Ethical investing? Its value depends where your values lie
Scandals. Corruption. Wilful disregard for human lives. Pollution. Slavery. It can sometimes seem that big multinationals will stop at nothing in their search for profit. As a result the general public is more attentive to “social” and “green” stocks as a way to mitigate the thirst for profit that drives big capitalistic entities.
Perhaps by putting our money in more virtuous companies, we can start a movement and change things for the better? Perhaps we can force the “capitalistic behemoths” to pay attention and mend their ways?
Let’s take a closer look at social investing. There might be a few surprises down the road, though: we might learn for example that big multinationals are in fact socially aware – at least according to ESG standards; and that green companies may not be quite ready for the retail investor yet.
What does investing mean to you?
But the underlying question is this: where should you, as an investor, put your money? If you have enough money to play venture capitalist, of course you are free to choose to invest in whatever company best fits your ideals, whatever its chances of economic survival – and profitability.
But if you don’t have that much money, and if you are investing in the stock market expecting a return on your investment – then perhaps “green” and “social” stocks are not exactly the first things that you should look for.
And what does ethical investing mean?
If you mention the term “ethical stocks” to any private investor and ask them what springs to mind, they will generally think of “green”, “fair-trade” and general “do-gooders”. However, in order to be included in MSCI KLD Social Index, companies need to have “high Environmental, Social and Governance (ESG) ratings relative to their sector peers, to ensure the inclusion of the best-of-class companies from an ESG perspective”.
If you compare the DIA, which is an ETF that tracks the DOW, and the iShares MSCI KLD 400 Social Index Fund, you will find some surprising elements. First, there are sixteen companies (among which McDonalds) out of the 400 social stocks that are also part of the mighty DOW. Those sixteen companies even hold 53.23% of the market capitalisation of the DOW Index, while making up 30.27% of the Social ETF.
This might be the first surprise: when it comes to ethical stocks, the social and large cap investing are actually not that far apart.
How do those social stocks perform?
Over the past year, the DIA (DOW) outperformed DSI (Social Index) by 2% – both delivered positive single digit returns which would have pleased investors in a volatile, yet ultimately directionless twelve months.
However, if you look at the last three and half years, since the market turned in March 2009, the two funds generated approximately 100% with a negligible 1.26% divide where DSI nosed ahead. From the peak of February 2007 to the depths of March 2009, again we see just 3.11% separating the two returns, which translates into a difference of 1.5% per annum.
As a result, perhaps those suffering guilty feelings of handing their money over to capitalist forces with a tunnel-vision for profit, and only profit, can relax a little: many companies that make a lot of money actually seem to be quite kind to their staff, the environment and society around them, according, once again, to ESG standards.
Surprise, surprise: the very ethical stocks are often those that are most profitable. If you are looking for a return in the stock market, you could very well be investing in those stocks that ethical investors are investing in also.
Similarly, the “cynics” who decry social investing may find that the social investors are actually buying the same stocks… They just happened to find them in a different way – one might invest in them because they have good earnings and the other might invest in them because of the EGM index. Perhaps one leads to other, in fact!
How about green energy shares?
On the other hand, the latest craze around green energy and the fact that generally accepted wisdom points to a future with much greater use of clean, renewable energy has not delivered the goods for investors.
With levels of debt to make an investor cry, this industry is a long way off being profitable. It still relies almost totally on (declining) government subsidies and private equity investment hoping to cash in on the next big thing (as well as the aforementioned government transfers).
According to Georg Erdmann, professor of energy systems at Berlin’s Technical University, “subsidies for renewable energy, including an expansion of the power grid, will saddle energy consumers with costs well over €300 billion”. Despite the green gravy train, German energy is getting more expensive, due to the expansion of subsidies per kilowatt-hour of renewable power.
With this massive waterfall of money available, the industry saw no need to become more efficient and in February, the German Minister for Economics & Technology described these solar subsidies as “a threat to the economy”. Even worse, after all that, solar power accounts for only about 0.3% of Germany’s total energy, due to the country’s less than sunny climes.
Good stocks come from sound companies
If one takes a look at the size of the companies that make up green ETFs, it is clear that these entities are houses of straw in comparison to the companies in the well capitalised social indices.
In addition, there is very little liquidity in trading these stocks, driving a very noticeable, expensive wedge between the bid and ask prices; the returns (or lack of them) illustrate the market’s conviction that this industry is not mature enough yet to deliver sustainable, consistent earnings into the future.
For example, the S&P Global Clean Energy Index Fund with a market cap of $24.9m lost half of its value last year and is down 37.26% since inception in June 2008. The Credit Suisse Global Warming Index Exchange Series with a meagre market cap of $2.9m is down 24.23% since inception in April 2008. In the last three years, the Market Vectors® Global Alternative Energy ETF fund, with 81.7% of those stocks lower than large cap, is down 24.09% and the five year return is identical.
Don’t get me wrong, I’m delighted to see green innovations that are taking place all around us every day – it promotes healthier living for us all and allows us to leave a more sustainable planet to our children. I reduce, reuse and recycle with the best of them and regularly take a serious look at how my company can be more environmentally friendly.
However, while socially aware large cap stocks make good investing sense, I’m not letting my portfolio near the area of clean energy until, as an objective, rational investor, I have reason to think that I can generate a return. After all, that’s the reason that I would invest, isn’t it?
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