Is ethical investment effective?

by BenGilbert5 min read4th Feb 201316 comments

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I've been doing some thinking about charity vs investment as alternative ways of doing good (leaving open for now what that means). One question I'm wondering about is, in what circumstances does your choice of what to invest in have any welfare consequences at all (beyond differences in your own future wealth). I'm not sure about the answer and so, if any of you have comments or ideas, please put them down.

 

There is an argument that ethical investment is largely or entirely pointless, at least as a way of affecting asset prices and therefore making it easier for ethically acceptable companies to raise finance, giving owners/managers incentives to do things to make their companies ethically acceptable, etc. The argument against the effectiveness of ethical investment is that other investors who care only about financial returns will counteract any price change that ethical investors achieve – they will, eg, sell shares whose prices move higher than justified by future financial returns, and buy shares whose prices move lower because ethical investors sell or stay away from them.

 

I think that, though there is a great deal of truth in this, there are exceptions. They include cases where investors can provide money directly to companies; where investors can make asset prices depend on something other than financial returns; and where they can influence expected future financial returns.

 

(1) When you can lend directly to a company, through a loan or when it is raising money by issuing shares or bonds, then you can more or less directly influence the price at which it can raise money.

 

(2) If there are enough ethical investors, they could end up influencing prices by making some prices depend on something other than expected financial returns. How much money would have to be invested ethically before this happens would depend on how it is invested and the market capitalization of ethically acceptable and unacceptable companies.

 

If ethical investors just avoid investing in some companies (negative screening), then, so long as non-ethical investors have enough capital to buy the shares, bonds etc. of those companies, and they value them at the level implied by future payments (dividends, interest etc), I don't think the ethical investors will make any difference at all. If prices of the companies that are unacceptable to ethical investors become low relative to companies that are acceptable, non-ethical investors will just move money from acceptable to unacceptable companies. If ethical investors instead invest only in the company or companies they think do the most good (and, for the sake of argument, they all agree what these are), then, if they have enough money to buy the entire stock of that company, they could push the price to more or less whatever level they want. But if they don't have enough money to do that, I don't think they'll make a difference, since, once they've invested all their money in those companies, there will always be non-ethical investors left wanting to sell (if prices are higher than are justified by financial returns), and the only people left to buy will be other non-ethical investors, so the price at which assets will trade will be the financially-justified one.

 

(3) Ethical investors might be able to influence prices by giving other investors financial incentives to buy or hold ethically-acceptable companies. Perhaps, if it is known that some people are willing to purchase certain assets at higher prices than is financially justified, then other investors will also be willing to hold those assets at somewhat higher prices in the expectation of selling them at an even better level (a version of the 'greater fool' approach – buying an asset that is already overvalued in the expectation that a greater fool will come along to buy it from you at a higher price).

 

This is more complicated to think through and I'm not sure what the result is. There is an academic literature on asset price bubbles which outlines the ways that prices can deviate from fundamental values, potentially indefinitely, but I don't yet have a good handle on it. In some conditions, it seems plausible to me that the existence of people willing to pay higher prices than are justified by fundamentals will make prices higher than they would otherwise have been. I am not sure about how large this effect would be, how long you could expect it to last for, how far it depends on other investors knowing about the intentions of ethical investors and how far the amount of money being invested ethically would have to increase over time so that there are continually new buyers willing to pay higher prices.

 

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My tentative conclusion is that it is likely that ethical investment can have an influence on prices, but it is probably quite small. Furthermore, it is uncertain what positive effects would follow from increasing the prices of certain companies. It might make it easier for these or other similar companies to raise money in future, but the good done by this would depend on how much more money they raise and what they use this money for. It could also create incentives for owners to make their companies acceptable to ethical investors, but only where the gains in asset prices from doing this outweigh any reductions in profits.

 

It might be possible to have some rough rules of thumb on positive ways to invest – eg invest money in emerging markets, if you believe that higher asset prices there could support economic growth and therefore higher welfare (just an example, not necessarily correct). If investment decisions on non-financial grounds do have an effect, then you will have done some good, and if not, then at least it will be no worse than investing in anything else, as you'll be investing at the financially justified price. On the other hand, perhaps the fees charged by investment managers, or transaction costs, will outweigh whatever good is done by making these investments.

 

In any case, it seems unlikely that the welfare consequences of investing in any particular asset in the secondary market are much different from investing in some other asset. If so, it seems a lot more important to explore the welfare consequences of particular primary market investments and donations, where the variance would be much higher. It would be good to have an estimate of the welfare consequences of a random investment into a secondary market investment, for comparison with the alternatives and to factor in to decisions about, for example, whether to save money now in order to donate it later.

 

I'd be very glad if anyone has any criticisms or something to add.

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16 comments, sorted by Highlighting new comments since Today at 7:38 PM
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What is ethical investment?

