The Morality Play

Is the growth of "ethical" investing a real issue for finance, or part of reputation management and best left to public relations?

Diageo, an €11 billion maker of some of the world’s most famous alcoholic drinks such as Smirnoff vodka and Guinness stout, has an ambiguous distinction: it is a constituent of the FTSE4GOOD stockmarket indices, designed to include only those companies that meet an array of ethical criteria, while also being a major holding in the Vice Fund, which sets out to do the exact opposite — invest only in stocks that are, as its prospectus puts it, “deliberately socially irresponsible,” that is, alcohol, tobacco, gambling and weapons. Diageo is joined on both the “good” and “bad” for you lists by similarly renowned purveyors of booze brands, Heineken and SABMiller. The anomaly can be taken as shorthand for the confusion endemic to the world of ethical investing.

The Vice Fund was launched by Dallas, Texas-based Mutuals Advisors in 2002 specifically as a retort to the growing ethical, or “socially responsible investment” (SRI), sector. It has outperformed the S&P 500 index by a ratio of almost two-to-one since its launch, giving investors an annualised total return in the high teens. The FTSE4GOOD tradable indices, on the other hand, have underperformed comparable tradable indices over the past three years, according to FTSE. The FTSE4GOOD Global 100 index, for example, had a total return of about 49% in the three years to May, while the FTSE Developed Large Cap index posted a 62% return, and there were similar gaps on indices covering Europe, the US and the UK.

However, despite its relatively good performance and low minimum investment ($4,000), the Vice Fund remains tiny by investment industry standards, with assets at the end of July of just $124m. There have been no notable emulators of the Vice Fund — Willis Owen, a British fund broker, generated much publicity a few years ago when it announced plans to launch Europe’s first vice fund, but dropped the idea after only a tepid response.

The SRI sector, on the other hand, has boomed, accounting now for an estimated 12% of managed funds in the US and a growing slice of the investment pie in Europe (see “Saintly Surge” at the end of the article).

It is little wonder, then, that few companies trumpet their inclusion on the Vice Fund. At the same time, many make a considerable effort to woo the SRI sector, emphasising their corporate “social responsibility.” Though difficult to measure, the impact of SRI is starting to be felt. “When we go to meetings with investment houses these days they’ll frequently have one person from ethical funds.” says Jann Brown, CFO of Cairn Energy, a £300m (€441.5m) UK oil and gas producer. “It’s premature to put numbers around [the capital markets impact], but as that grows over time those links will be defined and explored more.”

Even companies with apparently no hope of making it onto any ethical investment lists do have a go. Referring to the unanimity among ethics-focused funds to screen out tobacco companies, Hermann Waldemer, Switzerland-based CFO of Philip Morris International, says, “I have to respect the decisions of those fund managers, but I would like to bring up a couple of points for their consideration. Anyone with common sense will accept that people smoked in the past. The Indians smoked. Today people smoke; and there will be a sizeable segment of smokers in the future. Accepting anything else would be unreasonable. Now, would you prefer to have that in the hands of big, responsible companies, like Philip Morris International, British American Tobacco and Japan Tobacco, or would you want a zillion tricky entrepreneurs all over the place?”

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