Investing for good – ethical & impact investing – Episode 10 – Grow It

This is the final episode in this grow it series and I want to explain that while investing can grow your wealth it can make the world a better place at the same time. This is what is at the heart of the broad catch-all term of ethical investing.

Investing for good - ethical & impact investing

There is no single definition of what ethical investing is because it means different things to different people, but hopefully there will be more clarity when new FCA rules come into effect later in 2024. But in essence, it is a type of investing driven by morals, principles or religious values. Usually it is associated with negative screening, which means removing objectionable industries and sectors from the list of investments you'd consider adding to your portfolio be they direct share holding, bonds or funds that invest in a range of assets or companies.

There are lots of buzzwords and styles that are associated with ethical investing so I just want to run through a number of them so you can understand the nuances and the blurred lines between the definitions, buzzwords and styles mentioned. While I’ve explained what ethical investing is:

• Socially Responsible Investing (SRI) and sustainable or responsible investing are broader terms for investment strategies that consider a company's ESG (Environmental, Social, and Governance) records, including issues such as human rights, environmental sustainability, gender diversity and a sustainable supply chain.
• Impact investing is a subset of SRI that focuses on investing in projects or businesses that generate a positive measurable social or environmental impact in addition to financial returns.
• ESG investing focuses on the environmental, social and corporate governance factors when analysing companies.
• Green investing typically has an environmental focus which links to Climate Change investing, which is fairly self-explanatory.
• Dark green investing goes beyond traditional green investments and may exclude certain sectors that are not consistent with environmental and social values, such as fossil fuels, tobacco and weapons. It is a more stringent and selective approach to sustainable investing that prioritises companies with the most positive environmental and social impact.
• Light green investing involves investing in companies that are making efforts to become more environmentally sustainable and socially responsible, but may not have a fully developed sustainability program in place yet. Light green investing is seen as a more accessible and less stringent approach to sustainable investing that may appeal to a broader range of investors who want to align their investments with their values but are not as concerned with excluding entire sectors or companies that don't meet their standards.

On top of the current lack of clear ethical investing guidelines and definitions some ethical investment providers have been accused of "greenwashing" by labelling funds as ethical, sustainable, or green but still including investments that are not consistent with those values.

But I don’t want people to be put off considering investing ethically and for the greater good or in accordance with issues that they care about. Because despite the confusing array of terms out there it can be relatively straightforward to invest your money ethically - you just need to be focused about it.

The most hands-off approach if you want someone to run your investments for you, and you don’t want to seek the advice of a financial adviser, is to choose an ethical portfolio run by a robo-adviser. Services such as Wealthify and Nutmeg have a range of ethical portfolios alongside their standard portfolio range. So just as I explained in video 6 of this series when it comes to choosing a service like a robo-adviser to recommend and manage a portfolio for you, the same can be done but with an ethical tilt. Of course one trade off is that the money won’t be invested in line without your own ethics or morals, rather in line with the mandate decided by the investment manager. Not perfect but it is a step in the ethical direction.

The only way to be sure that your investments match your own ethics is to carry out your own research. That is why those investors who prioritise investing in line with their own ethics will more than likely have to build and manage their own investment portfolios. Most investors invest via funds (which are collective investments), be they investment trusts, unit trusts or ETFs and I explained the differences between these in episode 7 of this series. It is beyond the scope of this series to cover investing directly into individual company shares as such investments are, in my view, too high risk for most investors unless they have the expertise and time to analyse and diversify their holdings themselves.

So how do you go about researching potential funds, be they active or passive to invest in that will match your ethical criteria. There is a free tool from MSCI which analyses a fund’s holdings and gives it a score based on the ESG ratings of the underlying investments within the fund. So for an equity fund that would mean it will give a rating based upon the ESG ratings of the companies the fund invests in. The tool will also tell you how well a fund is aligned to global climate temperature goals as well as flag if any of its holdings are involved in tobacco, weapons manufacturing or whether they have contravened the UN Global Compact or faced serious controversies on issues such as human rights.

Of course that assumes you already know the fund that you want to invest in which you can then put into the tool. A potentially useful starting point for ethical fund ideas could be the ACE 40 fund shortlist provided by investment platform Interactive Investor* known as ii. Interactive Investor conducts regular performance reviews of its ACE 40 shortlist. Funds that make the ACE 40 list are labelled “Avoids”, “Consider” and “Embraces”.

• Avoids means funds that exclude specific companies, sectors or business practices, such as tobacco.
• Consider means funds that take into account strict environmental, social and governance (ESG) criteria, such as pollution levels.
• Embraces means funds that focus on companies that deliver positive social and/or environmental outcomes, such as renewable energy.

Alternatively you could use a research site such as Morningstar to screen for funds that match your criteria. Also make sure you check a fund’s own factsheet as it will tell you the sector breakdowns and also the top 10 holdings within the portfolio. So that gives you a good starting point and in the 'useful links' section below I have linked to our youtube ethical investing event which covers everything to do with ethical investing and will answer more of the questions you might have.

But does investing ethically impact performance? Does it cost more?

Actively managed ethical funds can be more expensive than their non-ethical peers and this is even true of robo-advice off-the-shelf ethical portfolios versus their standard portfolios. Here is a link to an article looking at the best ready made ethical stocks and shares ISA portfolios.

It is possible to buy passive funds such as exchange-traded funds (ETFs) which have an ESG tilt to try and keep portfolio costs down if you are managing your own investments. But often you would still have exposure to some companies doing things you might not like. This may include drug companies that test on animals and oil and gas companies that have records of polluting.

In terms of investment performance there’s a common perception that ethical funds underperform mainstream funds but, in fact, there’s a host of research that suggests that you could benefit from stronger share price growth if you hold sustainable companies over the long term. I look at three of these in the article titled “How can I invest ethically and what are the costs?”

However, one thing to bear in mind is that ethical funds tend to have an overweight to smaller companies as well as technology stocks. Prior to 2022 this served ethical funds and portfolios well as both these styles of investing had enjoyed a number of years of strong performance. However, in 2022 technology stocks struggled as central banks raised interest rates which sent their values tumbling. On top of that oil and gas companies performed strongly during 2022 as inflation soared along with the cost of energy. It was a perfect storm for many ethical portfolios.

But as with any type of investing, if you make sure you understand what you are holding then you can diversify and mitigate investment risks. The takeaway from this episode is that you can make a difference to society and the climate while growing your wealth at the same time. Not only that, but one does not have to be at the expense of the other. It may require more research and work on your part if your investments are to truly reflect your morals and ethics but it is possible.

Useful links

• ESG fund rating tool from MSCI
• Ethical investing videos
• Best Ethical Stocks & Shares ISAs
• How to invest ethically and what are the costs
• Money to the Masses Newsletter
• Money to the Masses Facebook community group

 

Previous episode

• Investing for children & intergenerational wealth - Episode 9

Please remember, with investing your capital is at risk and the value of investments can go down as well as up, so you may get back less than you invest.

 

 

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If a link has an * beside it this means that it is an affiliated link. If you go via the link Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. But as you can clearly see this has in no way influenced this independent and balanced review of the product. The following link can be used if you do not wish to help Money to the Masses - Interactive Investor,