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Why did Ethical portfolios have a strong 2020?

22 Feb, 2021

What’s under the bonnet of ethical investing and why have the good guys done so much better?

First up let’s get clear on the lingo. Ethical portfolios means no nasties. Out with tobacco, weapons, booze, porn and all the ‘bad stuff’. It’s a way for investors to apply some filters to their investments and make sure their money is not used to fund the dodgy.

A cousin to Ethical Investing is Sustainable Investing. This is less about keeping bad stuff out, and more about putting good stuff in. Companies which are well run and treat staff well. Clean energy. That sort of thing.

Back in the greed-filled oil-guzzling 80s this type of investing was seen as something for faith groups and unusually concerned investors only. Oil and tobacco stocks did so well that to exclude them meant taking a hit on returns. So many people - including financial advisers - learned to associate ‘doing good’ with ‘doing badly’. Not so any more as the Ethical portfolios from robo-advisor Wealthify show below.

So what’s under the bonnet and why have the good guys done so much better? I spoke with Wealthify Investment Director David Semmens to find out.

He explained to me 4 of the key contributing drivers of success and here’s my take.

First, the ethical portfolios have less property in them. Why? Well, if you invest in commercial properties you can’t always monitor who the tenants are. And if the building and rents come from gun-toting, fag-guzzling companies, your ethical description looks a bit shaky. More broadly, property as an asset class has not had a good 2020. So that’s a relative boost for the ethical lot who tend to give this asset class a clear berth.

Second, the ethical portfolios have less exposure to emerging market bonds. Governance is typically less regimentally monitored in emerging markets and governance is less strong can be rife – so strong ethical practices can be harder to prove. This particular type of investment also had a less good 2020 than equities so again, the ethical lot did well by not having so much in emerging market bonds.

Third and probably most important is that the ethical portfolios have less energy stocks and fewer financial stocks. Energy had a poor 2020 as the world stayed home and consumed less oil. If you are an investment gonk, and you buy pretty mainstream stuff as all these robo advisers do, or you remove whopping big sectors such as energy and financial services from your pie, that means you go relatively large on what’s left. And a big part of what’s left – especially in the dominant US market – is technology. Technology loved 2020 and so anyone with a proportionately higher amount here did well.

Finally, when it comes to ethical portfolios, there is a lot more cherry-picking going on. We want this, we don’t want that. This means that you cannot just buy the main indices which deliver you a slice of all the biggest companies, proportionate to their size. Because they will have some bad stuff in there. Even these indices which try to filter out the nasties may still have unwanted exposures somewhere which a simple data-sweep won’t pick up.

Here’s an example, mine not David’s. Apparently – and this is anecdotal so take as illustrative – about 8% of leading supermarkets’ revenues used to come from fags. At what point do ‘innocent’ old Tesco or Sainsburys become a conduit to the tobacco industry? It’s just an example of how nuanced this can get. A computer might include a Tesco because it’s a supermarket. It needs more detailed analysis to flag that 8% of revenue in fact comes from baccy.

For those wanting greater screening and control, they will pick active funds which are all about cherry-picking. 2020 was a year which took no prisoners, some things did very well – think online retailers and tech – and some things did very badly – think airlines and energy firms. The ability to cherry-pick (active funds) and not just have everyone on your team (passive funds) meant that some active funds did much better because they could avoid certain companies. And the Ethical portfolios are largely filled with active funds under the bonnet because of the requirements for greater filtering and cherry-picking.

So there you have it. 4 reasons why Ethical did so well.

As a final point it is worth noting that this won’t be the case every year. It’s for us to make a decision based on our personal values and also our financial judgements on what successful companies of the future will look like. But it is no longer correct to assume that doing good means you can’t do well.