Could ethical investing be an advantage?

What's the better investment: Titan Energy Serviced Ltd (ASX:TTN) or Australian Ethical Investments Limited (ASX:AEF)?

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Some say ethical investing makes it harder to get top returns, I'm not convinced that's the case. Basically, I think that companies with a positive environmental and social impact do better over time, although I can't prove that hypothesis. What I can prove, is that sometimes ethical investing is an advantage.

Let me give you an example…

Coal seam gas drilling company Titan Energy Services Ltd (ASX: TTN) plunged over 60% today on news that it will earn EBIT of just $10 – $12 million in FY 2015.

Many considered the stock undervalued prior to this fall, with one fund predicting that it was trading on a forward P/E ratio of just 7 times. However, the fact that so many people oppose the hydraulic fracturing of prime Australian farm land is rarely mentioned.

Indeed, the opposition to coal seam gas has already hurt Titan, a fact I revealed in the the most widely shared article I've ever writtenIt was for this reason that I avoided the company in the past, and will continue to do so, despite the fact that it is now even "cheaper."

The profit downgrade was not directly linked to environmental concerns, however, I doubt they are helping the company. In fact, the main problem is that the CSG industry is drilling less. To quote the Managing Director, Jim Sturgess: "The CSG market is transitioning from the high growth, start-up phase that we've experienced for the past three years, into an operation and production phase."

At the end of the day, my concerns about the environmental and social impact of coal seam gas drilling might have saved me from making a poor investment.

It's also clear that ethical funds beat the market.  In fact, I think ethical investing is becoming more popular, so I've invested in Australian Ethical Investments Limited (ASX: AEF). Australian Ethical's Small Companies trust has returned 9.9% per annum over the last 10 years against 5.5% per annum for the S&P Small Ordinaries Index (INDEXASX: XSO), and I'd be happy to put my money with them.

Certainly, the fossil fuel divestment movement is gaining traction – it turns out many do want to protect the interests of future generations. And the divestment movement has support in high places. U.S. President Barack Obama has exhorted, "invest in what helps, and divest from what harms."

Ethical investing simply means allowing your ethics (whatever they are) to influence your investing. My point is that sometimes ethical investing is an advantage. So next time you hear someone say that ethical investors hurt returns by excluding great investments, remember Titan.

In case you think I'm picking on coal seam gas, let me give you another example. I personally think fish farms are both efficient and environmentally friendly, because they reduce the need for wild catch. However, some investors avoid aquaculture companies, usually because they are vegetarians. Some might say they have missed gains of 117% over five years by avoiding Tassal Group Limited (ASX: TGR). However, they have also dodged a bullet in Clean Seas Tuna Limited (ASX: CSS), which is down 85% in five years.

The bottom line is ethical investing has advantages and disadvantages – but there is no doubt ethical investors can outperform.

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Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Australian Ethical Investment Limited and has an indirect interest in Tassal.

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