Ethical Investing: What is it, Ethical Investment Funds and ISAs (2024)

What does ethical investing mean?

Ethical investments are investments made with a view to the personal ethics, morals and social values of investors. It means investments made specifically in companies that are socially responsible, make healthy and legal products and stay away from unethical practices. For example, investors whose core values are that alcohol and tobacco are unhealthy will not invest in companies that make or market alcohol and tobacco-related products.

The primary purpose of ESG or SRI investing is to support businesses that make a positive impact. The secondary purpose, of course, is to generate good returns on the investment. The process of ethical investing focuses on social, environmental, and governance factors while investing and generating profits for investors.

Ethical investing vs. SRI vs. ESG: What’s the difference?

Ethical investing, SRI (Socially Responsible Investing), and ESG (Environmental, Social, and Governance) investing are three different approaches that incorporate ethical and sustainability considerations into investment decisions.

Ethical investing involves selecting investments based on personal or group values and moral beliefs. It aims to align investments with individual principles, such as avoiding industries involved in tobacco, gambling, weapons, or fossil fuels. Ethical investors may actively seek out companies that promote positive social or environmental practices. The criteria for ethical investing can vary widely depending on an individual’s values.

SRI, or Socially Responsible Investing: SRI is an investment approach that considers both financial returns and broader social or environmental objectives. It involves investing in companies that demonstrate responsible business practices, such as positive employee relations, community involvement, or sustainable environmental practices. The use of negative and positive screening is crucial in SRI investing.

ESG, or Environmental, Social, and Governance investing: ESG focuses on evaluating a company’s performance in three key areas: environmental, social, and governance factors. Environmental factors include a company’s carbon footprint, resource usage, and climate change policies. Social factors encompass aspects like employee relations, diversity and inclusion, and community impact. Governance factors assess a company’s leadership, executive compensation, shareholder rights, and transparency. ESG investing integrates these considerations into the investment process to identify companies with strong sustainability practices.

How to build an ethical investment portfolio

Building an ethical investment portfolio involves a thoughtful and deliberate approach to aligning your investment choices with your personal values. Here are some steps to consider when constructing an ethical investment portfolio:

1. Define Your Values: Clarify your values and identify the ethical issues that matter most to you, such as social justice, human rights and corporate governance. Understanding your values will guide your investment decisions.
2. Research Ethical Investment Options: Conduct research to find investment options that align with your values, such as ethical investment funds or companies with transparent policies, responsible practices, approaches to environmental impact, and governance standards.
3. Negative Screening: Use negative screening to exclude industries or companies conflicting with your values. For instance, you can avoid investments in fossil fuels, tobacco, weapons, or companies with poor labour practices.
4. Positive Screening: Apply positive screening to identify investments that actively contribute to positive change. Look for ethical investing companies that prioritise sustainability, diversity, renewable energy, and community development. Seek investments that align with your desired impact.
5. Evaluate ESG factors: Evaluate companies’ environmental, social, and governance practices. These include energy efficiency, waste management, carbon emissions, terms of labour standards, human rights, community involvement, transparency, executive compensation, and board diversity.
6. Diversification: Diversify your portfolio across different asset classes, industries, and regions. Consider a mix of ethical stocks and bonds, ethical mutual funds, exchange-traded funds (ethical ETFs), ethical ISAs and ethical index funds to achieve a well-diversified portfolio.
7. Monitor Investment: Regularly monitor your investments to ensure they align with your ethical goals and engage with companies or fund managers.
8. Seek Professional Advice: Consider seeking advice from a financial advisor specialising in sustainable investing who can provide tailored recommendations based on your values and financial goals.

Building an ethical investment portfolio is a dynamic and ongoing process. As your values evolve and new information becomes available, be prepared to adjust your portfolio accordingly.

Types of ethical investments

Ethical investments vary with the different values they’re based on. For instance, some ethical investments are driven by social values, while others are based on religious, political, or environmental values.

• Ethical investing driven by moral values: This category of ethical investing is driven by the moral values of investors. They invest in companies that support the same values as the investor, generally avoiding companies involved in tobacco, alcohol, firearms, etc. The other alternative for ethical investors is to invest in socially responsible investment (SRI) funds that invest only in socially-responsible businesses and avoid investments in businesses related to firearms, alcohol, and tobacco.
• Investments driven by religious values: Some ethical investors invest in faith-based funds. It allows them to invest in companies that align with their religious beliefs. You can’t buy stock in a church, but religious investing will generally avoid stocks on alcohol, tobacco or gambling, for example, and support those that champion human rights. There are, of course, fundamental differences between investing among the major religions that we haven’t space to fully unpack here.
• Investments driven by environmental values: In addition to moral, social, and religious ethics, many ethical investors opt for green investing. They prefer investments in companies using environmentally friendly products and processes that do not harm the environment. Thus, not investing in companies making single-use plastics is a part of ethical investing based on environmental values. Green investing also focuses on recycling, climate control, water usage reduction, conservation of natural resources and producing alternative energy sources.

