What is ethical investing?

What is ethical investing?

Ethical investing is a strategic approach to funding organisations, businesses, or projects, aiming for both financial returns and positive societal impact. It involves consciously choosing where your money goes, prioritising environmental, social, and ethical considerations. This can mean divesting from companies with harmful practices, such as those involved in arms or fossil fuels, or actively investing in ethical alternatives like renewable energy and community housing.

This might sound complicated, but luckily there are lots of investment platforms and providers that will do it for you. These can include banks offering ethical ISAs and investment accounts, ethical pension providers, and specialist ethical investment platforms. The robustness of their ethical practices varies greatly, however, so it’s worth spending some time looking for options you can trust.

Ethical investing involves an element of risk. A good rule of thumb is that you should never invest more than you can afford to lose. However, pensions, stocks and shares ISAs and cash ISAs are guaranteed by the UK Financial Services Compensations Scheme, which may be able to compensate you if your bank or provider goes bust.

Many of us hold investments, whether we realise it or not. Our pensions are a form of ethical investment, as are any investment funds or ISAs that we own.

The money we provide through our investments may be going to anything from coal-burning power stations to new wind farms. So making sure you choose an ethical option can be an important way to have a positive impact on the world.

Is ethical investing important?

Ethical investing is crucial for shaping a sustainable future. Your investment decisions directly influence whether companies and projects thrive. By choosing ethical options, your money can actively support sustainable initiatives such as wind and solar farms, rather than contributing to harmful ventures like coal mines. These long-term choices align your finances with your values, driving a broader ethical transition in the economy.

Types of ethical investments

Ethical investing offers diverse avenues, including Pensions, ISAs (Individual Savings Accounts), investment funds, and direct ethical investments. These options serve as distinct frameworks for channeling capital into ethical projects and organisations. 

Consumers can invest directly, for instance by purchasing stocks, or more commonly, through funds. A fund aggregates investments from multiple individuals, allowing for diversified exposure to various companies. Pensions are often a good example of this pooled investment model.

What ethical investments can I make?

Let's explore the different avenues for ethical investing: ethical pensions, investment funds, direct ethical investments, and ISAs. Each offers unique ways to support projects and organizations aligned with your values.

What is an ethical pension?

An ethical pension is a retirement savings plan where your investments are screened to avoid harmful industries, such as fossil fuels, and instead support sustainable sectors like farming or solar energy. 

Often representing an individual's largest investment, an ethical pension provides a significant opportunity to align long-term financial planning with personal values. For more details, consult our comprehensive guide on ethical pensions and pension providers. 

What is an ethical investment fund?

An ethical investment fund pools money to invest in companies or assets, aiming for long-term financial returns. By investing in a fund, you diversify your investments across numerous companies, which reduces risk. However, remember that all investments carry risk, and you could lose money.

An investment trust works in a very similar way to an investment fund, but is set up as a publicly listed company. Investing your cash in an investment trust means buying shares in the trust as you would any other company on the public stock exchange.

Some companies will offer funds or trusts that have special ethical criteria, such as no funding of fossil fuels. To find a provider that suits you, see our guides to ethical investment funds and fossil fuel free investment funds. 

What is direct ethical investment?

Direct investment platforms offer another avenue for ethical investing. Unlike funds, you choose precisely where your money goes, aligning your investments directly with your personal ethics. This gives you greater control over your portfolio.

Platforms like Ethex and Abundance Investment offer investment options and facilitate the investment process. Ethex has, for example, enabled investments in an organisation putting solar panels on schools and in Libraries of Things.

What is an ethical ISA?

ISAs are ‘individual savings accounts’. Every year, the UK government allows each of us to put up to £20,000 into an ISA without paying income tax on the interest or dividends you may get from it.

There are three key types of ISAs and you can find ethical options for all three types in our independent guides to Cash ISAs, Stocks and Shares ISA and Innovative Financial ISAs. 

What ethical investment options are there?

Recently, more and more companies have begun offering specific ‘ethical’ funds, for example ‘Fossil Free Investment Funds’. Unfortunately, though, some of these are more trustworthy than others. Companies may leave significant loopholes in the policies behind these funds, or simply not follow through on their own criteria.

Research by Ethical Consumer recently found that almost twenty percent of ‘sustainable’ investment funds were invested in the world's largest coal, oil and gas companies, or those providing essential service and infrastructure for them. (See video below.)

There are nonetheless some truly ethical providers on the market. Ethical Consumer has rated and ranked 20 ethical investment funds, 15 fossil free investment funds, and 13 pension providers, as well as 46 cash ISA options. Our guides give our Best Buy and Recommended companies in each section.

