical may just be a personal perspective. But what's wrong with me (or others) investing according to a personal perspective, if we wish?

  4. Hi Lyall, thanks for the post, interesting read as always. I don't really understand why this is an issue unless the fund manager does not state their intentions on "sin" investments upfront.

    If stated upfront, investors are choosing to take on the additional characteristic of "non-sin" stocks in their portfolios. Which is congruent with capitalistic, democratic values.

    I could see an issue if the manager hid their own preferences, and had a bias against certain investments, generating poorer returns as a result?