No-Good Ethical Funds


I do not understand the motivation behind buying ethical funds. They seem like a bad idea. By my understanding they

  1. Do not help ethical companies
  2. Do not hinder unethical companies
  3. Harm the (presumably ethical) investor

I think the motivation for ethical funds stems from thinking that owning stock in a company is an endorsement of that company’s behaviour. I argue that this is not the case.

To see this, let us look at predictions markets, which more clearly illustrates this point. When I purchase claims for the Republicans winning the next election on the IEM, I am not endorsing the Republican platform. I am not even necessarily predicting that the Republicans will will the election. All I am (more or less) claiming is that I believe the odds of the Republicans winning the elections are higher than the odds given on the market. I am essentially making a wager with the person on the other end of the trade. It just happens that I can resell this wager at a later time.

Another possibility is that I am hedging against the Republicans winning the election. I have mentioned this idea before. If the Republicans win the election I am going to need more money to fight their policies. If the Democrats win, I will need less money. However, I do not know who will win the election. By wagering on the Republicans, I get to pay a constant amount of money now to ensure I have sufficient funds for either outcome, thus reducing my risk.

Similarly, when I purchase stock in a company (ethical or not), I am also making a wager with the person I am buying the stock from. I am claiming that the (discounted) future returns of the company are higher than the cost of buying the share, while the person I am buying the shares from is making the opposite claim. I am not endorsing the company. I am not supporting the company. In fact, the company in question is not even involved in the transaction.

Alternatively, buying stock in an unethical company can be used as something like a hedge against it, both directly and indirectly. Owning stock in a company often gives you voting rights, allowing you to vote against their policies. Also, you can use any dividends you receive to lobby against them. The bigger the unethical company grows, the more money you have to fight them at exactly the time you need it.

Some people argue that removing buyers from the market will help lower the stock price of unethical companies; however, this is not really the case. Assuming a weak efficient market hypothesis, the stock price will still move towards its true value with or without your participation. Assuming that your investment in an unethical company would have been a sound decision, as the future unfolds your valuation will bear out and someone else will see this and move the price up appropriately. The only effect is a slight slowing of the increase in the stock price.

This shows that buying and selling stock in a company neither helps, nor hinders it. This means that buying stock in an ethical company does not help it, and that avoiding owning stock in an unethical company does not hinder it. The only effect that avoiding unethical companies has is reducing one’s options. If ethical people only buy stock in ethical companies, then the only thing that happens is that ethical people end up less money than they would otherwise and end up with less power to effect change.

Perhaps there is some argument about how ethical funds help that assumes that the efficient market hypothesis is false. I do not recall ever hearing of a mechanism of how buying ethical funds is supposed to help. I checked the Wikipedia article for socially responsible investing, but no mechanism was described in the article.

I am not saying, “Do not buy ethical companies”, rather I am saying to buy whatever stock maximizes your expected growth rate. Whether the company is ethical or not is irrelevant.


Russell O’Connor: contact me