What is ethical investing?
Concerned about climate change? Worried about workers’ rights? Well, ethical investing just might be the approach for you. Simply put, ethical investing is the practice of investing not just to get a return on your cash, but also to bring about a positive social or environmental outcome. It has grown hugely in popularity in recent years, with an estimated £23.5bn held in ethical UK funds according to The Ethical Investment Research Services (EIRIS) Foundation. Whichever way you slice it, that’s a lot of money being put where our morals are!
Negative and positive
When it comes to ethical investing, there are two key things to note. Firstly, there is no one definition of ethical investing, neither is there a set consensus on what the definitions mean. This blog will explore the definitions that are perhaps best known, and how they sit on a spectrum. One end of the spectrum is characterised by the avoidance of unethical investments — this is called negative screening. While the other end of the spectrum focuses on ethical investments – in other words positive screening.
Secondly, when it comes to ethics, each person’s views might be deeply personal. What one investor might consider unethical — investing in a company that produces alcohol — might be perfectly fine to someone else. Even between ethical investors, there are differences in opinion in what to invest in. One investor may choose to focus on the environment, while another may choose to focus on diversity in the workplace.
Before we go on to the different ethical investing types, let’s explore what we mean by traditional investing!
Traditional investing is the approach that you are probably most familiar with. As far as ethics are concerned the traditional approach is only concerned with investing ‘legally’. Depending on the types of assets you hold, and particularly if you invest in pooled assets like funds and ETFs (more on the different investment types ), you may be invested in companies that manufacture arms, tobacco or fossil fuels. This could even apply to your workplace pension if you’ve been auto-enrolled into a default plan, so it’s well worth checking with your employer whether you’re invested in an ethical plan or not, or whether you have the option to do so.
If you want to invest ethically, it would be an oversimplification to say ethical investing is good, and traditional investing is bad. Everyone must start from somewhere. However, with a few small tweaks it can be straightforward to get started with ethical investing, starting with the ESG approach.
ESG – Environmental Social Governance
At one of end of the ethical investment spectrum is ESG investing. ESG stands for ‘Environmental, Social and Governance’, and it is an investing approach that focuses on companies that are rated highly across certain environmental, social responsibility or corporate governance criteria. We use the word rated here because there are a number of research organisations who do exactly that. In the US, MSCI is one of the main ESG ratings firms, and in the UK, it’s FTSE Russell – yes, yes, the folks who created the FTSE 100 index!
The simplest way to invest in ESG companies is to invest in an ESG fund, and thankfully you can do this via a number of investment platforms. ESG funds tend to screen out or avoid certain companies, which is great if you don’t want to invest in industries such as tobacco or fossil fuels.
However, one of the limitations of the ESG approach is that a company doesn’t need to be rated highly across all three ESG criteria to be classed as such. For example, a company could score highly on its environmental practices only, and still make its way into an ESG fund. You may be surprised to learn, for example, that British American Tobacco achieved just that in March 2021.
SRI – Socially Responsible Investing
Next on the spectrum we have ‘Socially Responsible Investing’ or SRI. SRI also seeks to achieve positive outcomes, but goes a step further than ESG investing when it comes to which companies are chosen or not. With SRI, specific companies may be actively included or excluded when making investment decisions, and the business’s activities are also considered. So while a tobacco company might appear in an ESG portfolio due to its environmental practices, it wouldn’t necessarily be included in an SRI portfolio.
Another move along the spectrum takes us to Impact Investing. Building upon socially responsible investing, the objective of impact investing is to generate a specific and measurable social or environmental outcome alongside a financial return. Where it differs from the ethical investment approaches mentioned so far, is that although a financial return is expected, it is not the primary aim. An impact investor could choose to invest into a not-for-profit for example. With impact investing, investors are largely using their money to generate a positive outcome, not the other way around.
Finally, we have philanthropy, a term which has been popularised by the activities of some of the world’s wealthiest, such as Bill and Melinda Gates, and Warren Buffett. With philanthropy, an investor will use their capital to generate a positive social or environmental outcome, whether they make a financial return or not, for a very specific purpose. It is common for the philanthropist to pledge and donate money over specific time periods, sometimes years! While philanthropy is perhaps most associated with the super-rich, you don’t have to be a billionaire to be a philanthropist!
If you want to invest ethically, one of the most important things to do is decide what your values are and then choose the approach that best aligns with your principles. It’s also important to note that ethical investing is a journey, much like investing in general. You might not be investing ethically right now, but there’s nothing to say that you cannot move on to a more ethical approach down the line. You could also pursue more than one approach in tandem.
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