Is ethical investing good for your portfolio?


The blockbuster debut of plant-based meat company Beyond Meat made waves in the US recently, as the stock soared over 163% on listing. While debate over its prospects over the long-term continues, its success has brought ‘ethical investing’ back in the news.

Ethical investing entails making investments driven by an investor’s core values— moral, environmental, social or even religious. “It is an approach that incorporates environmental, social and governance factors and their impact through the process,” says Sivananth Ramachandran, Director–Indexes, Morningstar, which maintains the India Sustainability Index. “There are several ways to do this; at one end is a simple approach where investors exclude stocks with “sin” characteristics; at the other end is impact investing, where investors select stocks with specific characteristics to drive impact,” he adds.

Morningstar, for instance, precludes companies involved in controversial weapons, tobacco, and civilian firearms. The underlying principle is avoiding things that kill you if used-as-directed. “Other exclusions include alcohol and adult entertainment, or thermal coal,” says Ramachandran. Do note, a standard definition on what constitutes ethical investing is yet to evolve – a gap an investor will have to plug by using her judgment.

The strategy

For retail investors in India there are two mutual funds—Tata Ethical and Taurus Ethical Fund—and exchange-traded fund Reliance Sharia ETF BeES that belong to this universe. “Ethical investing in India is still at a nascent stage. Many investors are not even aware of the existence of such avenues,” says Rupesh Patel, Senior Fund Manager, Tata Mutual Fund.

Before investing, you will need to evaluate the fund’s investment philosophy and ensure it matches your value system. “Our ethical fund avoids ‘sin’ sectors such as alcohol and tobacco,” says Patel. In compliance with Shariah principles, it also avoids investment in companies that are heavily leveraged, are engaged in the business of lending and earn interest income. This includes banks, NBFCs and top-tier IT companies with significant cash on their books. “We focus on companies that offer a high return on equity and rely on internal accruals for growth,” he says.

Ethical funds avoid sin sectors

What constitutes ethical investing is still evolving in India


Returns as on 22 May. Fund size as on 30 April. Source: Morningstar India

If you are keen on building your own portfolio of stocks that adhere to your value system, you will have to first draw up a list of sectors and stocks you wish to avoid. These could be companies engaged in mining due to the likely adverse environmental impact of their operations. Similarly, if you avoid consuming meat and wish to lend the same flavour to your portfolio, you will have to stay away from companies that process meat products. “Next, find out whether any small subsidiaries of these companies are in contrast to your code. Run a scan for any not-so-prominent violation, like sourcing material from a supplier that employs child labour,” advises Amol Joshi, Founder, Planrupee Investment Services. You should also do your homework on whether the companies have future plans of entering segments that violate your ethics. Finally, monitor the companies in your portfolio regularly to ensure continued adherence to your standards.

There are the Nifty 50 Shariah Index, Nifty 500 Shariah Index and Morningstar India Sustainability Index, if you need some direction on choosing companies that meet your religious values and ethical standards. “It has exposure to a portfolio of about 80 Indian companies that exhibit high standards of sustainability while maintaining a risk/return profile similar to that of market,” says Ramachandra.

Not just moral victories

Following the strategy will deliver benefits that are not necessarily monetary in nature. “For such investors, the gains would not be from a ‘tainted’ source. The returns would be a secondary consideration,” says Joshi. This does not imply that such portfolios will necessarily underperform. “It may also happen that there would be phases when ethical investing strategy will outperform. Lastly, ethical, socially responsible, strong corporate governance businesses will last longer and of course, prosper, making the effort worthwhile,” he explains.

Morningstar data shows that funds that are part of its sustainability universe have outperformed the large and mid-cap category over one- and five-year periods, though their three-year returns are lower in comparison. “ESG funds invest in stocks that are typically of high quality and lower volatility, and may outperform in certain market conditions,” says Ramachandran.

The perils

While you may be doing right by your moral values, will it give a boost your portfolio? Like any other investment theme, this one, too, comes with its share of limitations. Firstly, the choice of companies and funds is restricted. “It is not possible to know everything about all companies that you invest in. Then, there is the possibility of a company chosen after careful due diligence diversifying into a sector that you want to avoid. In such cases, you will have to let it go. Overall, you might have to compromise on returns to an extent,” points out Joshi.

It also calls for additional research to identify the good businesses which follow the same set of principles as that of the investor to deliver returns. “Another practical limitation that investors face while investing in diversified companies is that the investor may not be comfortable with all the business verticals of the company,” says Devang Kakkad, Head-Research, Equirus Wealth Management. Besides, lack of standard definitions on what constitutes ethical investing is another risk factor. “Without common standards, investors are susceptible to green-washing, with firms claiming adherence to ESG principles without following through on them. Investors need to do their due diligence and not go by labels,” says Ramachandran.

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