Charities once led the way in ethical investment. So, where are they now? PMCL's Ed Jewson shares his insights on putting ESG at the heart of investment portfolios.
In recent times, responsible investing has become an increasingly important consideration for charity trustees and those with not-for-profit elements to their portfolios. In April 2022, the Butler-Sloss case became the first in almost 30 years to consider how charity trustees may take account of the non-financial aspects of investments.
The judgement by the High Court, while not legally binding, could be seen as a positive shift in the focus towards ethical and moral investment policies. It also provided confirmation of the discretion that trustees have when deciding which investment approach is most appropriate for their charity. It remains to be seen how this will be reflected in the Charity Commission’s forthcoming revised guidance which aims to ‘ensure trustees can confidently adopt appropriate policies including in the context of pressing concerns around climate change’. However, for those trustees looking to adopt a more responsible investment approach, it offers some clarity and reassurance.
Reputations on the line
For society in general, environmental, social and governance (ESG) issues have become a primary concern in our everyday existence, whether it is with regards to the recycling of plastics, sustainability in construction, or the use of fossil fuels. For those looking to donate/invest/raise funds for a charity, establishing whether it is adopting a more ethical mindset and conforming to its principles, may be a determining factor. Generally, when large sums of money are involved, one of the first ports of call tends to be the charity’s investment portfolio. And while investing ethically is a positive for those on the outside looking in, the presence of unethical investments is likely to raise a large red flag, the consequence of which could be hugely damaging for a charity’s reputation.
A journalist tasked with an investigation into a charity’s investment approach in terms of ESG will most likely begin by looking at its portfolio. If the underlying investments are considered suitable in this regard then the journalist is likely to look elsewhere, thereby leaving the charity’s reputation intact. However, a portfolio that raises more questions than answers, could end up being in the money section of the newspapers, doing untold damage to a charity’s reputation and subsequently its fundraising ability.
A client's close call
An example of this occurred with one of our clients where at around 5.30pm on a Friday the finance director called us to say they had just been contacted by a journalist from one of the broadsheets. They had been asked numerous questions about the positioning of the portfolio, its investments and whether it was in breach of its ESG guidelines. As their investment consultants we had in-depth knowledge of the portfolio and its underlying holdings. We were able to provide the answers and reassurance required to satisfy the journalist, who hurried off to find another less fortunate/principled ‘victim’, who subsequently appeared in the Sunday papers the following weekend.
While a negative perception of its investments can damage a charity’s reputation (particularly when it's in the public domain), conversely, it can be greatly enhanced by expressing its ESG credentials through its portfolio.
Charities in the vanguard
Initially, charities were at the forefront of the ethical debate. They were key to instigating ethical constraints in the forming of investment portfolios through the use of negative screening (e.g. excluding tobacco or armament stocks). However, the debate has moved on and charities are now beginning to use positive ESG selection as a key part of their process.
Investing in stocks that are misaligned to the mission or investment policy may be very damaging to a charity’s reputation. On the other hand, for those with portfolios that demonstrate an adherence to the highest ESG principles, the reverse could apply.
One of the ways this may be achieved is via the charity’s investment policy. For most, the investment policy statement was (and for some, still is), a basic summary in the annual report and accounts. However, where a charity has a portfolio, the investment policy statement could be a valuable tool that can be used to promote the charity’s positive ESG principles.
In doing so, the charity might increase its ability to attract funding, provide comfort to the donor base and give positive direction to the investment managers.
By demonstrating its ESG credentials, it can influence other charities to be motivated in the same direction and become a pioneer for best practice in the industry.
Forming an investment policy
If the charity wants to create an impact, it needs to consider where and how they might achieve it through investment. Before forming its investment policy, careful consideration should be given as to where potential reputational risks lie. Once this is clarified, thought should be given as to how this is incorporated into the investment policy statement to best enhance the charity’s profile. It is therefore important that ESG considerations and impact investment aspirations are embedded from the beginning, rather than seen as a nice-to-have ‘add-on’ option after all the strategic decisions are made.
On an ongoing basis, the portfolio should be monitored in terms of ESG requirements to ensure they are adhered to by the investment managers to avoid any potential negative impact (albeit unwittingly) on the charity’s reputation. The investment policy (together with the investment strategy) is unique to the charity and should be ‘owned’ by its trustees. It can be constructed internally or given that it is something that is done infrequently (and regularly reviewed) may be best using the assistance of an external, independent, and experienced investment consultant.