The Art of Green Finance

Information in this article is current as of June 2024.

Investing for income involves investing with the aim of generating money from a portfolio of stocks and shares; the income is usually in the form of dividends i.e. a share in the profit that the company makes. However, some of the companies paying the biggest dividends include tobacco, arms and oil and gas companies. So, is it possible to generate an income from dividend stocks without compromising on ethics?

How to invest for dividend income; the basic principles

First of all, it is worth noting that dividends are not guaranteed and that with current interest rates, the dividends of many companies can be beaten by savings interest, which is of course (a) guaranteed and (b) protected by the financial services compensation scheme. However, when interest rates eventually fall, dividend paying stocks and shares are likely to start looking more attractive once more. In addition, one may benefit from growth in the underlying value of the stock. So, how does one go about investing for dividend income?

The easiest option would be to buy shares in an ethical income fund that aims to provide an income from a combination of gilts, bonds and dividend paying stocks. However, as with all “ethical” funds, beware of green-washing. I have written more in depth articles about investing in gilts and about ethical investing in general. Read why I think ethical investors should consider choosing their own stocks and shares.

If you have decided to research and purchase your own portfolio of shares via an investment platform, remember that when we talk about dividend paying stocks we are still talking about an investment, so, you could lose some of your money or potentially all of the money you have invested if the company in question folds. Therefore, make sure you are in a position to start investing i.e. if you do not have savings, look at establishing savings first. Then, make sure you understand the principles of diversification.

Next, when investing for income, dividend income/dividend yield should not be your only consideration. If the underlying stock is losing value then this could undermine any benefit from dividends. Make sure you understand the business model of the company or companies that you are considering investing in and know how to read the company’s balance sheet. Also, check that there is sufficient dividend cover (ideally a cover level of at least 2) i.e. check that the company is paying out of profits rather than accumulating debt.

Also keep a look out for companies with a progressive dividend policy. This means that they aim to pay an increasing dividend yield year on year. However, this is a “nice to have” rather than an essential.

British dividend paying companies

Several large British companies have a good track record of paying dividends. However, amongst these are companies such as British American Tobacco and BAE systems that ethical investors will almost certainly want to avoid. In addition, the DRAX group is an energy company that generates high CO2 emissions and has been the target of a number of protests by climate groups. Not only is this undesirable in itself, this also presents a big financial risk, as eventually, these highly polluting industries will have to be phased out.

A list of UK Dividend Aristocrats can be found here. The UK aristocrats are large companies that have paid dividends every year for at least seven years without reducing the dividend.

A couple of companies amongst these that may be of interest to ethical investors are National Grid and Legal and General.

National grid operates power distribution infrastructure in both the UK and the USA. Included in this is fossil fuel based energy in the form of natural gas distribution, primarily in the USA but also including liquid natural gas facilities the south-east of England. However, the main thrust of the business is based around electrical transmission with an increasing role in connecting infrastructure for renewables to the grid. Although National Grid has a strong record of paying dividends, share prices have recently fallen sharply after National Grid conducted a rights issue to raise money for low carbon infrastructure investment. Given that energy infrastructure requires ongoing investment, it is not inconceivable that National Grid may have to repeat this exercise going into the future. National Grid has a current dividend yield of 6.3%. If you are willing to accept that the company is not completely fossil fuel free then National Grid could be considered as a possible investments for income as part of a diversified portfolio. National grid has a low ESG risk rating according to sustainalytics and has policies aligned to a 1.5 degree target according to MCSI. In addition, MCSI give National Grid a AAA ESG score in relation to industry peers. Please note, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Legal and General‘s primary business is pensions and insurance, however, the company has diverse investments including in property and clean energy. Legal and General has an attractive dividend yield of over 8%, however, a recently announced share buy-back and restructuring has caused the stock to fall in price. The main risk of investing in pensions and insurance is that this is a highly regulated industry and unethical practices such as mis-selling or changes in regulations could have big implications going into the future. Legal and General has a AAA ESG score from MSCI and a low ESG risk rating from sustainalytics. MSCI suggest that policies are aligned with a 1.6 degree temperature rise; slightly above the 1.5 degree target. However, Legal and General have a policy of engagement with companies in which they invest and have divested in companies that have failed to make sufficient changes. Given that they are such an important pensions provider, this policy could be very important in encouraging change. Please note, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

The author holds shares in National Grid and Legal and General.

US dividend paying stocks

In the US stock market, there are several big well established companies that have a solid track history of paying out dividends. Those S&P 500 companies (i.e. 500 of the biggest companies selected from the stock exchange) that have payed dividends for at least 25 years are sometimes referred to as the dividend aristocrats. For the purposes of this article I have looked at high dividend paying stocks in the Dow Jones that are sometimes referred to as the Dogs of the Dow.

Amongst the Dogs of the Dow are Coca-cola which regularly shows up in lists of worst environmental waste producers, and Chevron, a fossil fuel based energy company. Ethical investors will want to avoid these.

The “dogs” list also includes pharmaceutical companies which I tend to avoid due to a track record of controversial selling practices across the industry and risks related to new drug development and potential recalls, as well as telecommunications companies which individually can be volatile due to changes in regulations and rapid changes in technology.

Of the remaining “dogs” with an understandable business model, IBM stands out. This well established company has a current annual dividend of yield of 3.8% and has evolved to be a leader in cloud technology. IBM has also invested significantly in AI and could potentially profit from the AI revolution. IBM has an AA MCSI sustainability score with policies are aligned with a 1.6 degree temperature rise; slightly above the 1.5 degree target. However, IBM has a controversial history having supplied the Nazi regime with punch card technology that was employed in concentration camps. IBM is certainly not alone as a big business with links to Nazi Germany. Investors may be willing to view this as historic and not relevant to the current business, however, others may find it difficult to invest in a company that at any time has derived profit from operations in Nazi Germany, and even moreso when operations were directly linked to the Holocaust. An article in The Atlantic magazine from 2001 (pay-wall after the first section) gives a flavour of the allegations of a close partnership. Anyone wishing to read more about this should consider reading Edwin Black’s book on the topic (Nb. I have not personally read this book).

Therefore, I found it fairly difficult to identify truly ethical stocks on the American stock exchange that pay reasonable dividends and also have an understandable business model and avoid major risks.

European Dividend Paying Stocks

The European Dividend Aristocrats are blue chip companies that have sustained or increased their dividend share since 2000. Once fossil fuels, weapons, alcohol and tobacco are excluded, this list is also much shorter! Looking through the rest of the list for controversial business practices shortens the list even more. Finding companies that also pay a reasonable dividend yield (more than 3%) leaves:-

Munich Re (Muenchener Rueckversicherungs Gesellschaft) is a reinsurance and insurance business. Reinsurance is insurance that an insurance company purchases from another insurance company to insure itself against a major claim, for example in case of climate change driven weather events. Ironically, reinsurance companies may do well after a major event as smaller firms go out of business and premiums increase. Munich Re is one of the biggest players in the reinsurance field. It has a dividend yield of 3.25%. It has an AAA sustainability score and its policies are aligned with 1.3 degrees of warming. Please note, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

The author holds shares in Munich Re.

So, is it possible to invest in dividend paying stocks without compromising on your ethics?

In summary, it’s difficult! The more research that one does, the more ethical issues one comes up against. Very few big companies that pay reasonable dividends are entirely benign and in truth it is difficult to come up with enough companies to create a well diversified portfolio of such companies. This once again emphasises the importance of doing your own research as an ethical investor. Ethical dividend paying shares could form part of a well diversified portfolio but you are likely to have to seek other options to be well diversified.