Ethical Investment: How to get green investment fingers

New Zealanders may have green fingers when it comes to tending their gardens, but the same can't be said for their investment portfolios.

Ethical or socially responsible investing has gone from niche to mainstream overseas, with a plethora of funds on offer in Australia, the US and the United Kingdom.

The healthy growth of this type of investment is due to people being better informed and educated, and share ownership, particularly overseas, is more widespread.

A report by KPMG in Australia says there is also a renewal of basic values among the public.

Business ethics now form part of many business school programmes and consumers are increasingly taking ethical factors into account.

However, ethical investment strategies are something we don't hear much about in New Zealand.

That's likely to change in the next few months, thanks to the Green Party and the Government's plans to establish a multibillion-dollar fund to pay for a portion of future pensions.

Submissions on the bill governing the fund closed last Friday, and select committee hearings are due to begin soon.

While New Zealand First and Act argue that the fund should be in individual names, the Greens want to see the money invested ethically.

"If the fund does get off the ground [we are] determined that it should have some ethical component to it," Greens co-leader Rod Donald says.

But what do they mean?

Essentially, there are four main styles of ethical investing, ranging from activism at one end of the spectrum to best-of-sector.

Perhaps the most active of these styles is advocacy, or shareholder activism. This is where people invest in a company to try to force changes in the way it operates.

Tower Asset Management business development manager Mel Hewitson describes this as "converting the bad into good through engagement."

Investors, particularly big ones, can use their voting rights to force changes including social or environmental objectives.

Many years ago people invested in multinational companies which had operations in apartheid South Africa to try to force them to close down or exit the country.

The middle two approaches are positive or negative screening. Negative screening is the approach people most often associate with ethical investing.

Under this approach, "bad business" or "sin stocks" are excluded from consideration in a portfolio. For instance, a manager may say it won't invest in companies involved in tobacco, armaments or alcohol.

Positive screening, as the name suggests, is an approach where investors reward companies that demonstrate genuine commitment to socially responsible business practices in all their stakeholder relationships, including customers, staff, the community, the environment and shareholders.

Mel Hewitson says this approach helps identify industries of the future and encourages good business practices.

Best of Sector is a popular approach that is used widely by funds in Australia.

Under this style, a fund manager or investor can invest in any sector he or she likes as long as the company shows the best qualities.

Ethical investing is into its second generation of growth. The first generation was very much geared around negative screening and deep ethics. Generally, funds were small and volatile so investors were trading off return for personal benefits. They might not have been getting rich, but they felt good.

The second generation of ethical investing is focused more on positive screening and best-of-sector.

Investors are socially aware and want to integrate their investment objectives with their commitment to social justice, economic development, peace or the environment.

In many cases people don't wish to or can't afford to sacrifice their returns significantly, so there has been a need to find better ways to invest responsibly.

With positive screening and best-of-sector, ethical funds have lowered their risk profile and produced performance which foots it with mainstream indices such as the MSCI index for global shares.

Ethical funds are not widely used in New Zealand because of the lack of funds available and the low profile of this type of investment.

But overseas ethical investing has become more widely accepted.

Sealcorp Holdings director of investments Caroline Saunders says that when she first started looking at ethical investing in Australia, she thought it was a novelty and had no real place in a portfolio.

Now she says it has developed to a degree in which it can add growth to a portfolio.

It can add an extra string to an investor's bow, she says, and provides the ability to satisfy broader requirements than just returns.

On the returns front it is becoming clear that ethical investments provide good risk adjusted returns.

Several indices track ethical investments, such as the Dow Jones Sustainability Group, the Domini 400 and the Westpac Monash Eco Share index, and these indices have been outperforming the benchmark for global shares, the Morgan Stanley Capital Index.

There are a number of reasons for this. It's becoming clearer that using an ethical investing concept actually works as a screen on company management. That is, only the best-run companies can meet the criteria.

Mel Hewitson says managers tend to select companies for inclusion in a social fund on the basis of financial performance and social performance.

"Usually these two aspects of stock selection are conducted by different people, often in different organisations."

Another reason many of these funds and indices did well in the early part of last year can partially be related to the technology sector. Technology companies don't have the baggage of old, inefficient factories and they are generally considered to be "clean" businesses.

Donald says the time is right for ethical investing.