Wednesday, 12 December 2007

The Ethical Hedge

The Genocide in Darfur is very worrying. Over 200,000 people have been killed and several million are at threat. The genocide is carried out by the Sudanese Government, which is funded mainly by PetroChina.

The Save Darfur Coalition is urging people to divest or sell stock in PetroChina (see Divest for Darfur). It is also urging people to get their fund managers to divest from unethical companies as well.

If we assume that the firm was accurately priced to begin with, if many ethical people divest from PetroChina, it would become undervalued and unethical people would spot a cheap stock and start investing in the firm, thereby reaping the profits. Divestment or negative screening then effectively causes a transfer of wealth from ethical people to unethical people.

What I suggest is that ethical people keep their money in PetroChina and buy even more stock. As the firm's price-earnings ratio increases, unethical and self-interested investors will steer clear thereby keeping much the profits of the company in the hands of ethical investors. These ethical investors then donate dividends to a charity that acts against the unethical firm, e.g. the Save Darfur Coalition.

As the unethical company starts to perform badly, its earnings drop, its share price drops, your profits drop, and your donation to the charity drops, and so this system self-corrects. The severity of immorality caused by the firm is proportional to the amount going to the charity that combats the immorality and so you have effectively hedged against it.

The Ethical Hedge, as I call it, can be done not only on PetroChina but other unethical firms such as those found in the Vice Fund.

This idea will work if the charity chosen is effective. There is some controversy over the effectiveness of the Save Darfur Coalition.

Update: Even though I'm Australian, I have been reading up on the American Elections and interestingly Barack Obama invests in the Vanguard FTSE Social Index Fund. He invested in this after divesting from a fund that invested in companies that fund the genocidal Sudanese government. At the Sudan Divestment Taskforce, arguments are made that targeted divestment can be effective. The argument I made was that if ethical people divested, the firm would be undervalued and unethical value investors would spot an undervalued stock and start investing in it. However, would these unethical value investors invest in the stock if they believe that the divestment program would continue to reduce the stock price? Buying stock and then having the price fall is not what investors want.

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