There are three common approaches to socially responsible investment used by ethical funds: screening, best in class and engagement. Many funds utilise a combination of the three strategies in order to generate an acceptable list of investment opportunities.
Screening involves two facets: negative screening, which is the exclusion of industries and companies with business activities that do not align with the funds principles, and positive screening, which ?screens in? companies that actively contribute towards the goals of the ethical fund. For example, a managed fund that is focused on humanitarian concerns may screen out companies that exploit third world labour whilst screening in companies that provide safe, high-standard working conditions for their workers.
Best in class
The best in class approach is utilised by fund managers to choose among comparable companies by using a set of ethical guidelines. A primary example exists within the mining industry, where two companies may be financially similar. One company may have a superior environmental record compared to the other, so using the ethical fund?s guidelines the fund manager would choose this company. This method provides an incentive to companies to operate at a higher ethical and environmental standard then their competitors.
Lastly there is engagement. This strategy involves active encouragement of companies to adopt social and environmental best practices. Considering the substantial amount of capital in managed funds, the influence a fund manager can have on a company, especially smaller businesses, can be quite significant. This involves the fund manager engaging with the senior management of companies held within the manager?s portfolios and influencing their decisions to result in the best practices with regards to ethical concerns.
How do ethical investments perform? Check our summary here.