Fair question, and I should have been clearer, because the meaning is ambiguous. I would say 'ethical investment' has two main meanings: 1) investing money taking into account the ethically-significant consequences of your investment decisions. 2) making investments in the secondary market which avoid companies whose activities seem socially harmful (usually understood to mean companies involved in things like weapons or tobacco) and/or put money into companies who activities seem socially beneficial (usually understood to mean companies involved in things like clean energy or with strong policies on workers' rights or equal opportunities).

I think ethical investment (1) is very much worth thinking about, because a large amount of the influence that most people in richer countries have upon the world is mediated by what they do with their money (spending, investing, donating). My post was about whether ethical investment (2) can be a part of ethical investment (1), and my tentative conclusion is – not really. However, I would say that most people's understanding of ethical investment is ethical investment (2). Trillions of dollars are invested in funds committed to such policies, which suggests to me that many people think they are effective, especially since some of them pay management and other fees to invest in such funds which they could avoid by just investing in some sort of index fund.

Thanks for the clarification. The post is clearer now, but as long as I'm admitting that I don't know things, I'm not sure I understand the basic economics of investment either. Is there a "for dummies" resource you could recommend here?

There do in fact exist sin funds specially designed to invest in alcohol, tobacco, weapons, and so on.

Among best ways to spend 1 billion dollars, making companies 2% more ethical does not jump out at me.

Making all companies 2% more ethical would be a great way to spend a measly billion dollars. Not the literal optimum, but a way higher return in utilons than usual. Alas, you can't actually do that by trying to induce a predictable distortion in asset prices.

Depends on what exactly "companies 2% more ethical" means in real life (in near mode). It could mean saving human lives, maybe even more than if you used the 1 billion dollars to build a hospital (which obviously would be considered very altruistic).

Imagine less poison in food, less slave labor, etc.

One problem with ethical investing is how do you determine what companies are being "ethical". This essay points out just how poorly popular perceptions of a company's ethicality correlate with an actual cost benefit analysis.

I completely agree that it is not at all obvious what good and bad effects there are of companies' activities. I think it is very possible that some 'unethical' activites have more positive effects than many activities commonly understood as ethical. It would take a lot of reflection to work out what good and bad effects certain companies have. The point of my post was to ask, before engaging with this question, whether individuals' decisions about their investments in the secondary market have much or any influence on companies. If not, it's not urgent to think through the question about how much good various companies do, at least in terms of what influence this should have on your investment decisions.

This may have been obvious to many people from the start, but it wasn't to me.

Or rather, how the author's unsympathetic perception of popular perceptions ...

(I suspect this author has less idea of what people who care about "ethical investing" actually care about, than I have of what fans of the San Francisco 49ers care about. Broadly, people who dislike X are not able to provide credible descriptions of what people who like X like about it, even if they have accurate models of what those people do as a result of their liking.)

My thoughts on the topic are generally similar to yours. It seems like private ethical investment would have a minimal or no effect. However, I think it's possible to create genuine incentives for companies to act more ethically if you have a large amount of money to allocate (preferably many billions). The most viable route would be to have (or find - I think there are a few already) a fund that's explicitly aiming to promote ethical investment (and has specific criteria for assessing ethics). If there's enough money at stake, some companies would probably make at least the easy changes to attract it.

Of course, unless you think you might be able to start a movement towards more people supporting ethical investment, or you're actually a billionaire, chances are your personal impact would be minimal. Not only that, but supporting charity is almost certainly more directly beneficial, simply because the primary aim of charity is to help people, while the primary aim of investment is to generate returns, so it would be very surprising if it did better at helping people than charity, at least in the short- and medium-term. For the long-term (say 40 years), investment might be more beneficial (although it's debatable), but that would probably ultimately be dominated by the potential benefits of FAI research.

Not only that, but supporting charity is almost certainly more directly beneficial, simply because the primary aim of charity is to help people, while the primary aim of investment is to generate returns, so it would be very surprising if it did better at helping people than charity, at least in the short- and medium-term.

That makes no sense. It sounds like you're saying that charity is always more cost-effective than reducing your negative externalities, while not providing any evidence for this assertion.

Actually, I think it makes perfect sense. If you use money in the best way you can think of - or other people can think of - to help people, you should on average expect to help people more than if you use money for something else in the hopes that one of its side-effects will be to help people. If you disagree, I think the onus is on you to provide an example of why that would not be the case. (And I would prefer a modern example, not one about a company dumping toxic waste in the river a hundred years ago and you maybe being able to sway it with large enough investments, since I'm not aware of any similar things occurring currently.)

I don't mean to be confrontational, but I'm really having trouble thinking of any reason when this would not be the case (at least in the short- and medium-terms, as mentioned).

The positive consequences of investing $1 in a particular company don't have to be anywhere close to as good as the positive consequences of donating $1 in order for the investment to be more cost effective, because investments generate returns, so the cost of changing your investment behavior is no where near the amount you spend on the investments. For example, if investing in company A or company B has the same expected payoff for you, but investing in company A instead of B has positive externalities, then you can do good for free by investing in A instead of choosing one randomly. I don't have any actual examples where I believe this to be the case. I was criticizing your argument, not your conclusion, which BenGilbert has defended fairly persuasively with other arguments.

