What are Ethical Investment Funds?
The definition of what makes an investment fund ethical varies from one to another and can be complex but, in brief an ethical fund is one that is trying to improve standards and ‘do things better’.
There are several different methods that fund managers use to try and achieve this goal and it is these methods that make one fund more, or less ethical than another in the eyes of an investor.
A fund manager and their team will choose a selection of companies, government bonds, gilts and other assets to invest in, using the money of multiple investors. This pooling together of money creates a ‘fund’. Investors invest in the fund and the fund managers make investment decisions.
Traditionally, the underlying assets of a fund are selected based mainly on financial criteria. The success of a company, the demand for their products, the forward thinking of management etc.
Ethical funds take more than just financial criteria into consideration and look carefully at how money is made, not just how much.
What Makes a Fund Ethical?
The evolution of ethical funds began with the simple ‘exclusion’ of unwanted industries. This has become known as Socially Responsible Investing or SRI.
Funds will typically exclude fossil fuels, weapons, gambling, tobacco and other industries deemed to have no positive impact on society.
Because it can sometimes be difficult to avoid all exposure to these industries (e.g. Supermarkets sell cigarettes) there is usually a tolerance. Funds will avoid companies that generate more than a certain percentage eg. 5% of their revenue from a particular sector.
‘Impact Investing’ funds also follow a simple mandate to only invest in companies that generate most of their income working to solve the many problems facing humanity and the planet. This can limit the number of companies available to invest in and can lead to a more ‘volatile’ investment journey.
SRI and Impact funds have largely come about due to demand from conscientious investors, but it is not just demand for ‘greener’ investments driving positive change.
Companies must also align themselves with a changing world in order to survive.
Enter ESG investing. Environmental, Social, Governance.
Thanks to advances in technology and availability of data, ESG funds are able to use detailed information about a company to determine the negative impact of important Environmental, Social and Governance factors on the company.
While ESG does take into consideration important environmental and social issues, they are looked at from the perspective of the company and the negative impact decisions and behaviours can have on the success of the company.
This is why ESG practices also make good business sense and give a company a reason to consider them.
If a company fails to address the impact that climate change will have on the business and align themselves with global goals to transition to a low carbon economy, they will suffer financially as a consequence.
Companies abusing human rights and using cheap labour will suffer from associated costs (staff turnover, legal costs etc.) as well as negative investor sentiment as conscientious investors become aware of issues through media coverage.
Poor governance in areas such as transparency of manager remuneration (bonuses), quality and integrity of accounting practices and ‘questionable’ or fraudulent activity will also reduce investor confidence in the long-term sustainability of a business.
Companies addressing all 3 ESG areas are scored on their efforts and graded accordingly.
Good quality ESG funds will only select the highest scoring companies.
ESG investing does not actively seek to exclude industries or sectors, rather it rewards companies that are working towards a more sustainable, lower carbon and fairer future.
SRI, ESG & Impact are the most common terms used to describe ethical funds and many examples of each type exist, with a wide range to choose from.
Some funds or portfolios will blend the approaches to create a broader, more diverse investment.
My aim is to match clients ethical preferences with a need for positive financial outcomes to create a rewarding investment experience.