Ethical Mutual Funds – A Better Way to Invest?

The following is a condensed, less academic excerpt of a paper I recently wrote for my final graduate course. It also represents the completion of Task #3 on my 9-Week Productivity Challenge and the beginning of a series of posts here on Earth and Money related the social and environmental impacts of our investments. The series began unofficially two weeks ago with a look at an emerging type of investment vehicle, community bonds, and last week, introduced how we might be funding our own demise, and what corporate social responsibility represents.

In 1992, Michael Jantzi founded Jantzi Research Inc., an investment research firm created to monitor the social, environmental and governance performance of publicly traded Canadian companies. Jantzi used a best-of-sector approach to rank companies relative to each other and to industry best practices. The fundamental problem with such an approach is that a company only has to be better than their peers in order to achieve a high ranking. This can result in a company that is not by most definitions “socially responsible” being labelled as such only because their peers are even less socially responsible than they are.

In 2000, Jantzi launched the Jantzi Social Index, an index of 60 socially responsible companies based on the framework of the S&P/TSX indices. Major mutual fund vendors began to take notice of the demand for such a product by investors who did not want to be associated with the unethical behaviours of many corporations. In 2001, Meritas Mutual Funds offered the first mutual fund in Canada based on the Jantzi Social Index. Seeking a broader appeal to the average investor, in 2007, Jantzi partnered with the Royal Bank of Canada (RBC) to offer the Jantzi Canadian Equity Fund, a mutual fund investing solely in companies ranked highly on the Jantzi Social Index. According to RBC, one dollar out of every five that is currently invested in Canadian assets is invested in a ‘socially responsible’ manner.  RBC’s mutual funds are built based on a four-step process. Firstly, all potential publicly-traded companies are evaluated based on Sustainalytics’ (formerly Jantzi Research) best-of-sector methodology. Within this methodology, all companies that are involved with the production of nuclear power, the manufacture of tobacco products and weapons-related contracting are immediately removed from consideration. Companies are then evaluated on six areas of concern: community and society, corporate governance, customers, employees, environment and human rights. Companies are then ranked based on their performance relative to all other companies by Sustainalytics, and the best performers are ranked based on their financial characteristics by RBC, to produce a final mutual fund portfolio. The details of Sustainalytics screening process are not publicly available, other than a broad statement indicating that the screening model incorporates 60 to 100 indicators.

This highlights one of the most fundamental problems associated with the current Canadian mutual fund investment model – investors are left to trust and put faith in fund managers and research firms such as Sustainalytics to responsibly handle their money. From a banking point of view, there is little incentive to change this practice. Information is power, and if the bank holds all the information, then they also hold all the power. People choose to invest in mutual funds because they do not want to put the work in to invest their money themselves. Much like someone pays for a plumber to fix their toilet, people are generally very willing to pay someone to manage their money. And just as people expect their plumber to do an honest job, and fix their toilet properly and for a reasonable rate, people expect and are willing to accept that their bank is appropriately investing their money. The difference is that people can flush their toilet and check that their plumber did a good job. They cannot do the same with their bank and their investments, as the banks keep all the information hidden behind an impenetrable wall.

Other companies are pushing the boundaries of socially responsible investing even further, and using their position to impact the way companies do business. Much like Sustainalytics, Ethical Funds screens companies for social responsibility, environmental performance and governance. Where Ethical Funds differs from Sustainalytics, is that they offer their own mutual funds and investments rather than partnering with a bank. Much like Sustainalytics, the firm does not disclose the specifics of how it evaluates companies. However, they do provide a little bit more information than a typical bank with regards to their investments – rather than list the top 10 holdings in any specific fund, Ethical Funds listed the top 25 holdings. Still a far cry from what is possible.

Where Ethical Funds really demonstrates the power of socially responsible investing is in their use of their position as a major corporate investor to engage companies and create real change. Every quarter, they release a newsletter outlining how they have approached certain companies and demanded action on certain issues. For example, Ethical Funds has been actively engaging Enbridge to become accountable for the impact on First Nations Communities that their heavily controversial Northern Gateway Pipeline would produce. This kind of collective action on the part of investors has the potential to transform the corporate world to one where companies become accountable to their shareholders not just for financial profits, but also for their environmental and social performance. In essence, it’s a way of putting certain lost intangibles back on the balance sheet. Ethical Funds currently holds approximately six million dollars in shares in Enbridge, which allows their voice to be heard, yet still easily dismissed as Enbridge is a billion dollar company. However, should one of Canada’s five major banks step up and make a similar demand on behalf of the many more investors with holdings in Enbridge, such a voice would have to be heard.

It is, unfortunately, up to the individual investor to make such a transformation possible. This can be achieved either by petitioning the banks to make such demands under threat of removal of the investments, or better yet, by removing the investments in favour of redistributing them to more favourable, socially conscious investments. Canadian citizens ultimately hold the power, and it is up to them to speak with their money. The Social Investment Organization noted that, as of May 2012, there were 12 firms offering socially responsible mutual funds (including both RBC and Ethical Funds). Socially responsible investments have grown to represent over $6 billion in Canada as of the year 2000, up from only $15 million in the 1980’s. As of June 2010, that number has grown to nearly $531 billion, representing 19% of all managed investment funds in Canada. In a 2001 study, Asmundson and Foerster noted that socially responsible mutual funds performed no better or worse than the stock market index. At the very least, if there is no downside to making such an investment, it does allow the individual investor to feel a greater degree of comfort with their choice. As investors continue to choose socially responsible funds over other options, the power of investors to make real transformative change in corporate actions should also continue to grow.

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6 thoughts on “Ethical Mutual Funds – A Better Way to Invest?

  1. Great post. I agree with you that sustainable investing is not as available as it could be nor are there enough options for people to diversify. Ethical investing is still quite hard and has not taken off enough main stream to be something everyone will want to do.

    I do try to invest in what is there though so that I can support the changes that need to happen. We need to invest in greener stocks as our future depends on it. We need to change the way we do things and this will only happen when more and more people make noise about it and support it.

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