'I think it's possible to create genuine incentives for companies to act more ethically if you have a large amount of money to allocate (preferably many billions)'

-'Assets in socially screened portfolios climbed to $3.07 trillion at the start of 2010' So there are already billions invested there. However, it's questionable what is ethical about these investments. First, billions or even trillions might not make much of a difference to prices, according to the logic of the argument I gave above. Second, these funds' criteria about what is ethical are open to question. Third, even if money invested in them makes a small difference, you also end up paying various management and other fees which might be close to wasted money, when you could instead invest directly and, say, give the money you save to charity.

I think it's worth clarifying whether or not there's anything ethical about ethical investment as currently practised, and, if not, what real ethical investment would be. There are already some movements towards this, eg impact investment, although I'm not sure there are yet convincing answers.

'Of course, unless you think you might be able to start a movement towards more people supporting ethical investment, or you're actually a billionaire, chances are your personal impact would be minimal.'

-I'm not certain what you mean by 'minimal'. It could mean two things which are often not distinguished but I think should be. If my $1,000 has a millionth of the impact of someone else's $1 billion, well, that's fair enough, it's a million times less money. I wouldn't see this as a minimal effect; it could be the maximum difference I can make given my resources. Or you could mean that my $1,000 makes no difference at all, whereas over some cut-off point - $1 million, $1 billion or whatever - it would start to make a difference. This is possible but one would have to explain why.

-Even if ethical investment has no different effect from any other type of investment, investment per se might have welfare consequences, in raising the total amount of money available for investment globally.

-I don't think there's much doubt that ethical investment is part of a wider set of attitudes which have led many companies to some combination of changing their policies and changing their self-presentation to fit better with common ideas of what ethical and unethical practices are. Large amounts of money in ethical investments may powerfully signal to companies that they should respond to the attitudes expressed in those investments even if there is no direct effect on asset prices.

I have doubts about how much difference this has made, although I am very uncertain and don't know enough about it. The first doubt is about how far companies have changed their practices rather than just their self-presentation. The second doubt is over how far the changes they have made are in fact changes for the good. eg it could be the case that higher wages and better working conditions for people in poorer countries leads to fewer people there being employed (I don't know if this is the case, it's just an example)

'supporting charity is almost certainly more directly beneficial, simply because the primary aim of charity is to help people, while the primary aim of investment is to generate returns'

-I don't know if we agree or disagree here. I think the fact that the primary aim of charity is to help people does not make it almost certainly more beneficial. People working in and donating to charities might have false beliefs about the good that charitable work does. If no-one actually knows what good a charity does, and no feedback mechanism exists to put an end to charities that do harm or no good (since, eg, the people served by the charities are totally disconnected from the people who fund them), there is no reason why many or most charities could not be totally ineffective or harmful. The pursuit of returns, on the other hand, could be a powerful force driving companies to be beneficial if they generate those returns only by offering people things they value enough to pay for. I think you might agree with me given your comment that investment might be more beneficial in the long-term.

First, billions or even trillions might not make much of a difference to prices, according to the logic of the argument I gave above.

That's a good point. For some reason it didn't click the first time I read it, but you're right. It probably depends on precisely what most other investors expect - if they're primarily investing based on their expectations of price movements, the prices might be swayed, but if they're trading on value, they probably would not.

As to what constitutes ethical investment, that would certainly be the first thing to figure out. I'm not sure you would find a clear consensus even among the LW community, let alone the wider world.

I'm not certain what you mean by 'minimal'.

You're right, I should've been clearer. I meant it in the sense that such an investment would be completely indistinguishable from noise to the market at large, and would consequently make nearly no difference at all. If many people made these types of investments using the same definition of "ethical" it might be noticed; if one person makes an investment it would probably be very hard to figure out that it's correlated with ethics or to decide that it's worth considering for future decisions (that it's not one-off).

I don't think there's much doubt that ethical investment is part of a wider set of attitudes which have led many companies to some combination of changing their policies and changing their self-presentation to fit better with common ideas of what ethical and unethical practices are.

I'm actually not entirely sure about that. I haven't investigated the issue very closely, but my impression has been that where companies changed their practices, this has mostly occurred as a result of consumer boycotts (or just unfavorable media coverage), of wishing to retain valuable employees, or of wishing to remain in favor with governments. Do you have any particular evidence in mind?

If no-one actually knows what good a charity does, and no feedback mechanism exists to put an end to charities that do harm or no good (since, eg, the people served by the charities are totally disconnected from the people who fund them), there is no reason why many or most charities could not be totally ineffective or harmful.

My impression is that at least in the last decade or so this has not been the case. While I don't know the specifics, it is my impression that GiveWell, for example, does extensive research to determine which charity actually has high impact (on quality-adjusted life years). I have also read that Bill Gates focuses on ensuring effective use of funds and hitting actual goals with his Foundation.

I do agree with your optimism about investment being beneficial, though.