One of the sea-anchors to growing older is the accumulation of past experiences and observations. These form a bias which distorts the lens through which we observe and interpret current phenomena… and so we muse on the vagaries and problems of attempts to invest in a socially responsible manner.

Socially Responsible Investments

Over the years, my view of such investments has become a little jaded. I have watched groups justify paying large premiums for businesses or industrial processes that were clearly not commercially viable, all in the name of acting ethically. In the early years of such investments, the fees charged were often rather large compared to alternative “standard” investments. It was especially galling to see some managers of other people’s money act this way – i often wondered if they would have been so cavalier with their own money?

A tribe of inspired people decide to support a particular cause or idea or industry, and others step up to provide businesses, companies, projects and organisations to harness that pool of goodwill and keen capital donations. I say “donations” because that is what many investments into such areas become.

These musings are more a sharing of my thoughts than any declaration of being for or agin’ such investments. Often, people making these investments understand they are what demographic analysts like to call “first movers”. They are getting in first because they like the ideas, the possibilities, and they have the money to take a more speculative approach. That is something i completely understand. What gets my goat though, are the groups/funds/institutions that pander to the genuine desire of individuals to act in the public good, while all the while their real focus is simply on taking advantage of a large market trend. As Seinfeld would say, “not that there’s anything wrong with that” – it is after all the basis of commercial endeavour – but my own hypocrisy annoys me enough on a given day, so seeing it in others just irks.

At a later date, we will consider specific environmentally friendly, ecologically sustainable and ethically correct products. For the moment, we are simply considering the ideas behind these types of investments.

Many years ago i performed an analysis of the publicly available investment trusts which purported to offer “socially responsible” or “ethical” or “environmentally sustainable” options. The list was quite small but what struck me was the range of ideas as to what constituted “appropriate investments” under these various “responsible” terms. Here’s an example…

Remember a while back, when BHP was just the Big Australian, and hadn’t yet been acknowledged as the global giant it is today? Remember when they bought up Western Mining Corporation (WMC)? There were various “ethical” funds that held BHP in their portfolios as you would expect they would. BHP fitted under their terms of reference for filtering out inappropriate investments. It turns out that different funds use different terms to describe these filters and hence the specific investments they can or cannot hold in their portfolios. What struck me at the time, was that some changed the specific wording of their filters to allow them to retain BHP after the purchase of WMC. Why? It was to cater for WMC having greater contact with Uranium than BHP had up to that point. Olympic Dam has been a great buy for BHP, and the funds that were able to retain BHP have most likely done quite well out of their holdings. However, this little shuffling of the deck chairs left me a little bemused at the whole “ethical” approach.

Sustainable Investments

Maybe we don’t have to be quite so picky about being ethical if we can clearly show that we are being sustainable? Surely that is a reasonable approach – and meets Jeremy Bentham’s “greatest good” test? Well, my opinion is “yes” and “no” (with a tip o’ the ‘at to Sue E, who suggested to me that the fence was not always a comfortable place to sit). i hope you have a coffee/tea/scotch at hand because i’m going to be a little verbose here.

What is “sustainable”?

The most obvious example here is oil because the global consumption of oil is clearly NOT sustainable. If oil is the product of the long term decay of trees and goodness knows what other organic matter that has been squished between rocks for quite a while then we’d have to say that this constitutes a finite resource. There have only ever been a certain number of trees and bugs on the earth, and not all those that are squished between rocks have (or even will) become BP Ultimate. The idea of “Peak Oil” is well documented. It’s just a matter of argument whether the peak has already happened, is happening or will happen soon. So investment into oil is not sustainable in the pure sense. It is “sustainable” if we think that keeping our existing society operating while alternatives are found is a good idea but that is about as far as “sustainable” can be stretched. Therefore, societies are seeking “alternatives” to oil.

Alternatives include such ideas as :

• Solar Power
• Wind Power
• Tidal Power
• Gas – LNG, Coal Seam Gas
• BioFuels
• Thermal Power
• Nuclear Power
• People Power

Nuclear power has taken a bit of a rap post the Japanese earthquake and ensuing nuclear power reactor failures and fallout. Germany has decided to move away from nuclear power altogether. The fears of radiation leaks, problems with safely storing waste products for a couple of hundred thousand years or so and niggling concerns about nuclear weapon proliferation have all dampened enthusiasm for nuclear power. However, nuclear power is far more “sustainable” than oil, and may have the capacity to carry industrial society over until a better alternative is developed. It has less carbon emissions and so is far lower in its carbon footprint than oil.

Is an investment in nuclear power “sustainable”?

Australia is often held up as a logical place to host solar power. After all, we are a sunburnt country. We have quite a bit of space not currently taken up with car parks, roads or football ovals, so there’s room for vast arrays of solar panels. Transmission and storage, peak usage and core capacity are issues but we can work on those – so is Solar Power “sustainable” and should we direct money towards it?

Here is a bit of a story about a region in Germany that has embarked down the solar power pathway, and it embodies many of the things that cause me to hesitate on the selection risk involved in throwing money at oil alternatives simply because they are alternatives. The story is from the International Edition of the German online Spiegel “German solar firms eclipsed by Chinese rivals”. http://www.spiegel.de/international/business/0,1518,784653,00.html

 After reading the article, would you consider an investment in solar power generation to be “sustainable”?

