The rise of Ethical Investing

It is a truism that the main aim of investing is to make money.  But the idea that investors should only and exclusively be concerned with maximising their return, regardless of the other consequences of their actions, has long been seen as too simplistic, and since the turn of the century at least, the feeling that investors should be concerned with the actions of the companies they invest in, not just the returns they derive from them, has steadily gained ground.

For most of the last 20 years, though, few investors have followed their high-principled words and warm sentiments with hard actions.  Although the United Nations introduced their “Principles of Responsible Investing” as long ago as 2006[1], for many years the number of asset management firms signing up to the principles grew only slowly, and until recently, the impact of responsible investing practices on markets generally, and more importantly on the companies that asset managers invest in, has been very limited.

This is changing, and, at a time when climate change awareness and public dissatisfaction with traditional economic models is growing rapidly, the general view among both professional investors and their clients is moving from “It is praiseworthy but unusual to prioritise ethical principles in investing” to “It is increasingly expected that asset managers will invest responsibly”. 

And when Blackrock, the largest asset manager in the world with over $7 trillion in assets under management, decided in January of this year to publicly espouse and prioritise sustainable investing[2], sentiment appeared to have reached an important tipping point. It is now increasingly seen as not just unusual but unprofessional, if not actually bordering on immoral, for asset management firms not to have strong ethical investment principles.

The result is that even investors who do not themselves have strong ethical principles or policies are finding that they need to pay more attention to the issues.  Even those investors who are still for the moment unsure about how much weight to place on the subject have to be aware that other investors place a great deal of weight on it, enough in fact to move markets.  And as Keynes once observed, successful investment in markets depends less on the validity and accuracy of your own beliefs and more on the beliefs and actions of the mass of other investors. If the majority opinion is that fossil fuel companies have no future, for example, then their share prices will suffer regardless of whether that opinion is correct or not.

We think the current emphasis on ethical, responsible or sustainable investing will only increase.  But that one sentence highlights a major problem with the whole concept:  it is in practice very poorly defined.  And while more and more people agree that investment ought to be responsible, ethical and so on, it is far less clear what this means in practice.

Even the name of the subject is undecided – we have used all three of Ethical, Responsible and Sustainable in this essay almost as if they were interchangeable. But they are not.  Although most in the investment industry would interpret “Responsible Investing” as meaning that investors should be aware of the need to not do harm, “Ethical Investing” as meaning that investors should go further and actively seek to do good, and “Sustainable Investing” as more specifically focussing on the sustainability of economic activity, primarily but not exclusively in the areas of planetary resources and climate change, these are not well-defined terms. 

Indeed the whole subject is full of arbitrary decisions and judgmental assessments:  there are almost no hard facts, almost no agreed definitions, almost no black-and-white rules and almost no absolute reference points.  Not surprisingly, therefore, the subject is full of differing approaches, and also prone to exaggerated claims, bordering at times on flagrant virtue-signalling, as investment companies seek to burnish their ethical and green credentials.  

Even among those who do genuinely espouse responsible investing, and are not just “talking the talk” but also “walking the walk”, there are many who are (if they are candid) at least as much driven by what others might think of them if they don’t go down the ethical route than any overwhelming desire to do good.

So, is the whole subject just hot air, smoke and mirrors?  We do not think so.  Although definitions are currently still vague, the “direction of travel” for the industry – driven as much as anything by the expectations of an increasingly vocal client base – is clear.  And in one area at least, there is already considerable agreement.

This is the area of the so-called ESG principles.  ESG stands for Environmental, Social and Governance, and in a nutshell, the E part of ESG is concerned with assessing whether companies operate in a way that damages the environment, the S part of ESG is concerned with monitoring companies to ensure they do not operate in a way that causes distress to society or takes undue or unfair advantage of other (weaker) members of society, and the G part of ESG is concerned with the way companies conduct their business, and is aimed at improving the general standard of corporate behaviour[3].  And the investment industry is converging around ESG as the appropriate way to assess companies that it invests in.

But even here there is much room for judgment and disagreement.  Two difficult subjects which divide the asset management industry are how to treat “good” companies in “bad” industries, and how to treat investment in countries that are corrupt or otherwise fail the ESG criteria.

As an example of the first of these dilemmas, some investors have decided simply to shun all fossil fuel companies, an approach which has at least the merits of simplicity and auditability.  Others however recognise that while some fossil fuel companies are content to run their existing businesses for cash while they still can, making no attempt to change their business practices, others are making considerable efforts to develop cleaner energy, and too blanket a ban on investing in the industry risks discouraging such efforts and ironically making the global economy more dependent on “dirty” energy not less.

The second issue – how to handle whole countries – is equally contentious.  And without doubt the elephant in the room here is China.

