Does having ethical investment preferences limit returns?
This chart shows the five year performance of the FTSE4Good UK and the FTSE All-Share indices. Over five years the FTSE4Good UK Index has outperformed the FTSE All-Share Index by 3.49%.
What does it tell us?
That over time it is possible for ethical investments to outperform traditional investments. Each index has different requirements for company inclusion which we will discuss in more detail.
The FTSE4Good UK Index is made up of companies who demonstrate strong environmental, social and governance (ESG) practices. ESG factors are a subset of non-financial performance indicators that help investors evaluate corporate behaviour and the potential future financial performance of a company. There are various indicators that an investor may consider ranging from energy efficiency and greenhouse gas emissions to litigation risks and corruption before making an investment. This index excludes tobacco, nuclear power and arms industries.
The FTSE All-Share Index is made up of the FTSE 100, FTSE 250 (which make up the FTSE 350) and FTSE SmallCap indices. In order to be included companies in the FTSE All-Share must pass screening for size and liquidity and meet other requirements set by the UK Listing Authority (UKLA). The FTSE All-Share is a good proxy for the performance of the UK equity market and includes a range of companies across all sectors.
What is our view?
The interest in ethical investing has grown significantly over the last few years. Companies are now actively engaging with stakeholders to improve their social, environmental and governance standards and encourage sustainability in their business practices. The chart above demonstrates that having ethical preferences does not necessarily harm returns – a key argument for ethical investing is that a focus on long term issues, such as climate change, can provide companies with a competitive advantage in the future. However, investors should be mindful that ethical preferences can exclude some sectors of the market such as oil & gas companies and to some extent pharmaceutical companies. This can lead to concentration in certain sectors and potentially increase volatility.