 How about Wind Power? Wind is free and effectively harnessing wind power has a lower carbon footprint than oil, so it should be a good contender for the role of a viable alternative?

Tidal power has potential but again, at what level does it compete commercially with oil, nuclear or gas? While on tidal power, did anyone hear the initial results of Carnegie Wave Energy’s test operation off Garden Island? http://www.carnegiewave.com/

Obviously, there is more to “sustainable” than just energy and power. Issues such as food, building and waste disposal are all of paramount importance. However, oil and energy replacements for it are the most visible areas to tackle when thinking behind the basic concepts. We will look at specific funds and investments and how they tackle this sustainability issue in later posts.

What is ethical?

Now we are getting onto shakey ground. Each alternative has its benefits and detractions. Each can be more environmentally friendly than oil and arguably more sustainable but how do we decide where to actually place money?

We could go all the way back to Jeremy Bentham and decide that the greatest good to the greatest number constitutes what is best as a guideline for action – http://en.wikipedia.org/wiki/Utilitarianism. This is at least broadly measurable and helps to set objectives for measuring progress. However, the arguments against utilitarianism can just as easily be levelled against “ethical” investing (and yes, i am using ethical/ responsible/ sustainable as synonyms). Here are a few of the arguments, altered to give a financial perspective:

1. The ends justify the means. Yes they can but just as often they do not. Investing in an area just because you are hoping that an outcome will occur does not abrogate the responsibility of making sure the actual investment itself is reasonable. Otherwise, it is just a case of throwing good money after bad and, as Albert Camus suggested, focussing too strongly on the ends can often lead to distortions and corruptions along the way – http://www.amazon.com/Rebel-Essay-Man-Revolt/dp/0679733841.
• Financially – just because it wears the correct name it doesn’t make the investment itself logical or even sustainable in the way that you may expect.
2. Doing what is best for the wider good often stamps all over the best interests of smaller groups. Perhaps you are in an exposed industry, perhaps you live near a proposed wind farm site – there is usually someone who is worse off from a large society change in direction, and how much thought or care is given to their position? I often read comments that suggest people operating in or employed by “dead industries” shouldn’t be surprised when they close down, and these suggestions are often made with a nil empathy component. It is true that coal is highly polluting but if all of Australia’s coal stations were to close today then there would be an awful lot of new dark patches on our night-time continental profile. In other words, change is not likely to come abruptly, so some level of concern for those providing todays infrastructure is at least logical, even if it is not the pathway of the purist.
• Financially – In this case, it is your own financial outcomes that you should be interested in. It is a good idea to make sure that you are not allocating too much money to an area simply because it exhibits traits that you find attractive – there are often less attractive areas that can still be financially worthwhile without cutting down rainforest or producing military hardware.
3. Doing what is best doesn’t always clarify what outcomes we will encounter. The most obvious example here is Biofuel. Western countries improve their sustainability, environmental care and ethical approaches by switching to biofuels. This reduces the issues surrounding Peak Oil and reliance of existing oil exporting nations. The less obvious outcome is a scramble for scarce arable land and crops, contributing to a sharp spike in basic cereal and food costs, which in turn leads to difficulty for millions of the world’s poor. So acting in one way will often have an impact that we did not consider. Another good example is the switch from CFS’s to protect the planet from “the hole in the ozone layer”, only to find that the products switched to have a carbon footprint over 100x that of the CFC’s.
• Financially – You are taking a selection risk by reducing your market exposure to particular industries, companies or demographics. This increase in selection risk increases the likelihood of returns outside those of the general market itself. All ironic pointing at the current state of markets aside, that outcome could be positive or it could be negative. You need to be prepared for that variance and be comfortable with the outcome range.
4. Acting on consequences. It is argued that going the greatest good is not enough. If the outcomes are not good then something else needs to be done. It does not matter whether the outcome was predicted or predictable, if it is not a good outcome then what will be done?
• Financially – Increasing selection risk generally involves a need for greater scrutiny of outcomes and results. In other words, a more regular or more thorough assessment of the investment itself and its outcomes versus expectations and the market itself.

A common methodology of defining what is “ethical” is to define what is NOT ethical. In effect, this becomes a filter that can be used to identify areas that are not suitable, leaving a set of potentially acceptable investments from which further financial measures can be refined. This is the most common approach within socially responsible investment funds, and one that we will tackle in more detail in later posts. 

Alternatives = Government Subsidy

 Here is one of the greatest threats within an alternative investment. In general terms these industries do not yet have the scale or access to capital that would allow equal competition with “standard” businesses already entrenched in our system. Therefore, they will generally need the support of government subsidies or handouts until such a time as they can gain full investor support or be proven profitable enough to satisfy standard commercial lending requirements. Many see this government support as a “guarantee” of success, whereas facts would tend to suggest that it is simply a temporary level of assistance that should definitely NOT be taken for granted.

Just consider the Australian experiences of solar panels and windfarms. Government generosity can be taken away far more quickly than it was granted, and the decimation of your investment won’t make you feel much better about having contributed to the development of environmentally sustainable alternative products or services.

These subsidies are most visible in the area of alternative energy sources, owing to the massive capital requirements to get any projects to scale. Again, there are other areas of sustainability or ethical investments that are not so heavily reliant on government subsidy – but where a government subsidy exists, care should always be taken.

OK, so which products..?

Well, that is a bigger question. We will look at this at a later time. Please feel free to make suggestions of any particular areas you would like covered.