Advantages and Disadvantages of Ethical Investment

Recently we have been made aware of the reputational damage sustained by Rio Tinto as a result of the destruction of 46,000-year-old archaeological treasures.  Rio Tinto is Australia’s 12th largest company based on market capitalisation – a very large and profitable company with a very strong balance sheet.

Based on the above should you remove this company from your investment portfolio? Whilst you may or may not hold this investment directly, most superannuation funds have an Australian Share allocation that includes the ASX20, Australia’s largest companies, based on market capitalisation.

This leads to the question should ethics be the basis of our stock selection criteria? Could we gain the same return on our investments, including superannuation, if we gave ethical criteria a higher weighting in the decision selection criteria?  If the ethical criteria played a larger role in the portfolio selection process, what would this “ethical criteria” be?

Investopedia defines ethical investing as the practice of selecting investments based on ethical or moral principles. Clearly, a portfolio of ethical investments would exclude gambling, alcohol, smoking or firearms. But does it or should it go further to screen out those companies that have a negative impact on the environment, such as plastics or packaging companies, and those companies that emit greenhouse gases in their manufacturing process. Even further, we could consider companies that have little or no female representation on their board.

From my experience, clients have a very individual definition of their belief of what constitutes an ethical investment. There is clearly a demand for ethical investment, but it needs to be pointed out that the broader the definition, the smaller the population to sample select appropriate investments, and the narrower the portfolio diversification.

One may conclude that by including a more extensive definition of ethical investment, more profitable companies will be removed from the selection population. For example, if the ethical criteria removed oil from the selection criteria on ethical grounds, then an ethical portfolio without oil may not perform as well as a non-ethical portfolio with oil, particularly when there is an increase of world oil prices.

Are we happy to do the right thing at the expense of our overall investment performance? Well, that too is an individual ethical question.

Should you require more information about ethical investments, contact Peter Quinn now by submitting an online enquiry or call us on +61 2 9580 9166 to book an appointment. We also offer a FREE 45-minute consultation should you have other financial planning, taxation or superannuation issues you may wish to discuss.

The information in this document does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it.  It is important that your personal circumstances are taken into account before making any financial decision and it is recommended that you seek assistance from your financial adviser.