Ethical investing | Monday 11 Mar 2024 (2024)

Ethical investing is a broad term covering a wide range of activities. But at its simplest, it’s when you choose investments based on their moral behaviour – not just their potential for a financial return.

You may come across concepts that overlap with ethical investing. These include ESG investing, stewardship, green investing, socially responsible investing, and social impact investment.

Ethical investing can trace its history back more than a hundred years, with its roots deeply entwined with Quaker and Methodist values. But in the last five years or so it’s gained widespread traction, prompted by the rise of the climate emergency in the popular consciousness, and campaignerslike Greta Thunberg, Sir David Attenborough, and the Extinction Rebellion movement.

As a result, much the focus of ethical investing recently has been on environmental matters, or what might be termed green investing.

What is ESG investing?

ESG stands for environmental, social and governance. It’s an approach to investing that evaluates companies not just on their ability to make a financial return, but also how they measure up on ESG criteria.

For instance, a company with a high carbon footprint wouldn’t score well on environmental impact. Similarly, a company that negatively affects people’s health wouldn’t score well for social impact. And a company without appropriate structures and processes to ensure good corporate decision-makingand behaviour probably wouldn’t rate highly for governance.

Types of ethical investing

There are different ways to invest ethically. Below we’ll explore the main approaches followed by active fund managers.

Keep in mind that some funds will combine two or more approaches. This goes to show that if you want to invest ethically, you need to roll your sleeves up and do a bit of homework to ensure your fund ticks the right ESG boxes.

Stewardship

The stewardship approach to ethical investing means looking after the investments you manage from the point of view of the environment, society, or the economy at large.

At the weakest level, this would mean voting on proposals made by the company. At the strongest, it would mean lobbying the company – either in private or in public – for change. It’s probably hard to find any actively managed investment fund that wouldn’t claim to engage in some form ofstewardship, so it’s a broad church.

Stewardship can be an important component of ESG investing, but it’s probably not enough on its own to warrant the ESG tag.

ESG integration

This means considering ESG factors when making investment decisions. The effect that ESG integration has on a portfolio can be minimal, or quite substantive.

For instance, a fund manager could simply factor in a stock’s ESG rating, alongside other financial information, when making their investment decision. In this case, ESG integration would have a very small effect on the portfolio.

At the other end of spectrum, ESG integration can be much more robust. For instance, an investment manager might decide not to invest in a company based just on its poor ESG score. But this is still a judgement call made by the fund manager – unlike in an exclusionary fund (see below), wherecertain sectors are explicitly off limits.

Green investing

An approach favoured by customers concerned about the environment. Green investors look to hold only environmentally friendly investments, and exclude companies which might be damaging to the environment.

Tilting

This is when a fund use ESG scores to ‘tilt’ their portfolio away from companies with poor ratings, and towards companies with good ratings.

When you choose this type of fund, some of your money may still be invested in companies and industries which you’re not keen on – but there’ll be a significantly lower amount of them compared to the market. So tilting strikes a balance between ethics and pragmatism.

Best in class

Similar to tilting, best in class allows investment across a range of industries, even carbon intensive ones. But it picks a portfolio of companies that lead their sector in terms of their ESG credentials.

The benefit of this approach is it’s easier to produce a balanced portfolio, so may suit investors who believe the likes of BP and Shell are critical to the transition to cleaner energy.

Exclusions

One straightforward way to invest ethically is to exclude certain industries from your fund portfolio. Typical examples are tobacco, oil and gas, gambling and defence companies.

This approach might suit you if you don’t mind too much where you invest – as long as your money isn’t held in companies you believe are doing harm. As well as being a traditional way of investing ethically, it’s also easy to understand and implement.

Positive impact investing

Some funds go a step further. Positive impact investing involves seeking out companies working towards solving the ESG problems facing the world – whether that’s climate change, financial inclusion, or poverty.

These funds can be more risky, often because they invest in fairly specialist areas. Two examples are renewable energy investing and social impact investing. Renewable energy investing is where funds invest in businesses that produce renewable energy, such as wind or solar farms. And social impactinvesting is where funds invest in projects with a positive social effect, often on disadvantage communities.

What are examples of ethical investments?

What makes an investment ethical is very much in the eye of the beholder. For some, holding an oil company like Shell, which makes money from oil and gas production, is simply unethical. For others, the commitment oil companies have made to transitioning towards renewable energy makes them part ofthe solution as well as the problem. So they don’t believe investing in oil companies transgresses any ethical boundaries.

Some ethical investors choose companies that are making a positive contribution to the world, such as the Danish renewable energy firm Orsted. Alternatively, they might pick stocks that aren’t doing much harm – Microsoft and Alphabet, for instance, are quite common in funds that invest in ethicalcompanies.

When you're researching for your funds, you can find the Morningstar sustainability rating, which will give you a score out of 5 for each of our funds available for investment.

Is ethical investing profitable?

The point of ethical investing should be to make a financial return. This distinguishes it from philanthropy, where people invest without any financial motive.

So, yes, ethical investing should be profitable. But is it more or less profitable than traditional investing? There probably isn’t a definitive answer, as there are times when ethical investing can perform better, and times when it can perform worse. For instance, ethical investments got a bit ofa bump when Joe Biden was elected president, thanks to his green infrastructure plans. But in 2022 green investing fell behind more traditional investment strategies, because high oil and gas prices meant a rise in share prices for companies that produce these fossil fuels.

What are the benefits of ethical investing?

A significant benefit of ethical investing, for many, is the peace of mind that their money isn’t invested in companies doing harm to the world.

Of course, choosing not to invest money in a company like Shell won’t have as much positive environmental impact as if you stop consuming petrol or diesel. But the rise of ethical investing makes companies more broadly alert and accommodating to ethical concerns – because they know thatshareholders, as well as customers, can turn against them if they take a wrong turn.

Important information: Remember that the value of investments can change, and you could lose money as well as make it. We don't offer advice, so it's important you understand the risks. If you're not sure, please speak to a financial adviser.