Updated 03 September 2020
When you invest money, that money ends up being used temporarily by someone else – such as a company or a government, to fund their activities. But what if some of these activities clash with your personal values, or those of your own business? For instance, if you are anti-smoking you probably won’t want your investments propping up the tobacco industry. Some organisations may even face serious embarrassment from their investment choices – such a homeless charity finding out that it has money invested in gambling firms.
Unfortunately, it’s often not easy to tell how your money will be used. Whether you’re investing for yourself or for your organisation, or even just building up a pension fund, you can gain reassurance that your values will be respected by choosing ethical investments.
The term ‘ethical investing’ is a fairly loose one. Broadly, it means you have another goal besides a return on your investments: you also want your money to do good (or at least, to do as little harm as possible).
For example, one ethical investor might simply aim to avoid putting their money in industries known to cause harm, such as tobacco, armaments or gambling. A more rigorous ethical investor may look to invest in companies with particularly high standards with regard to the environment, society and how they are run. Such standards are known as Environmental, Social and Governance (ESG) criteria, and are often used by socially conscious investors to screen their investments.
The fact that some investment funds are called ‘ethical’ doesn’t mean that all the others are necessarily immoral or harmful. Rather, with an ‘ordinary’ investment fund it is possible that your money is funding some activities that you would disapprove of.
If you want to invest ethically, first ask yourself how strict you want to be. If you are content just to avoid certain types of industries or business practices, then Socially Responsible Investing (SRI) may be enough for you. SRI funds set broad criteria when constructing a portfolio, to screen out less ethical companies. However, SRI funds tend to focus on ‘best in class’ companies rather avoiding whole industries, so may include (for example) oil companies that show more responsibility than their competitors. Such funds are sometimes described as ‘light green’.
If you prefer a more rigorous approach, then you may want to look at fully ethical funds. These will hand-pick companies to invest in based on their strong ESG criteria, and will exclude any that don’t meet its standards. Such funds may be described as ‘dark green’ or (for those with slightly looser restrictions) ‘medium green’.
Another kind of fund is a ‘passive’ ethical investment fund. A passive fund invests in a range of ordinary companies, regardless of their ethics, and then uses its position as a significant shareholder to try and address any ethical concerns by voting on resolutions. Of course there is no guarantee that the fund will succeed in improving the companies’ behaviour.
Even when investing ethically, consider your own interests first and foremost. This isn’t about giving to charity, but a mutually beneficial financial arrangement. So initially, approach this as you would any other kind of investing. Talk to a specialist financial adviser about your investment goals, assess your risk profile together, work out how much you have to invest, and only then start looking at individual funds. Notwithstanding their ethical credentials, assess them as rigorously as you would any other kind of investment.
You should also confirm that the fund really is ethical and not just claiming to be. Read up on it and find out what its top 10 holdings are, check how much of its portfolio consists of social or environmental investments, and investigate further if anything doesn’t fit your idea of ‘ethical’. Ultimately, what is ethical for you is your choice.
Investing ethically may have addition benefits beyond social responsibility. Many ethical industries (such as low-carbon energy) attract government subsidies, which may give them a growth advantage. One key ethical criteria is ‘sustainability’, and sustainability is also a good thing for investors if you are looking at the longer term. Similarly, ethical funds look for companies with good governance, and these are likely to be more stable and less prone to volatility. Also, ethical investments are growing in popularity, while the younger generation favours more ethical companies – both of which point to a bright future for this kind of investing.
There is little clear evidence that ethical funds perform less well than conventional funds. That said, there are some factors to take into account. Ethical investment restricts your choice of companies to invest in, which may lead to less diversity in your portfolio (and less diversity can mean higher risk). Your choice of funds may be similarly limited. The lower volatility of ethical investments can also mean you see slower growth with fewer peaks, even if overall growth may be steadier.
Finally, ethical investment funds may require higher management fees, as fund managers need to take more time researching the companies they invest in. You may also use more of your own time.
Always remember that this is still about making money for you, rather than supporting a particular cause. Don’t confuse the cause with the investment. If you think a company is particularly admirable from a moral point of view, you may be biased towards it and give less scrutiny to the quality of the investment itself. This is another good reason to consult a financial adviser first, as they will bring vital objectivity and ensure that you make your decisions with the head, not just the heart.
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