Are you one of the 74 per cent of Kiwis who want to invest ethically? Do you want to align your investments with your values and avoid investing in industries that cause harm to people, the planet and animals?

Annual surveys of the public show that two-thirds of those who want to invest ethically haven’t done so yet, but most intend to within the next five years. So, what’s holding people back?

Ethical returns

A possible reason is the misconception that ethically investing delivers lower returns due to exclusion of some sectors or companies.

There is a body of evidence that show returns from well-managed ethical investments are, on average, at least as high as from conventional investing. For example, Morgan Stanley reported an 8 per cent outperformance in the five years from 2019 to 2023 for global “sustainable” funds verses “traditional” funds. It’s a myth that investing in line with values requires a trade-off with long-term returns.

In the short term, however, traditional funds may outperform ethical funds due to acute events. In 2022, following the Russian invasion of the Ukraine, oil and gas prices spiked leading to higher returns from traditional funds. Despite this spike, the long-term trend continues for global transition to new forms of energy. In fact, acute events may speed this up. For example, since 2022 the EU has acted to reduce demand for gas and to distribute more finance for renewable development.

Higher or lower risk?

Some investors may believe ethical investment has higher risk due to lower diversification. However, diversification does not need to be comprehensive to be effective and even when maximum exclusions are applied, they reduce the investing universe by only around 10-15 per cent.

Exclusion primarily reflects the concerns of investors about the harmful effects to society. Some excluded sectors are also in long-term decline and affected by social taxes and high regulation (eg tobacco, gambling and alcohol). A fund excluding these harmful products still has a wide choice of consumer products, which reflect contemporary preferences.

Exclusion of fossil fuels can be offset by an active strategy to select companies developing a range of climate solutions. These include renewable energy, innovations to reduce energy use, or electrify polluting industries eg, cement, construction, packaging and consumer products.

Approach by managers

Offsetting the potential impact on risk of any reduced diversification are approaches taken by fund managers of ethical funds to lower the portfolio’s risk by reducing the likelihood of the fund being affected by company losses due to bad practices. An index-hugging fund remains exposed to these and relies on diversification benefits from other holdings to offset the risk.

The responsible investment manager analyses holdings using global data about environmental, social and governance (ESG) quality and risks. A manager reduces the allocation of the portfolio to companies with poor ESG performance and increases it to companies with higher performance. Alongside harmful outcomes for the planet and society, poor management of ESG increases the risk of material monetary loss through lawsuits, regulatory fines, costs to clean-up pollution or consumer backlash. These events can reduce the share price.

In contrast, companies with strong ESG performance may benefit from lower costs (eg less energy and waste), fast growing revenues (eg selling EV cars), and more productive and motivated workers. Good corporate governance supports better performance; a well-qualified and diverse board of directors oversees good culture and sustainable long-term results.

Effective fund managers use engagement and stewardship to influence action by the companies in their portfolios on ESG issues. They use the power of the funds they manage to vote at AGMs on motions about the Chair, executive pay and to demand action on issues.

Fund managers also consider climate risk and carbon emissions. Over the next two decades global economies are transitioning from fossil fuel reliance to low carbon models. Oil companies that hold large reserves with current value on the balance sheet will eventually need to write off these “stranded assets” as demand falls.

This year sees the introduction of mandatory reporting in New Zealand on climate factors for all listed companies and fund managers who manage more than $1 billion. New reporting will make it easier for investors to analyse exposure to climate risks and future losses and to find companies with effective adaptation strategies.

Changes in the economy

Over time traditional funds will also rebalance to reflect changes in the economy. But there is risk of the investment portfolios changing more slowly compared to the pace of development of new economic models and rising climate risks.

It’s worth noting that in 2008 the energy sector represented 16 per cent of the US S&P 500, but by 2023 this was only four per cent. Technology companies now dominate the S&P 500. A responsible strategy may help investors to access high returning opportunities sooner.

An emerging investment approach is to seek opportunities for investment that create positive social and environmental impact along with further diversification. Mindful Money’s annual conference on June 12 will focus on this exciting development in NZ. As examples, community housing projects can provide long-term government-backed rental returns and help solve our housing crisis and investment in green technology accelerates the development of low carbon solutions.

There has been huge growth in the number of funds claiming to be ethical or responsible in NZ and globally. It’s important to find a fund that aligns with your values and your investment preferences. Mindful Money’s tool helps to navigate the range of ethical investment options by showing what each fund invests in and provides easy access to information about each fund’s approach.

Global momentum is with diversified ethical investment. It provides lower risk in the long term and opportunities to invest in higher returning opportunities aligned to new economic paradigms. Investors who embrace the trend are well-placed to achieve good returns and contribute to a better future.

How to Become an Ethical Investor

As an investor, you have the power to effect change. By making informed decisions and advocating for responsible investing, we can collectively create a significant impact and build a more just and equitable world.

Here’s how you can ensure your retirement savings align with your values:

Visit the Mindful Money website
www.mindfulmoney.nz to check, for free, whether your KiwiSaver or investment fund supports companies involved in weapons production, human rights abuses, environmental damage, animal cruelty, or social harm.

If you’re unsatisfied with your fund’s investments, reach out to your fund manager and express your preferences for how you want your money invested.

Use Mindful Money’s Mindful Fund Finder to discover ethical funds that align with your values and principles.

The information contained in this article is general in nature and is not intended to be financial advice. Before making any financial decisions, you should consult a professional financial adviser. Nothing in this article is, or should be taken as, an offer, invitation or recommendation to buy, sell or retain a regulated financial product.