Navigating the minefield of ethical investing

I mentioned earlier in the year that one of my financial goals this year was to look deeper into ethical investment options. There’s definitely been some underlying tension between my love of the concept of financial independence, and my social and environmental justice values.

Although that little niggling feeling of guilt has been persistent, I’ve been pretty good at ignoring it. But it’s about time to bring my FI-loving half and progressive half to a coherent whole. If I make conscious decisions every day based on my values – like what I eat and where I shop – my investments should complement those efforts, right?

 

Why bother with ethical investments?

Let’s face it – the world is pretty screwed up. Inequality is skyrocketing, climate change is just around the corner (if not already here), and corporate power is pervasive and often binding. I personally don’t want my investments to fuel this trajectory.

I see the wealthy (and often FIRE bloggers) talk about the moral imperative to give back via philanthropy. But I don’t want to build wealth off of companies engaged in destructive business practices, only to “give back” in a piecemeal fashion once I’m FI*. I’ve worked long enough in the non-profit sector to understand the value, but also the inherent limitations of charitable giving.

Short of a bloody good overhaul of the capitalist system, it would be great if we could support companies that provide social value, and stop supporting those that actually cost society and the environment in the longer term.

 

Ethical living is HARD

Mind you, I understand just how difficult that is to actually do. I also don’t want to come across as judgemental of other people’s investment choices – we each have our own values and priorities. And I’m far from perfect myself after all.

As The Good Place wonderfully illustrates in its latest series, trying to live an ethical life in the 21^st century is complicated, if not near impossible. I still use Amazon and Facebook services for example, which are known for exploitative labour practices and fuelling genocide, respectively (I guess I’m going to The Bad Place). There are no doubt amazing people who aren’t somehow compromised by the worst excesses of capitalism, and I applaud them. However, I struggle.

But just because it’s difficult doesn’t mean we shouldn’t stop trying to become more responsible citizens, consumers, and investors however we can. Let’s try to be good!

What my current investments look like

My brain tends to fog over when thinking about investments, so I’ve had the whole “set it and forget it” mindset. That means my investments are incredibly simple. They are split between my ISA and pension and I only invest in one fund under each tax-efficient wrapper.

Stocks & Shares ISA

My ISA represents 28% of my total investments, and is invested in the Vanguard LifeStrategy 80% equity accumulation fund. This means that 80% of my funds are invested in equities through a number of index trackers, with the remaining 20% in bonds.

I chose this fund at least five years ago when I started learning about financial independence. I was overwhelmed with the amount of information out there about investing, so I decided to drown out the noise and take action by choosing the simplest option out there.

While I really like Vanguard’s approach, co-operative structure, and the returns I’ve received so far, there are no ethical considerations behind this fund. For example ExxonMobil – who are known for climate change denial – appear prominently in the fund indices. So yeah, not exactly ideal.

Pension fund

I could console myself with the fact that 72% of my investments are in an L&G Pension Ethical Fund. This fund invests in all types of companies in the FTSE 350 Index except for those significantly involved in tobacco sales, arms, gambling, water pollution, and intensive farming.

So there are no ExxonMobils hiding in here (I think?!), but it doesn’t screen out businesses that have destructive practices that happen to be in other industries, or actively invest in companies doing good.

Furthermore, this pension fund hasn’t done all too well since I opened it 10 years ago (again I was overwhelmed by information and went for a simple option). With its enormous fees and underwhelming performance against the overall FTSE 350, I should have looked at changing up my pension a long time ago and transferring to a SIPP.

With the growing range of ethical investment options out there, couldn’t I do better – both in terms of ethical considerations, AND with better returns? That’s what I wanted to know before I delved into the minefield of ethical investing.

 

What does ethical investing really mean?

My idea of ethical may be different to yours, which means that how we look at ethical investments will differ. Thankfully, there seems to be an increasing number of options available to match our values. In fact, it took me a while to distinguish between all the different ethical investing labels that get thrown around.

But at the heart of it, there are two approaches to ethical investing:

Negative screening: This means not investing in companies in certain sectors, or those that are known to do harm, such as arms, tobacco, etc.

Positive screening: This means investing in companies that are known for good practices, and could include companies in any sector. This could include companies that are known for treating their employees well, or creating renewable energy for example. It’s this type of screening that will vary a great deal and that you have to research carefully to make sure the fund really reflects your values.

Ethical investment options

These are the common types you might come across:

Ethical funds

These funds use negative screening, much like my pension fund. They screen out companies doing bad based on limited criteria, instead of selecting companies doing good. A lot of SRI (socially responsible investing) funds also fit into this category.

Sustainable funds

These are investments in companies that are having a positive effect on the world or acting responsibly, regardless of sector, and can differ depending on the fund manager. For example, the criteria could range from whether a company’s product can be recycled, if it engages in social projects, or if it is invested in green tech or clean energy.

Impact funds

Impact funds often invest in companies that can show quantifiable social or environmental benefits, for example companies that can save a certain amount of water or CO2 a year. These are more restricted than sustainable funds.

ESG integrated funds

These are funds that carry out due diligence on companies in regard to the how their environmental, social, and governance (ESG) factors impact their performance. It means, for example, that they might invest in a mining company if it has good environmental policies in place. ESG funds are much more focused on financial return and invest in a much broader range of companies, so are probably the least ethical option of the lot.

Individual shares

Choosing exactly which companies to invest in is how an ethical investor can get maximum control and ensure their investments fully align with their values. You can also buy shares in a company you don’t agree with, and use your voice as a shareholder to influence its practices.

