Ethical investment remains a work in progress

It’s still too challenging to find funds that match your principles.

The flurry of activity around Good Money Week this year feels more than justified.

Launched in 2005, this annual initiative —24 to 30 October  — aims to help people understand the benefits of sustainable and ethical finance, whether in pensions, investments or savings. And 15 years on, Covid-19 is providing new motivation for investors to explore investing in ethical funds.

The hard months of lockdown have made us focus on what really matters. For some, climate change is the spur to action, as evidence of its effects continues to pile up regardless of the pandemic. For others, social issues are at the top of their minds. The Black Lives Matter campaign gained huge global momentum this year, slave trader statues were pulled down, and this week even that most traditional of institutions, the Royal Mint, joined in, launching the UK’s first coin to celebrate diversity.

While aligning profits to principles is now the hottest investment trend, it’s a myth that this movement is just for the young and “woke”. Assets in ethical propositions held by customers of interactive investor, the investment platform, have increased significantly over the past four years, and Baby Boomers are leading the charge over younger adults.

The generation born after the Second World War moved from holding 0.47% of assets in ethical funds or investment trusts at the end of 2015 to 5% (as at April 27 2020), outstripping millennials, whose holdings rose from 0.88% to 4.35% over the same period. This could suggest that older generations are concerned about not just passing on wealth but passing on a healthier planet.

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The dramatic increase in ethical exposure could be down to a combination of factors: more availability, increased awareness and long-term performance. There is a growing body of evidence that suggests companies with good environmental, social and governance (ESG) practices should be expected to outperform their less ethical counterparts, especially as interest in sustainability and the environment grows.

A study by Moneyfacts found that ethical funds available to UK investors have proved particularly resilient during the coronavirus pandemic, with the average ethical fund growing by upwards of 4.3% over the past year compared with an average 1.5% loss from non-ethical propositions.

A longer-term piece of evidence is a “study of studies” conducted by Deutsche Asset and Wealth Management with the University of Hamburg in 2015. This looked at 2,000 studies since 1970 into the impact on returns of investing along ESG lines. It found that in 62.6% of studies, the use of ESG criteria had a positive impact on corporate financial performance, compared with just 10% producing adverse effects. 

Profits with principles have become a reality. At the same time, ethical investing in the 2020s has come a long way from the handful of ethical investment funds developed in the 1980s that simply avoided the “sin stocks” involved in traditionally unethical activities such as gambling, alcohol or weapons.

The Investment Association, which represents the funds industry, says more than a quarter of the UK’s assets under management are invested using a socially responsible strategy of some kind.

Recognising that there is an oppressive amount of jargon around, last year it introduced some definitions in responsible investment to help fund managers create a common language that their customers will understand. 

This fell short of the simplification that’s needed to aid understanding. It’s still too difficult for would-be ethical investors to navigate the alphabet soup of ESG criteria, socially responsible investing (SRI), impact and sustainable investing, which all have different nuances, alongside traditional negative screening strategies.

And, before you choose a fund, investment trust or ETF, you need to be clear about what matters to you. One person’s ethical stock is another person’s sin stock, and this applies to fund managers and index providers too.

Boohoo’s (LSE:BOO) prominence in ESG funds was due partly to the high scores the UK fashion retailer was given by ratings providers. But fast fashion is cheap and disposable — two things that scarcely fit with being sustainable.

You might also be surprised by the regularity with which certain oil and gas companies appear in ethical and ESG portfolios. But while oil is a long way away from what many would define as ethical, many such companies are investing heavily in clean energy.

The Good Money Week campaign recommends that investors who are not sure about what matters to them look for inspiration to the United Nations’ sustainable development goals. But there’s too much for the average investor to digest here: 17 sustainable development goals on issues from ending poverty and hunger, to clean water and energy, decent workplaces and reduced inequalities, climate action and peace and justice.

Even when you are clear on your investment criteria, there’s the huge challenge of finding a fund to match. Across open-ended funds, investment trusts and exchange-traded funds, there are about 5,000 collective investment options, but little help for investors on which of them should be considered as ESG funds. 

interactive investor has identified 140 socially responsible and environmental funds, investment trusts and exchange-traded funds. It’s still a small and immature market. However, every year more funds are launched as the sector gathers momentum.

In a poll by interactive investor of 21 sustainable asset managers, most said ESG considerations will, in time, be integrated into all investment decisions. Two-fifths believe this will happen in the next five years.

However, greenwashing, where firms market products and investments to appear more sustainable and ethical than they really are, is a phenomenon of growing concern.

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Last year, the Financial Conduct Authority promised to challenge companies it deems to be “greenwashing” products as it moves to protect consumers from being misled over the sustainability of their investments.

So investors must tread carefully and we need to see those challenges made urgently. interactive investor groups recommended ethical investments into just three categories: avoid, consider and embrace (ACE). The first includes funds that avoid companies and sectors which don’t meet their criteria; the second that consider a range of ESG issues or themes; lastly those that embrace companies active in delivering positive social or environmental outcomes.

If you do want more detail, Fund EcoMarket (FEM), run by SRI Services, is another great resource that zeroes in on the core issues and approach of the fund manager. Investors can also check out Morningstar’s Sustainable Fund Type and carbon score for funds.

Fundsmith Sustainable Equity, which is on our rated ethical investment list, has a carbon score of just 2.77% - anything below 10 is considered climate-friendly.

The simplest place for most people to start could be Good Money Week’s core recommendation to ask your employer for an ethical or sustainable workplace pension. This underlines the gap highlighted by the Make My Money Matter campaign, launched this year by film director Richard Curtis, which aims to increase the transparency of how pensions savings are invested.

But there’s also an ethical education gap to fill. interactive investor’s Great British Retirement Survey of more than 12,000 people revealed that more than half of us have no idea if our retirement nest egg is invested in a way that aligns with our moral values, let alone a good carbon footprint.

Mr Curtis, could it be time for Pensions Actually, starring Greta Thunberg, David Attenborough, and the newly styled political activist Hugh Grant?

Moira O'Neill is the head of personal finance at interactive investor. Twitter: @moiraoneill.

This article was written for the Financial Times and published there on 23 October 2020.