Under any remotely rigorous assessment, China’s ESG credentials leave a great deal to be desired.  The emphasis on economic growth in the last 30 years or so has come at a considerable cost to China’s and the world’s environment (the country is the biggest emitter of CO2 in the world by some way), social conditions for its population remain well below western standards, and its governance, whether at the corporate level or at the political level, is opaque and inspires neither confidence nor trust.

To date, this has not seriously impacted either China’s economy or its integration into the global financial and economic system.  Investors have turned a collective blind eye and Chinese trade and global influence have both continued to increase.  It is just possible, though, that this might be about to change.

For China has not had a good 12 months.  China’s problems in Hong Kong, and in particular the strength of the feeling against the Mainland and Beijing’s inability to control the situation, may not have had much impact in the West, but it was noticed in Asia, and nowhere more so than Taiwan, where voters took due note, decisively rejecting China’s overtures of closer relations and returning Tsai Ing-wen, the pro-autonomy DPP candidate, as president in January’s presidential election.

The negative publicity of China’s treatment of Hong Kong and its dissidents has been compounded by growing awareness in the rest of the world of its treatment of its minorities.  The government’s suppression of Tibetan aspirations is well known and no longer new news, but its assault on the Muslim Uyghur culture of Xin-Jiang province and persecution of its Uyghur people is becoming increasingly well-documented and irrefutable, and has appalled human rights activists and cast further doubt on the veracity and credibility of official reports from Beijing.

It remains the case though that most in the West have largely ignored Hong Kong’s summer of insurrection and unrest, and largely struggle to empathise with the Uyghurs.  But there has been no such complacency over the coronavirus outbreak.  The spotlight has again been thrown on China’s very poor record with major diseases – Covid-19, to give the coronavirus its new formal name, is the fourth major health scare to emerge from the People’s Republic in the recent past, following SARS, Bird flu and then Swine flu (a disease which did not affect humans but which was nevertheless devastating for China’s pig herd) – and few outside China are prepared to trust the repeated claims by the central government that the outbreak is being controlled. 

As a result, physical links with China have been quickly suspended, including economic links and trade.  And this matters, because whereas at the time of the SARS epidemic in 2003, China’s economy represented just 4% of the world economy, it is now closer to 17% and Chinese companies are now an integral part of many western companies’ supply chains. 

Indeed the degree to which the West depends on Chinese supply chains has been dramatically highlighted as companies run short of parts and face suspending production.  Many in the West have been surprised to find how dependent on China their economies are, and there is a growing sense that this degree of dependence is not altogether a good thing.

If one combines the rapidly growing importance of Responsible ESG-based investing principles on the one hand, and widespread distrust of China’s government and its pronouncements (the G part of ESG), growing dismay at its social policies (the S part) and fear over its lack of control of its environment and health issues (the E part) on the other, the time for a reappraisal of Western economic links with China may well be approaching.  And with a US president who is keen to preserve America’s economic autonomy (as he would see it) and no fan of extensive reliance on Chinese supply chains, Beijing may find that the welcome for its companies in the West becomes more strained.

The Chinese regime is very strong, and external pressure has never been enough to effect change. Nor in the 30 years since Tian-an Men Square has internal opposition ever seriously threatened it: it has surprised the West that China’s growing material wealth over the last 30 years has not led to greater pressure from its population for more political freedoms or better social governance, and expectations that a growing Chinese middle class would demand a more liberal regime from within have proved wrong. 

But Covid-19 is changing this. There is genuine anger in China at the way the government has handled the outbreak. The likelihood is that President Xi will prove strong enough to survive, but for the first time the regime is facing serious criticism on the same subject from both internal and external sources. And China’s integration into the global economy, ironically for so long an ambition of Beijing and seen as one of the country’s great successes, might just, when coupled with growing Western emphasis on ESG principles, prove a catalyst for change.

[1]              The UN’s Principles arose from an initiative of then UN Secretary-General Kofi Annan in 2005, in which he challenged the investment industry to formulate policies for responsible investing.  The resulting principles declare that “We believe that an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.  The PRI will work to achieve this sustainable global financial system by encouraging adoption of the Principles and collaboration on their implementation; by fostering good governance, integrity and accountability; and by addressing obstacles to a sustainable financial system that lie within market practices, structures and regulation”, and offer 6 specific and actionable points for asset management firms to sign up to.  Source:

[2]              Blackrock’s client letter is here, and – perhaps as befits the newly converted – is a more forceful statement of their new investment principles than many asset managers have given.

[3]              A typical ESG policy might for example include climate change, carbon emissions and fossil fuels, pollution and deforestation as subjects covered under Environmental; human rights, the arms industry, slavery and child labour, animal welfare, pornography, gambling, alcohol and tobacco under Social; and bribery and corruption, tax evasion/manipulation, board diversity and executive pay, employee relations and general transparency under Governance.