Does ethical investing cost more?

If it costs more to be a socially responsible consumer — say, spending more for fair-trade coffee beans and ethically-sourced diamonds — does it cost more to be an ethical investor? The answer is as clear as tar sand.

“The quick answer is no,” says Rogers Group Financial certified financial planner Bryson Milley. “It doesn’t necessarily cost you more in the sense that … management expenses of ethical portfolios appear to be very much in line with what you’d find in a regular retail mutual fund. But the performance of the significant majority of ethical funds does not match up with retail funds. That’s where you could argue there are some costs.”

Recent events like the Newton, Conn., shooting are prompting more investors to examine their holdings and there is no shortage of ethically-manufactured securities to choose from.

In the U.S., there are more than $3.74 trillion in total assets under management that implement sustainable and responsible investing strategies. This figure represents a 22 per cent increase from 2009 to 2012, according a recent report from the US SIF Foundation, a member association for socially-responsible financial services professionals and firm.

In Canada, socially responsible investments represent 20 per cent of all assets under management in the financial industry, accounting for $600.9 billion, states to new report from the Social Investment Organization.

Inquiries about socially responsible investments (SRIs) are on the rise and investors have a greater awareness of exactly what type of companies they’re putting their money into, Milley says.

Typically it’s members of younger generations who have stronger views about ethical investments. “I’ve noticed a slight philosophical change or taste in portfolios [among younger people],” Milley says. “If there are two companies to choose from and one happens to have a better green record you’ll know which one they’re going to choose. It matters," he says.

"We also see it come up with RESP conversations. People will say ‘I’m investing for my kids’ education so it only makes sense I should be concerned about the next generation.’”

Finding the right investment

Part of what makes ethical investing tricky is that investors are typically provided with, or pay attention to, only the top 15 holdings in a mutual fund or exchange traded fund. From there, it’s easy enough to find alternatives if that list includes a company whose values don’t align with the investors’.

But, funds commonly have hundreds of holdings. “What are the chances that one of two or three hundred is going to attract a little ire? Pretty high,” Milley notes. “Where do you draw the line?”

It usually takes some digging to discover details that could affect investor attitudes. Consider Carmanah Technologies Corporation, a B.C.-based company that produces LED lighting and solar photovoltaic systems used in everything from bus shelters to air strips.

One of its biggest clients is the U.S. Air Force, a fact that could steer some investors away, Milley notes, adding that one way to support socially responsible companies is to purchase stock directly as opposed to buying mutual funds.

What about returns?

The most common argument against the profitability of socially responsible investing is that the pool of funds to choose from is small compared to the conventional route.

A study by the Ethical Investment Research Service found that the SRI approach has its drawbacks. “At the portfolio level, the use of ethical criteria to define your investible universe means that there will be some degree of reduced diversification,” the report states. “The diversification effects of selecting stocks from an ethically constrained universe are likely to be very tiny indeed.

“There will be times when opportunities might be missed because an ethical policy prevents investment in a company that is predicted to perform well,” the report states.

Milley agrees, adding investors need to be prepared for reduced performance.

"The numbers may be a percentage point or two behind the norm. There are clients who will say, ‘That’s the cost of being responsible. If that’s what it takes for me to do this, then so be it,'" he says, adding none of his clients have yet to commit to a full SRI portfolio.

Research by RBC Global Asset Management, however, challenges the myth of lower long-term results for SRI investors. The 2012 report “Does Socially Responsible Investing Hurt Investment Returns?” analyzed four distinct bodies of research that have focused on that very question.

“The chief finding of this research is that socially responsible investing does not result in lower investment returns,” the report says. “This is an important finding because it provides support to individual investors and trustees of institutional funds that they can pursue a program of socially responsible investing with the expectation that investment returns will be similar to traditional investment options.”

What is certain is that the debate over whether ethical investing reduces returns isn’t going to go away anytime soon.

“This question will never be answered to everyone’s satisfaction because many of the people engaged in this debate carry with them strong ideological baggage,” the RBC report says. “The challenge … is to ignore the rhetorical noise emanating from … extreme views and focus on the facts.”

Or, focus on what will produce a better night's sleep -- healthy returns or a socially-responsible portfolio? If lucky, an SRI strategy will produce both.