Ethical investing typically involves using pre-determined rules to avoid companies that may be in conflict with your personal values or beliefs, such as tobacco or weapons manufacturers.
The UK’s first ethically-screened investment fund, the F&C Stewardship Growth Fund, launched more than three decades ago in 1984, with some dubbing it the ‘Brazil’ fund, because they claimed you’d have to be nuts to invest in it.
Since then, the appetite for ethical finance options has grown and there is now a diverse range of approaches from which to choose.
As at 27 September 2017, UK investors were estimated to have more than £19bn invested in green and ethical funds, according to the EIRIS Foundation,up from around £16bn in 2017. The EIRIS Foundation is a charity that provides free and objective information on ethical finance and corporate activity to the public. Separate figures from the Investment Association (IA) show that net retail sales of ethical funds were £101m in June 2018, with ethical funds representing a 1.3% share of industry funds under management.
Awareness of environmental and social issues has certainly increased in recent years. The COP21 conference in Paris in December 2015 received a large amount of publicity, with a total of 195 countries signing a treaty pledging to reduce national greenhouse gas emissions. Although, in June 2017 President Trump announced that he would withdraw the US from the Paris climate agreement.
The largest energy companies are turning to clean energy supply chains. Exxon Mobil, for example, has a $500 million joint venture with Synthetic Genomics to produce renewable crude from sunlight and carbon dioxide, by genetically engineering photosynthetic algae. Other examples include Royal Dutch Shell, with their 44% stake in solar developer Silicon Ranch, and Chevron’s investments in wind power, solar and geothermal projects.
Does investing ethically mean poor returns?
Many investors are turned off by the idea of investing ethically because they believe that it may mean sacrificing returns. However, it isn’t necessarily the case that performance will be compromised, and there is research available which suggests that ethical funds have at least provided comparable financial returns to funds without an ethical theme.
There is also evidence to suggest that the average ethical fund has outperformed the average non-ethical fund over certain periods, although of course past performance should not be used as a guide to the future. All investments can fall as well as rise and you may get back less than you invested.
According to a November 2015 white paper from the managers of New Zealand’s official pension fund, good management of environmental, social and governance (ESG) factors – including governance, employee relations, safety, and environmental risks – is material to the long-term successful performance of any business.
It’s important not to underestimate how catastrophic the impact can be for investors when environmental and governance issues arise, as evidenced by BP and the disastrous Deepwater oil spill of 2010, and Volkswagen, whose poor governance led to the 2015 scandal over its rigging of emissions tests.
How to invest ethically
While it is possible to invest directly into ethical companies, putting your money into individual shares is a comparatively risky strategy.
Many investors prefer instead to opt for ethical funds, which invest in a broad range of socially responsible companies. Often these funds have more of a bias towards medium-size and smaller companies as some of the largest companies which are constituents of the FTSE 100 Index are commodity, defence and tobacco companies, which are naturally excluded.
The number of investment funds which incorporate ESG principles is increasing rapidly too, so there is a much wider choice available to investors than there was a few years ago. Research by ratings agency Vigeo Eiris found that there were 1,204 socially responsible investment funds in Europe by June 2015, a 221% increase compared to a decade ago.
Whilst ethical investment is useful for expressing preferences and easy to understand, it isn’t always easy to find funds which tie in with your own ethical approach, as what is ethical for one person may not be ethical to another. Although it can be relatively straightforward to identify industries which are widely considered ‘unethical’ such as tobacco or pornography, for example, the activities of many companies aren’t black or white. This can be the case, for example, with pharmaceutical companies that produce medicines to help people and cure illnesses, but which might perhaps use animal testing to develop their drugs.
When choosing which ethical fund to invest in, it’s therefore a good idea to look at what sort of screening approach fund managers take to the investments they hold. For example, some funds use ‘negative’ screening, which means they steer clear of certain sectors and stocks.
An alternative approach
Whilst ethical investing screens out companies which an investor believes may be harmful to society or the environment, impact investing is an alternative approach which focuses on investing in the companies which are seeking to contribute to solutions to our most pressing environmental and social challenges. This approach has the dual aims of generating positive financial returns alongside positive social and environmental outcomes.
Millennial investors, typically those born in the 80s and 90s, are particularly interested in this approach. According to Barclays ‘Investor motivations for impact’ research published in 2018, the millennial generation is four times more likely than older people to invest their money for positive social and environmental impact.
Read a summary of the research here [PDF, 1.2MB]
Whilst ethical investing typically involves rules about the companies which are to be excluded from a fund, impact investing instead focuses on the impact of each company. It relies on impact evidence over personal beliefs, and recognises that companies aren’t necessarily wholly good or bad. As a result, impact funds may hold investments that ethical funds may screen out, as long as those companies can demonstrate they are taking positive steps to improve society or the environment.
Find out more about the differences between ethical and impact investing
Please bear in mind that this article is for general information purposes only. If you are unsure, seek professional independent advice.