Non-Financial Returns

When you invest money, you usually buy shares in a company, lend money to a company or government, or make property available for a company or a government to use.

There are two types of return you can get by investing – financial and non-financial. Financial returns are what most people associate with an investment – capital growth, interest, dividends or rent. A non-financial return is anything else an investment may provide – it could be that the investment you make provides more employment opportunities, reduce the amount of carbon in the atmosphere or help to provide housing for those who couldn’t otherwise afford somewhere to live.

Unsurprisingly, the focus of the investment industry has always been on the financial returns. However, there has been a shift recently, as people seek out investments which are aligned with their ethics and values.

This shift started with investors wanting to avoid companies whose activities were unacceptable to them, from an ethical perspective. The obvious example was people wanting to avoid investment in tobacco companies, but other areas, such as weapons and animal testing, were also commonplace activities to be avoided. From the perspective of non-financial returns, investing in a tobacco company could be said to have a negative return, which should be subtracted from the financial return it makes. You might be happy with the financial return, but the negative non-financial return means that you may not want to invest.

It continued with a movement towards making positive investment – in companies involved in cleaning up the environment or making medical breakthroughs, for example. Investing in a company which cleans up the environment could be said to have an additional, non-financial return, which should be added to the financial return it makes. The financial return might not be enough, on its own, for you to invest, but the non-financial return means that you still want to invest.

The investment industry has struggled with this concept and the current trend is to try to measure the Environmental, Social and Governance features of a company or fund. I’m not sure whether these ESG factors ring true with clients. Regulators, including the UK’s Financial Conduct Authority, have been working on ways of providing clarity, but are struggling to come up with workable answers that clients understand.

There is a fairly straightforward solution to this, and, for me, it lies with the concept of non-financial returns. Let’s assume that all investment funds are seeking out a financial return; then we can ask questions about the non-financial returns of an investment:

  • Is it seeking to provide a non-financial return as well as a financial return?
  • If so:
    • Is it seeking to minimise the non-financial losses (e.g. by avoiding companies involved in certain activities)?
      • If so, which activities are being avoided?
    • Is it seeking to achieve non-financial gains (e.g. by favouring companies involved in certain activities)?
      • If so, which activities are being favoured, and to what extent?

This approach can also help investors understand whether a non-financial return is being provided by accident or purposefully. For example, a fund might invest in companies which are involved in clean energy; however, this might just be because the manager thinks that the financial returns in that company will be good. Knowing this would help the investor work out whether they want to invest in that fund and whether the manager might decide to replace the clean energy shares with an oil company in future.

However, the only people who can place a non-financial return on an investment are the investors themselves. I think that this can be done if investors ask themselves how much more return they would need from an investment which ignores the non-financial return. In a simple example, if you were to invest in a traditional fund of UK shares, how much extra return would that fund have to achieve relative to a fund which was also giving you a non-financial return? For some people, the answer will be “zero”, whilst for others, it might be “5% per year”.

Of course, different people will place a different value on the non-financial return, and different activities will be important to some people and not others. That’s probably uncomfortable for the big investment companies, who prefer to pigeonhole investors. And it means that it’s more likely that people seeking a non-financial return should take advice before investing.

Our view remains that advice is essential when ethics is part of your financial personality, and that it is important to only invest in funds where the manager has made a full commitment to ethical investment.

Philip Wise |

Managing Director and Chartered Financial Planner

This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances. 
The value of investments may go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.

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