All right. I’ll show you mine if you promise not to sneer. Is that a deal?
I’m talking about my portfolio, of course. For starters, let me reveal my single largest holding. It’s Wal-Mart. Yep, that’s right: the Beast of Bentonville, the much-despised colossus of discount retailing. And, no, there’s no need for you to phone. I can hear your boos and hisses as I type.
But, hey, you said no sneering, remember? So let’s move on. After Wal-Mart, I’ll also admit to fairly significant holdings in Dell you know, the computer maker that’s shifting jobs to low-wage destinations overseas and a stake in Anheuser-Busch, the giant booze merchant. I’m in bed with Molson Coors, which makes a lot of the suds that Anheuser-Busch doesn’t, and I’ll even ‘fess up to owning a chunk of Rupert Murdoch’s News Corp., which among other things purveys Fox News, the right-wing squawk box.
I think you get the idea. To many people, I’m someone who doesn’t let questions of right or wrong get in the way of his investing. I’m beyond shame, a black-souled capitalist, the very picture of an unethical investor. And you know what?
I’m OK with that.
Now no hissing, remember? And before you pick up that stone to cast at me, let me say that I have absolutely no problem if you want to see things the other way. Go ahead: invest using whatever ethical compass you choose. It’s your money.
My only point and I’ve raised eyebrows for saying this at too many dinner parties to count is that you probably shouldn’t expect your portfolio to perform chores that investing is not designed to accomplish. Trying to express your ethical viewpoints through your stock holdings is a bit like trying to express your musical tastes through your choice of a hacksaw. In other words, it’s fundamentally the wrong instrument for your purposes. If you can wait just a second before you cast that stone at my skull, I’ll explain what I mean.
Let’s imagine we live in a small country with only two publicly traded companies. Nice Inc. generates power from windmills, bakes organic tacos and bottles spring water. Nasty Corp. brews liquor, operates casinos and sells sugary, fat-laden treats. To keep things simple, we’ll say that each firm makes a million bucks in profit a year and each has a million shares outstanding, so each company earns a dollar in profit for each share it’s issued. We’ll also say that each stock trades at $10 a share.
You, being a public-spirited citizen, can’t help but notice the vast disparity between the niceness that is Nice and the nastiness that is Nasty. So you begin a campaign to encourage ethical investing. You succeed in getting many of the investors in Nasty to dump their shares. As these newly ethical investors purge their portfolios, the price of Nasty shares careen downhill. The shares that once changed hands for $10 plummet to $5. Nasty Corp. shareholders are screaming bloody murder and management is issuing press releases to reassure investors. Mission accomplished, right?
Well, maybe not. Remember that you haven’t affected either company’s profits. So once the initial selling binge ends, investors have a choice. They can pay $10 a share to buy a dollar of earnings through Nice or they can pay a mere $5 a share to buy a dollar of earnings through Nasty.
The choice is clear: Nasty is now a far better value than Nice. Assuming an ample supply of profit-seeking investors (and, in my experience of the world, that’s a very realistic assumption indeed) Nasty shares are going to rocket back upwards as the market smells a money-making opportunity. The net result of your ethical-investing campaign is simply the creation of a highly profitable chance for other investors to cash in.
The unintended consequences of your campaign may not end there. Many of the investors you’ve shamed out of Nasty are likely to take the proceeds from their shares and invest them in Nice. By doing so, they’ll give Nice’s share price a one-time boost which is great if you happen to be an original shareholder, but not so good if you buy in a bit later, at the inflated price. In that case, once the buying binge ebbs and the market readjusts, you’re destined to suffer a loss as a result of your flight to virtue.
As simplified as this example may be, Nice Inc. and Nasty Corp. demonstrate a fundamental reality. Most ethical investors figure they’re using the market to reward virtue and punish vice. Unfortunately, their actions if they influence the market at all are going to wind up having just the opposite effect.
This law of unintended consequences holds true in every stock market that’s populated by a significant number of greedy investors which is to say, all of them. By discouraging people from putting their money into profitable but questionable companies, ethical investors clear the way for investors who don’t share the same ethical concerns to make even bigger profits. And by encouraging folks to put their money into virtuous enterprises, they dilute the payoff for other ethical investors.