For each market, Ethical Consumer examines the companies’ policies and track record on issues like tax avoidance and directors’ pay, as well as their investments.

Triodos is a great example, offering both ethical investment funds, direct investments and cash ISAs. The company screens all of its investments based on its thorough ethical investment policy, and publishes a full list on its website.

Greenwashing in the investment industry

Understanding greenwashing in the investment industry is vital, as certain 'fossil fuel free' funds might not align with their stated environmental claims. 

Our research into over 100 of the largest ‘sustainable’ UK funds and trusts found that:

• 21% of funds/trusts invested in companies on the Carbon Underground 200™ (the 200 largest global publicly-listed coal, oil, and gas reserves owners in the world) or were not disclosing sufficient information for us to know.
• 18% of funds/trusts invested in companies on the Macroclimate®30 + top ten oil services and infrastructure list, or were not disclosing sufficient information for us to know.
• 13% of funds/trusts did not disclose their holdings.

This video shows how to identify and differentiate genuinely ethical investment options from those employing greenwashing tactics.

How can I manage my ethical investments?

Decide how you want to manage your investments. You can manage them yourself by selecting specific stocks and shares, potentially saving on management fees. However, self-management carries risk, so only do this if you're confident in your investment knowledge. Consider seeking professional advice if you're unsure.

Where complex decisions around pensions or involving large sums of money need to be made, seeking professional advice is recommended. You can speak to your bank or investment funding company. However, they are ‘restricted advisers’, meaning that they will only give advice on a limited range of products, namely their own.

Independent Financial Advisers (IFAs) will offer more impartial advice. For a fee, they will help you understand your financial situation and your different investment options. In recent years, there has been a growth in IFAs specialising in ethical options. We have a guide to choosing an ethical independent financial adviser.

Citizens Advice also has a useful webpage on getting financial advice.

Passive or actively managed ethical investments

Different investment providers and platforms will manage your investments in different ways. If a fund is ‘actively managed’, a portfolio manager and a team of analysts will be following trends and deciding what to invest in.

If a fund is ‘passively managed’ investments will be more long-term, and there will be less buying and selling. They will often follow well-known indexes such as the S&P 500, and just make investments in whatever companies are on these lists. Some ethical investment funds are linked to sustainability indexes, like the FTSE4Good. These indexes are not always particularly robust unfortunately, meaning you may end up with a fund that is less ethical than you hoped.

When choosing an ethical investment option, you probably want to understand how the investments are managed and what this means for its ethics. E.g. are all investments screened in line with the providers’ ethical policy, or are they chosen based on a sustainability index? For the reason outlined above, lots of the more ethical options are actively managed.

How much does it cost to invest ethically?

Ethical investment funds typically involve various fees, primarily calculated as a percentage of your total investment, not your return. The most significant is the 'annual management charge,' which fluctuates based on the fund's management style. 

Actively managed ethical funds, which involve human expertise in investment decisions, tend to incur slightly higher costs compared to passively managed options due to the specialized oversight required.

Which? says that you should expect the following annual management fees as a percentage of your total investment:

• 0.75% to 1.25% in most actively managed funds
• 0.1% to 0.85% in most passively managed 'tracker' funds

Which? also has a good guide to different types of investment fees.

Of course, you may be able to reduce this fee if you choose to manage your own investments, but this is only recommended for those who feel comfortable. You will still be charged for buying and selling your stocks and shares.

There will likely be other smaller fees. In order to keep track of these, a fund should give an Ongoing Charge Figure: this will give you an aggregate amount. You’ll be charged these fees whether you use an investment platform or a direct investor. They usually also apply to any ISAs or pensions you own.

On top of the management fee, you may also be charged a set-up cost (a flat amount) and a monthly or annual platform or administration cost (a flat amount or a percentage). There may also be a ‘exit fee’, particularly for funds that are linked to a specific time period. Look for these additional fees, as they may often be in the small print.

Money Advice Service has a good guide to different fees.

Do ethical investments perform better or worse than conventional funds?

Historically, concerns existed regarding the returns of ethical investments. However, recent evidence suggests these worries are largely unfounded. A June 2020 study by Morningstar, a global investment company, revealed that sustainable investment funds often outperformed traditional counterparts. 

Analyzing nearly 4,900 European funds, the research indicated that almost 59% of sustainable funds yielded superior performance. While data is encouraging, it's crucial to remember that investment returns are never guaranteed.

While your return on a fund will be based on its performance, cash ISAs and pensions often have a fixed rate of interest.