A complete guide

The Ethical & ESG Investment Guide

What does Ethical investing mean?

Ethical investing refers to investing activities that reflect the investors’ moral or ethical values. For instance, an investor who believes in protecting the environment would not invest in companies that harm it. Similarly, an investor who believes in high wages for workers would not buy financial securities linked to sweatshop labour.

People often use the terms “ethical investing” and “socially conscious investing” interchangeably. However, socially conscious investing refers to a generally accepted portfolio structuring approach whereas ethical investing is more personalised. 

Different types of ethical investments

Ethical investing can take on a variety of forms. Here are some of the ways ethical investors allocate their capital according to values:

Ethical Funds

Ethical funds are bundles of financial securities that make ethical investing easy. Investors transfer capital to fund managers who invest in ethical securities on their clients’ behalf. 

These funds are suitable for most investors, but not all. For instance, Islamic investors may view banks as unethical (because they charge customers interest) whereas Western fund managers may not. 

Ethical stock Investing

Ethical stock investing is the practice of preferentially investing in companies that attain good ethics, according to the investor’s personal moral code. Examples of popular ethical companies include Hewlett Packard, Salesforce, and First Solar. However, whether these firms meet the investor’s personal ethical standards depends on their values. A company that is ethical to one person may be unethical to another.

Ethical Property Investing

Ethical property investing refers to the practice of investing in housing or commercial real estate with the intention to do good. Investors, for instance, might put their money into social housing projects or invest in facilities that produce green energy. Typically, they stay away from buy-to-let investing or other schemes that keep people trapped in rented accommodation or harm the environment.

In some cases, ethical property investing also includes investing a little extra into private commercial buildings so that they offer civic function, too. For example, a commercial real estate developer might provide outdoor seating as part of a project that anyone can use, including non-patrons.

Ethical Investment Bonds

A bond is a financial instrument that requires a debtor to pay back the principal and the coupon (an interest payment) at a predetermined date in the future. Bonds are essential for capital markets to function and for projects to get off the ground. However, people may view certain investment bonds as unethical.

Bonds and bond funds let investors avoid exposure to certain industries based on their ethical preferences. For instance, a bond fund might avoid the weapons or fossil fuel industries. 

ESG

ESG stands for “environmental, social, and governance” and is a popular way of classifying various investments. Rating organisations score individual securities and equities on their ESG characteristics, providing investors with granular information on how various firms perform ethically. 

ESG and ethical investing are not the same. The former uses generally accepted rules to rate a company on an ethical scale while the latter is a matter of personal preference.

SRI

SRI or “socially responsible investing” is a type of investing that seeks to foster a more peaceful, just, and sustainable world. SRI and ESG investing are similar, but SRI is a simpler approach. It involves investing in companies simply looking to do good in the world, while ESG investing actively focuses on firms that are working to reduce negative externalities and deliver social benefits to wider society. 

Impact

Impact investing is another term for investing that seeks to generate positive, measurable environmental and social effects while providing investors with reasonable financial returns. The idea is to encourage real change in the world through dynamic, innovative and risky methods. Positive impacts should ripple out to both investors and the community. Again, however, the definition is not precise.

Faith-based Funds

Faith-based funds are collections of assets that meet the requirements stipulated in various religious texts and doctrines. For instance, Islam forbids usury. Therefore, an Islamic fund might eschew bonds and stocks of companies that make a profit by lending to customers. Likewise, a Christian equity fund might avoid companies involved in supplying abortion medications, contraceptives, weapons or pornography. 

Is Ethical Investing Profitable?

Investors often worry that investing ethically means lowering their risk-adjusted returns in exchange for a portfolio that aligns with their values. However, the evidence does not support this conclusion. Ethical portfolios appear to offer similar performance to traditional funds, and in some cases, they may be superior. 

ESG firms, in particular, appear to outperform the market. Far from being a weakness, their ethical strengths are a resource that generates trust, produces a better brand image, and yields higher productivity. 

What are the main benefits?

• You can invest in alignment with your personal values and ethics
• You can avoid investing in financial securities that conflict with your faith or spiritual beliefs
• You could earn a higher return than investing in a random index of companies 
• The value of ethical securities could rise in the future as demand increases
• It encourages businesses to adopt ethical practices, improving quality of life for their vulnerable stakeholders

Disadvantages to ethical investments.

• Diversification options may be limited
• It can require a lot of research, particularly if you rely on your own analysis of whether a security is ethical or not
• Fees for ethical investment funds can be higher due to the research involved in establishing them

Does ethical investing make a difference?

Ethical investing can make a difference, but not always in the way that you might expect. When an investor buys a stock, they are usually purchasing it from another investor. If the market believes that the stock is unethical, then the value will go down, and then the owner will receive less for it when they sell. Therefore, there is an incentive to sell stocks of companies that do not fulfil most investors’ ethical stances. 

Whether this makes holding these stocks less profitable over time, though, depends on the growth rate of their price. If the price continues to rise at the same speed as ethical firms, then returns to new investors will be the same, even if the absolute stock value is lower. However, if ethical investing picks up speed over time, returns to unethical stocks will be lower than the market, and returns to ethical stocks will be higher.

Ethical investing can also increase the money ethical firms raise at their initial public offerings (IPOs). If a firm’s ethics align with more investors’ values, there will be more competition for the company’s stock, pushing up the price.

What are the trends in ethical investing?

Ethical investing is a movement that started slowly but is gaining significant traction. 

1. Ethical investing is leading to an explosion in sustainable debt. Data suggest that global sustainable bond issuance hit £1.31 trillion last year, up from just £23.58 billion in 2013, and £626.7 billion in 2020. 
2. The UK ethical funds sector returned an average of 8.58 percent in 2021, compared to 14.23 percent for the non-ethical sector
3. Seven percent of new UK investors between the ages of 18 and 34 chose to invest in ethical funds or projects last year, whereas only around 5 percent of all investors did

Ethical investing is now worth around £17 billion in the UK and rising every year.

UK Vs Global Market Trends

According to research, over half of UK investors, approximately 57 percent, hold ethical investments of one kind or another. That compares to just 33 percent of global assets. The youngest generation in the UK, Gen Z, is the most likely to invest ethically at 66 percent.

Financial Risk

The financial risks of ethical investing are often the same or lower than conventional investing. Investors are still able to diversify their portfolios in the normal way, spreading their risk across a variety of asset classes. They are also able to avoid the risk of investing in unsustainable stranded assets or companies that face reputation risks.

Top tips for sustainable investing.

• Don’t try to pick your own stocks first. Instead, stick with sustainable funds. 
• Look for funds that offer more diversification. Avoid those that focus on just a small number of highly vetted companies or instruments
• Carefully monitor funds for changes in their ethical status
• Consider both the fund’s performance and sustainability. Many ETFs that score highly in the ESG ratings perform poorly

Getting the right advice on Sustainable investments.

If you’re looking for advice on which sustainable investments to choose, contact Acumen today. Our experts can help you make your investments and pensions more sustainable. Contact us today to learn more or book an appointment. 

Ethical Investment FAQ

About David Thompson - Director & Financial Adviser

David is the company Director at Acumen in its various guises since 1995. Extensive economic background, starting with degree from LSE.

View all posts by David Thompson