Community investments

There are a number of community initiatives you can invest in, like the Stockwood Community Benefit Society (which offers 5% annual return) or Energy4All, which invests in renewable energy co-operatives in the UK. I am sure there are many more similar schemes out there, but there doesn’t seem to be a handy Morning Star-type directory of funds that makes the research easier.

Passive investments

Passive tracker funds will link to an index like the FTSE4GOOD, which bars certain types of companies.

Even Vanguard has SRI options in place which surprised me. I got quite excited about this until I looked closer at its SRI Global Index, which looks VERY similar to its non-SRI indices (i.e. ExxonMobil is still in the Top 10 Holdings). The fund criteria “takes into consideration environmental, social and ethical factors as determined by the Index provider and exclude stocks that violate United Nations Global Compact principles.”

This is a typical example of how ExxonMobil and other unsavoury companies get an ethical pass thanks to the really shitty governance mechanisms we have in place to hold corporations to account.

 

A note on risk

There is a certain degree of risk inherent in these investment options (as there is with investing in general). Depending on which type of ethical investment you choose, you might be exposing yourself to more risk than if you were invested in the total stock market.

For example, excluding big companies involved in fossil fuels and tobacco could mean you’re more heavily invested in medium and small businesses, which are more volatile and vulnerable to economic downturns.

Like with any investment decisions, do your research beforehand!

 

Does ethical investing actually give you a good return?

I don’t think ethical investors should be penalised with really crappy returns and higher ongoing charges. Financial independence is just as important to me as my values, so while I expect to make some sort of trade-off with ethical investing, I’m still looking for my investments to grow.

Research on the performance of ethical investments throws up mixed results. According to ThisIsMoney**, ethical stock market indices have either beaten the regular indices over five years, or have performed very closely.

Ethical funds on the other hand have performed badly over the past 10 years, and have cost ethical investors a pretty penny:

“[FundExpert’s] analysis found that if you had invested £100,000 a decade ago in the best ethical fund in the UK All Companies and Global investment sectors you would be £230,040 and £302,650 worse off respectively than if you’d put that money into the best unconstrained fund.” !!!

This Money for the Rest of Us podcast episode on ethical investing also says that research “suggests portfolios with social, environmental and governance screens underperform both the broad stock market and portfolios with a concentration of ‘sin’ stocks,” although there are other factors that come into play.

They say that ethical funds are likely to continue to underperform until consumer behaviour aligns with ethical values. This is where I’m hopeful. Honestly, I think we’re moving towards greater social and environmental awareness and behaviour. At least 1% (maybe even 7%) of the UK population is now vegan. We have schoolkids on the streets protesting climate change. This is latest cover of The Economist.

I’m definitely no expert, but I really think ethical investing makes a lot of sense for people and planet, as well as financially. Fossil fuel companies will eventually see their dominance wane, and non-smoking policies will kill off big tobacco. So why continue investing in these sinking ships?

 

Now, what to do with my investments?

I still feel like I’m only just scratching the surface of ethical investing, and that I have a ton of additional research to do.

From what I’ve seen so far, I’m still quite dissatisfied with the mainstream options on offer. It seems a lot of ethical investment funds focus on reducing harm while maximising return – which is fair enough, but I think a lot of companies I find problematic will slip through the net.

However, with my modest level of funds and moderate appetite for risk, I am more likely to go for bigger investment funds that have a solid track record. I know that whatever I end up choosing, it won’t be perfect, but at least it will be better than what I have now, both in terms of ethical considerations and financial return.

Funds that have caught my eye include:

Stewart Investors Worldwide Sustainability Fund – this might not be the most obvious choice, but I’ve met with fund managers from Stewart Investors in the past through my work with refugees. They were smart, generous, and incredibly likeable. They were also a fantastic donor, and this counts for a lot as a person who has dealt with a lot of terrible donors. The fund has a great track record (+8.76% over one year, +73.63% over 5 years). The ongoing charge is quite high (at least compared to Vanguard) at 1.66%

WHEB Sustainability Fund – this is an impact fund that focuses on health and population, climate change and resource efficiency. The performance seems pretty amazing (+12.08% over one year, +84.57% over 5 years). Again, the ongoing charge is quite high at 1.68%.

I also like the idea of continuing with some passive investing, so I’ll be looking further into FTSE4Good and other ethical trackers.

Any seasoned investor will tell me to not over-invest in a particular region, and balance my portfolio with stocks. Plus I need to look at overall costs. So yeah, I’ve got a lot more homework and decision-making to do!

And just as investors review and rebalance their portfolios on a periodic basis, I know I’ll have to stop being a lazy backseat investor and review my investments on an on-going basis from an ethical and financial perspective. With the ethical investing landscape growing and developing, hopefully in a few years there will be better options for more discerning ethical investors.

 

If you made it this far, thanks for reading! I’m still learning and growing as an ethical investor, so if you have any thoughts, clarifications, or advice on this matter, I’d love to read them in the comments below.

 

*This is a great article from Triple Bottom Line FI on why our investments are just as (if not more) important than philanthropy:

**Thanks Weenie for sharing this article with me!

 

Additional reading and resources

Hargreaves Lansdown Guide to Ethical and Sustainable Investing

Vanguard White Paper on ESG, SRI, and impact investing

The Difference Between SRI and ESG Investing

8 ethical investment funds that could make the planet and your wallet a better place