Ethical investment funds

An ethical investment fund’s goal is to prioritise environmental, social and corporate governance factors in its investment decisions while netting positive returns for investors. Money pooled together from multiple investors creates an “investment fund”.

The fund manager makes the ESG investment decisions and selects from different types of investments, including stocks, bonds, and government debt. Some ESG investment funds are more ethical than others, as fund managers use different criteria and methods to achieve this goal.

Ethical stocks and shares ISA

An ethical ISA gives individuals the chance to invest in a socially conscious manner by avoiding investments in unethical and controversial industries. Investors can choose ethical stocks and shares ISAs that exclude companies that are involved in fossil fuels, tobacco, or arms.

The benefit of investing in ethical stocks and shares ISA is that investors can grow their wealth, and their portfolio can reflect their personal values regarding global sustainability while paying low fees.

Moneyfarm has cherry-picked high-quality, ethical investments via an ESG screening to build you ethical ISA growth portfolios that are fully diversified and tailored to your level of risk.

Some companies that invest in ethical stocks and shares ISAs may be transparent about how they make decisions when they choose investments and have strict environmental, social and governance ESG policies. However, some companies aren’t transparent about the criteria they use, so ensure that comprehensive research is conducted before investing.

Ethical pension

An ethical pension is a pension whose investments overlook companies and industry sectors that harm society or the environment or go to great lengths to harm things actively. Ethical pension funds bring ESG investing to retirement planning by ensuring the underlying investments meet environmental, social and governance criteria.

Pension holders should be more aware of how their pensions are invested. Pensioners need to find out from their pension providers how much control they have over the investments held in their portfolios. With a workplace pension, an employee may be able to select from a range of ethical funds offered by the employer.

With a Self-Invested Personal Pension (SIPP), an individual can choose which investments they want to hold in their pension from an extensive range of assets. When picking an ethical pension, the fund’s objectives, asset management and its top 10 holdings should be considered when making a decision. Also, ensure the pension is regulated by the Financial Conduct Authority (FCA).

Ethical companies to invest in

There are several ethical companies to invest in, and they pan across several sectors. Here are some ethical companies investors can choose to put money in.

• Renewable energy companies such as PG&E, First Solar, and Green Energy UK.
• Green transportation companies such as Tesla, NIO and ChargePoint Holdings.
• Meat alternative companies such as Beyond Meat and Agronomics.
• Waste reduction companies such as Republic Services and Waste Management.
• Alternative agriculture companies such as United Natural Foods and Mowi ASA
• Water purification companies such as York Water Company and United Utilities.
• Healthcare companies such as Merck, Johnson & Johnson, and MeVis medical solutions.

Why is ethical investing important?

Ethical investing is beneficial for both investors and society at large. For investors, it can mean greater satisfaction when they invest in businesses that they support. Investors can benefit financially and emotionally by investing in companies they share core values with. Investing, fundamentally, plays a critical role in society while generating returns in the process. Thus, ethical and sustainable investing can be a win-win situation for both investors and the world.

The growth in ethical and sustainable investing promotes more and more companies that follow ethical business practices. Sound practices are encouraged, and harmful practices are discouraged. As a result, ethical investing can help support the long-term well-being of the environment, among other ethical concerns.

Does ethical investing work?

Ethical investing can be great for the emotional and personal satisfaction of investors. In addition, it can be reassuring to avoid funding companies involved in malicious and harmful practices. However, not investing in unethical companies does not eliminate them – these companies are still able to raise capital from other investors looking for high returns.

In terms of generating returns, ethical and socially responsible investment funds have generally performed well, matching traditional investments in many cases. In fact, in 2019, many sustainable and ethical investing funds performed better than their traditional counterparts. Moreover, during the Covid-19 pandemic, when the world’s attention was placed even more on sustainability and ethics, ethical investing funds again performed well when compared to their conventional counterparts.

However, it’s important to understand the various challenges associated with ethical investing. The creation and management of ethical investment portfolios involve a lot of research to ensure that the investments align with the values of the investors. Therefore, they can come with high fees. Additionally, ethical investors may need to sacrifice their returns at times to comply with their ethics and values.

How do I choose an ethical fund?

When choosing ethical investment funds, consider the following steps to ensure it aligns with your values and investment goals:

1. Define your values and identify the ESG factors you prioritise.
2. Research the fund’s objectives and ensure they align with your values.
3. Assess the fund’s screening process for negative and positive criteria.
4. Evaluate how ESG factors are integrated into the fund’s investment analysis.
5. Review the fund’s performance, track record, and fees.
6. Look for independent ratings or certifications.
7. Consider seeking advice from a specialised financial advisor.

By following these steps, you can make an informed decision and select an ethical fund that meets your ethical considerations while also aligning with your investment objectives.