If you’re like most people, this will strike you as backwards and maybe even a bit perverse. But the more you think about it, the more you’ll see how the logic works. Imagine, for instance, that everyone on earth everyone, that is, except for a single person refused, on ethical grounds, to hold shares in tobacco companies. That single nicotine-stained investor could buy up all the shares for a penny (since there would be no other bidders) and enjoy enormous profits from all the dividends that would flow to him. No, he would not be a particularly admirable person. But he would be very, very rich.
You can’t say the same for ethical investors. Fund companies that cater to the virtue market like to assure people they can do good while still getting strong portfolio returns. But the jury’s out on that. Ethical funds have been around in any number for the past 20 years or so. In that time they’ve enjoyed periods of both decent and dismal performance, but overall have been mediocre. If you invest in one, you’re implicitly signaling that you’re willing to sacrifice a bit of return in exchange for the quiet glow of doing good.
Is that sacrifice justified? At least in my experience, many ethical investors suffer from a misunderstanding of how the market works. They regard owning shares in a company much as they would regard voting for a political candidate or a Canadian Idol contestant. They assume that if they refuse to own shares in a company, the company will feel pressure to change its behavior, just as a political candidate or aspiring rapper would.
In fact, investing in most companies isn’t like voting at all. It’s much more like splitting up a pie at a big family picnic. If you happen to like a particular type of pie strawberry-rhubarb happens to be my favorite the last thing you want is for everyone else at the picnic to develop a taste for strawberry-rhubarb. You’re delighted if an anti-strawberry-rhubarb faction springs up and encourages people to eat apple or cherry instead.
In much the same way, most investors in cigarette or alcohol companies are quite happy if ethical investors shoo people away from these companies. By doing so, ethical investors leave hefty rewards on the table for those who stay behind. In fact, the more that ethical investors succeed in pushing others away from the table, the richer the treat that’s left for everybody else. Ironically, ethical investing winds up being the best friend of unethical investors.
Some people have done me the courtesy of listening to my opinions on ethical investing and have told me that I’m missing the point. These people have poured their money into mutual funds that bill themselves as being ethical or socially responsible, not because they have any great hopes that their actions will force companies to change their behavior, but because they don’t want any link between them and enterprises they think are immoral.
If that describes your attitude, I respect your motivation. I would, however, encourage you to peer beneath the labels and look carefully at how your money is being invested. You may find that trying to define what’s ethical and what’s not ethical is tougher than you thought.
Consider Wal-Mart, a stock that I love but that I’ve grown accustomed to not mentioning in polite company. The giant retailer has become the favorite whipping boy of the U.S. labor movement, which denounces it for its low wages and shoddy treatment of workers. Both the Swedish government pension fund and the Norwegian Ministry of Finance recently divested themselves of any shares of Wal-Mart on the grounds that the chain mistreats its employees.
Strangely, though, many other ethical investors disagree. The Ethical Funds Co. of Vancouver as well as the Evangelical Lutheran Church in America, the Sisters of St. Francis of Philadelphia and many other similar groups were all recently listed as shareholders in the world’s biggest retailer. If nothing else, their presence among Wal-Mart shareholders indicates how difficult it is to arrive at a uniform judgment of what’s ethical and what’s not.
The ethical groups that invest in Wal-Mart recognize that the retailer benefits a wide swath of North American society by offering people access to a huge variety of goods at cheap, cheap prices. That’s not just opinion: a recent study by Global Insight, a well-respected economics consulting firm in Boston, calculates that Wal-Mart saves the typical U.S. household $2,300 (U.S.) a year through lower prices.
Am I claiming that Wal-Mart is the unrecognized Mother Teresa of commerce? Not at all. It’s a tough, efficient retailing machine that makes a scant three pennies in profit on every dollar in goods it moves off the store shelves. To squeeze out that profit, it pays most of its shop-floor employees just a bit above minimum wage. But think about it. Those low wages are one key part of how it offers low prices, which, in turn, is how it convinces customers to drop by. It’s also a big reason it can employ so many people 1.8 million at last count. If you want to lambaste the chain for low wages, you have to be fair and praise it for saving consumers money and creating nearly two million jobs. Like most companies, Wal-Mart is neither wholly admirable nor wholly objectionable.
