On Investing Ethically

Two recent posts, one on Christian Personal Finance, the other on Consumerism Commentary, discuss ethical, or as it is known in the trade, socially responsible investing. For those of you blissfully unaware, this is the notion that when investing your money you avoid companies that do things you think are morally reprehensible.

Back when I was just starting out in the investment world I had some involvement in socially responsible investing. I worked for a large institutional money manager. Our clients were pension funds, endowments, and the like and each one had its own account, sort of like a mutual fund with only one shareholder. We had hundreds of them and almost all were perfectly identical, holding the same stocks in exactly the same proportions.

The non-identical ones had “client restrictions.” Most of those were prohibitions against investing in certain industries to which the client, often on religious grounds, objected. I remember we had several accounts associated with the Catholic Church. They prohibited investments in any company even vaguely involved in abortion and in, for reasons I cannot recall, for-profit hospitals. We also had a few accounts associated with the Lutherans, who prohibited us from putting their money in companies that made alcoholic beverages or were involved in gambling. They were fine with abortion and hospitals, just as the Catholics were indifferent to booze and gambling. Another set of accounts prohibited arms makers and we had several different levels of prohibitions against tobacco.

It was an administrative mess and my job (well, a small part of my job) was to simplify and automate things so that the portfolio managers would not have to spend time adjusting each account to accommodate the restrictions. I built a clever system that boiled down to finding a second-choice stock in a similarish business to substitute for a forbidden stock. So, to cite the only example I can remember, when most of the accounts bought cigarette maker Phillip Morris, the no-tobacco accounts got McDonald’s instead.

This was working well for some time when some genius in the marketing department discovered that not only did the restricted accounts have somewhat different returns than the normal account, but that on average they consistently did worse. He called me in a huff and I very patiently explained to him that of course they underperformed. They were supposed to. The normal accounts had the portfolio managers best picks in them. The restricted accounts not so much. Restrictions can only cost you money.

With utmost respect to the moral values of others, I personally think that ethical investing is bogus. To begin with, I have a lot of problems with the idea that one degree of separation from evil is evil but that two degrees of separation is okay. Investing in a company that pollutes is bad, but investing in companies that make money with the electricity made by the polluter is okay? And if it is, why isn’t investing in a mutual fund that then invests in a polluter okay? Wherever the line gets drawn it is arbitrary. We have one big global economy and cleanly excising out the dirty money is not an option.

I am also very uncomfortable with the idea that by investing in a company I am necessarily endorsing everything the company does. I own some Treasury bonds. Does that mean that I endorse everything the Federal Government does? I really hope not.

That said, if you want to invest ethically, as you personally define it, go right ahead. It’s your money and what makes capitalism work is that only you get to decide where it goes. But keep in mind that you are making a sacrifice. Your moral high ground will, over time, cost you money as you pass up unethical but profitable opportunities.


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