Best ethical investment funds in 2023

A large number of funds support ethical investing. In addition, a new family of ethical funds, called impact investing funds or ESG funds, have cropped up in the investment world and form a considerable part of modern-day investment portfolios. Some picks for the best ethical ETFs and mutual funds investment for 2023, based on the returns generated, are as follows:

• Vanguard FTSE Social Index Fund: The fund is invested in large and mid-cap companies. Its top holdings include Apple, Tesla, Amazon and Alphabet Inc. The fund reported a return of 13.5 % over the past year and 18.97 over the past three years.
• iPath Series B Carbon ETN: The fund is an exchange-traded note that provides exposure to Barclays Global Carbon II TR USD Index. It provides exposure to the carbon price. The fund had a one year return of 76.65%.
• KraneShares Global Carbon Strategy ETF: This fund tracks the most traded carbon credit futures contracts and is benchmarked to IHS Markit’s Global Carbon Index. The fund had a one year return of 62.09%.

Here are some of the best ethical investment funds that have had excellent track records but have had a low or negative performance as of 2022 due to COVID-19.

• Baillie Gifford Positive Change Fund: The fund invests in companies of any size, sector, or country; however, the investment is limited to companies creating a positive impact. Its holdings include Tesla, Moderna, Illumina, and other companies addressing issues related to healthcare, education, and the environment. The fund reported a return of – 15.39% over the past year and 26.23 over the past three years.
• Baillie Gifford Global Stewardship Fund: This ethical investment fund invests in companies that are dedicated to social issues, environmental challenges, and corporate culture. The companies in the Global Stewardship fund behave in the best interests of all their stakeholders. The fund reported a return of – 23.83% over the past year and 16.52 over the past three years.
• Royal London Sustainable Leaders: This ethical fund has at least 80% of its investments in UK companies listed on the London Stock Exchange. Its holdings cut across various sectors and countries and include stocks like AstraZeneca, SSE and Sage Group. This fund reported a 7.77% annual return on investment last year.

How can you ensure you are investing ethically?

To ensure you are investing ethically, just follow the steps on how to choose ethical funds. You can also choose a thematic investing option that focuses on a collection of companies involved in certain ethical areas that you want to invest in and predict will generate above-market returns over the long term. Also, review your ethical stance regularly to ensure your ethical investments align with your values.

History of ethical investing

Ethical investment finds its roots in religious movements like the Quakers and Methodists, dating back to the nineteenth century. These movements were concerned with issues like temperance and fair employment conditions.

Malthus’s 1798 ‘Essay on the principles of population’ warned of population growth surpassing the planet’s capacity to support human needs. Socially conscious business practices emerged in the 1700s, led by mutual societies and philanthropists like Cadbury’s. Quakers in the 1800s prohibited participation in the slave trade.

Ethical investing can also be traced back to Methodism, with John Wesley’s 1872 sermon on the ‘Use of Money’ promoting social investing principles. Wesley urged investors to avoid harming others through business practices and to steer clear of sinful industries such as pawn-broking, alcohol, tobacco, and firearms.

In the late 1960s and early 1970s, several groups in the UK began exploring ethical investment possibilities. Charles Jacob, an investment manager with the Methodist Church, proposed the first ethical unit trust in 1973. While it initially failed to gain approval from the Department of Trade, permission in principle was granted a few years later.

The investment themes of 2023 reflect the growing importance of ESG factors to investors as sustainability investing, impact investing and social responsibility investment themes become important.

What is the future of ethical investing?

The future of ethical investing appears promising and is likely to continue gaining momentum as megatrends.

Since investors have started to realise the potential impact their investments might have on the world, ethical investing has grown in popularity. According to a survey conducted in 2021 by the Global Sustainable Investment Alliance, the amount of assets managed by sustainable and ethical investment funds increased from $22.9 trillion in 2016 to $35.3 trillion in 2021.

The growth of ethical funds and investing is driven by increased demand from investors, increased awareness of environmental and social issues, mainstream integration, regulatory focus, advancements in ESG data, technology and innovation, impact investing focus, collaboration, and engagement, evolving ESG frameworks, and improved performance of ethical investments.

Overall, ethical investing is an ideal form of investing for the future. Know how SRI investing works and how it generates excellent returns for investors while allowing them to support their moral, social, religious, and environmental values. Financial advisers can also help with the process of picking an ESG portfolio that reflects personal values.

FAQ

What are unethical investments?

Unethical investments are investments made in companies and industries that are harmful or partake in harmful activities, but it also depends on an investor’s personal ethics, morals and social values. But the generation norm for unethical investments is ‘sin stocks’ from companies in the tobacco, alcohol, sex-related industries, gambling, and weapons manufacturers industry.

What is an example of ethical investing?

Ethical investing is for investors who want their investments to be used for good causes. An example of ethical investing as an investor who thinks weapons are harmful is to avoid weapon manufacturing companies or companies with investments in weapon production companies.

What are the benefits of ethical investing?

Investors will feel better as their investments align with their personal ethics, morals and social values. It drives change and encourages companies to implement and improve their ethical practices.

*Capital at risk. Tax treatment depends on your individual circ*mstances and may be subject to change in the future.