Brent Sheather: Ethical investments - or not

With the investment industry's long history of non-ethical behavior it's hard to believe too many people would entrust them to advise on ethical investing.

Brent Sheather is an Authorised Financial Adviser and a personal finance and investments writer.

Maybe I'm a cynic but when I see fund managers or financial advisors advocating ethical investing I have a quiet laugh to myself.

I mean, really, cigarettes, alcohol, illegal drugs - what's not to like? Seriously though, whilst the idea does have limited merit - climate change for example is a legitimate issue - retail investors need to be careful. The economics of the fund management and financial advisory businesses are all about gathering assets under management and ethical investing is a great marketing angle. With the investment industry's long history of non-ethical behavior it's hard to believe too many people would entrust them to advise on ethical investing. A better strategy might be to invest widely via an index fund or other low cost product then made charitable donations direct to worthy causes.

There are some fundamental issues with investing in ethical funds which retail investors should be aware of. For a start they seem to charge even more than your standard, high cost non-ethical fund which typically involves fees consuming one-third or more of returns delivering to poor old Mum and Dad the risk of equities with the return of bonds. That doesn't look hugely ethical does it? Furthermore, as John Plender writing in the London Financial Times the other day pointed out, if you really got serious about eliminating companies whose products or actions were deemed unethical it wouldn't leave you with much to invest in. Mr Plender looked at a number of "ethical" funds and found that some of their biggest investments might not be so ethical.

For example, one fund had as its biggest investment a shareholding in HSBC. Mr Plender wrote "is that the same bank that laundered money in Mexico for drug cartels, facilitated tax evasion by the clients of its Swiss Private Banking arm and manipulated Libor and currency markets? This wasn't an isolated case. The second largest holding was Glaxo, a company which has been fined for bribing doctors in China and accused of further bribery in Eastern Europe and the Middle East. Shell was the next largest holding and it stands accused of polluting the Niger delta. Mr Plender then concludes that people wanting to invest ethically "should not just take their advisor's word for things but look at what is in the tin". If anyone did this properly how many ethical funds would pass the test?

So far we have seen that investing ethically frequently costs more and may include unethical investments anyway. But there is another important issue - the latest iteration of the Credit Suisse Global Investment Returns Yearbook (GIYR) suggests that a focus on ethical stocks, all things being equal, implies lower returns for an investor. First some background - The GIRY is produced by London Business School Professors Elroy Dimson, Paul Marsh and Mike Staunton (DMS) and was first published in 2000. The core of the yearbook is 115 years of long term investment return data, from 1900 - 2014, for short term government bills, long term government bonds, shares, inflation and exchange rates, for 25 of the world's largest stockmarkets. The Yearbook is the global authority on long run investment returns and foreign exchange performance and is sponsored by Credit Suisse.

Each year the Professors focus on a couple of subjects that they think are relevant and this year Chapter Three was entitled "Responsible Investing : Does it pay to be bad?

First off the professors look at the rationale for responsible investing and highlight three main reasons that people might pursue this strategy:

• The owners of businesses share in the responsibility of the firm's actions
• Through their shareholding they can persuade management to improve corporate behaviour
• Long run returns may be enhanced by ensuring that companies have high standards of behaviour

The authors cite various research papers that suggest that, historically, investing in the likes of tobacco, alcohol and other stocks outperform less objectionable stocks. They explain this by arguing that because companies that violate social norms sell for lower prices they produce higher returns: "if the sin discount stays constant the capital gain is the same for sin and non-sin stocks but the excess returns of sin stocks should come in the form of higher dividends over time".

The authors write that ethical investors face a choice: should they avoid objectionable stocks or should they own those stocks and engage with management and agitate for change. The professors conclude by saying "the implication is that buying shares in responsible companies cannot be seen as a strategy that would generate outperformance however a better course of action might be for investors to engage with the firms whose shares they own to facilitate change for the better and this could be rewarded with a higher share market rating", i.e. the sin discount is eliminated.

Changing the subject completely - those 9/11 fools continue to make life difficult for everybody and I don't just mean the increased security and hassle involved in travelling overseas. Last week a client of about 20 years tried to sell a small number of shares as part of winding up his deceased father's trust.

Despite knowing this client well the anti-money laundering laws required my staff to tell him that he needed to provide the following information before we could make the small one-off sale:

• certified copy of the trust deed.
• A certified copy of the trust's bank statement.
• Details regarding the type of trust.
• A certified copy of an approved identification document for each trustee.
• A certified copy of proof of residential address for each trustee.

In the case of the certified identification documents the certifier or trusted referee must sight the original document and make a statement to the effect that the documents provided are a true copy and represent the identity of the named individual (linking the document to the presenter). Certification must include the full name, occupation and the original signature of the certifier and the date of the certification.

Goodness knows how long it would take to get all this stuff together and the cost. Seems like it is easier to buy a gun than it is to conduct a simple non-life threatening financial transaction.

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent may have an interest in the companies discussed.