Many ethical investors don’t get that. They think of the world as being neatly divided into good and bad. But is it?
It’s my experience that as long as a company operates within the law, intelligent people can debate its ethical stature from now until dividend day without reaching a conclusion. Should brewers and cigarette companies be shunned for producing unhealthy but perfectly legal products? If so, where does that leave pop manufacturers or producers of those heavily salted pork rinds that my taste buds respond to with unnatural zeal? Similarly, should pharmaceutical companies be embraced for developing the drug that saved my mother’s life after her blood clot? Or should they be condemned for profiting from her misery?
Ethical investing assumes that somebody an ethical fund manager, or a certain group of thinkers knows more than lawmakers and more than the rest of us about what constitutes morality. Unfortunately, questions have a bad habit of having two sides. You may think a uranium miner is off-limits because it supplies fuel to nuclear generators. I, on the other hand, may think that nuclear energy is our best hope of reducing our dependence on fossil fuels and thus preventing global warming. You may condemn a company for employing workers in the Third World. I may applaud it for giving people in those countries the chance to start climbing the economic ladder.
Even the purest of hearts can wind up perplexed as to who the good guys are. Consider Pax World Funds, one of the oldest and biggest ethical investors in the U.S. It used to shun any company with even the slightest connection to gambling or alcohol. But then its zero-tolerance guidelines forced the fund company to sell its stake in Yahoo when the Internet search company was found to have some tenuous business links to Internet casinos. Shortly afterward, the same guidelines forced Pax to divest itself of its Starbucks shares, after the coffee company entered into a deal with Jim Beam, the distiller, to market a coffee-flavored liqueur. Tired of seeing basically good companies tossed out the door for petty infractions, Pax wrestled with its conscience, then changed its guidelines in October to allow it to invest in such companies, so long as their gambling or alcohol revenues are just minor sidelines.
The new guidelines seem far more sensible than the old ones, if you ask me. To their credit, most ethical investment firms have already made, or are in the process of making similar moves. Rather than simply labeling companies good or bad, they judge them on a scorecard. And rather than kicking offenders out the door, they try to talk to management.
But that raises all sorts of questions for people who want to invest in these funds. What happens if a fund’s morality scorecard isn’t the same as yours? And exactly how does the fund manager balance ethics against return? If a company has shining principles but a mediocre profit outlook, does the fund keep it around for virtue’s sake? Or does it go looking for an investment with a better profit outlook, even if it has just barely acceptable morality?
Every ethical fund answers those questions in different ways. If you’re thinking of investing in one, I encourage you to look beyond the label and examine exactly what the fund holds. Compare it to other ethical funds and to similar funds that invest in the same area, but without the ethical banner. You may be surprised to see the differences or the lack thereof. At the very least, you’ll get a better sense of how closely the fund’s sense of morality aligns with your own.
In my own case, as I’ve already confessed, I’m an unethical investor, at least by the standards of many so-called ethical types. But despite my stock-picking style I firmly believe that we should strive to leave this world a better place than we found it. My contention is simply that investing in the stock market is an awkward way to do good.
As we’ve seen, ethical investing if it has any effect at all tends to reward unethical investors and punish the virtuous. No matter how pure you may be, it’s difficult to come up with universal guidelines as to which investments are virtuous.
Given all that, I’m happy to invest my portfolio purely on the basis of potential return but I also consider it my duty to express my moral opinions through other channels. Remember the story of Nice Inc. and Nasty Corp.? Ponder it and you’ll realize that the best way to affect a company’s behavior isn’t by buying or selling its shares, but by threatening its profits. If instead of convincing investors to sell Nasty’s shares, you had convinced consumers to boycott Nasty’s products, you would have gotten management’s co-operation with lightning speed. Ditto if you had lobbied government for changes that would have hobbled Nasty’s core businesses.
These methods are direct and effective in real life, too. I donate to charities and to political groups that I believe in. I vote to express my convictions, boycott products made by firms I don’t like, write angry letters to politicians and help in my small way to publicize wrongdoing. I think the world is too tolerant of lax morality but I also think the most effective way to create change is through spreading knowledge, pushing for consumer action and calling for changes in laws and regulations.
By comparison, buying and selling shares doesn’t do much. So call me an ethical unethical investor. And please put down that stone.