Ethical Investment Funds

Ethical Investing

For most people in the UK, investing is not just about making money. According to the Financial Conduct Authority (FCA), 81% of adults would like the way their money is invested to do some good as well as provide a financial return.

Investment firms have been keen to seize upon this desire to invest ethically: UK-domiciled 'responsible' investment funds grew 64% over 2021 to reach £79 billion, far more than the 11% growth in UK domiciled funds overall.

The market is expected to continue growing, one firm predicting that the global market for 'sustainable' investment products could reach $30 trillion by 2030. All these unfathomably large figures, alongside a market that is jam-packed with jargon, can make the world of investment a difficult place to navigate.

In this guide we will talk you through the basics of ethical investment and highlight some of the best ethical funds on the market.

Ethical investing is sometimes seen as an activity reserved for those with stacks of cash, but the market has become far more accessible in recent years. There is new technology such as online investment platforms and lower minimum investments, from a minimum investment of only £1.

What is an ethical investment fund?

An investment fund allows investors to pool their money together and invest collectively, which has advantages over lone investing, such as reducing risk.

If you put your money into an investment fund it will likely be invested in the following:

• Equity (aka ‘shares’ or ‘stock’) – an ownership stake in a company, the value of which can go up or down. When you buy equity in a company you own a (probably small) proportion of it.
• Bonds – essentially debt. Governments and corporations issue bonds (or gilts in the case of the UK Treasury) to raise money. Bonds usually provide a fixed income for the investor, e.g. 3% per year.
• Other investment funds – many investment funds also invest in other investment funds, which is a rather meta way of spreading risk.

At its most simple, ethical investing is ensuring that your money is invested in things that align with your ethics. If you are a vegan, you probably don’t want to own a stake (or eat a steak) in McDonald's.

For many, the idea that they might be earning money from something that they consider unethical does not sit well within them. If your job is treating cancer patients, you might feel uncomfortable if your savings are invested in tobacco companies.

For this reason, many wish to align their investments with their morals to make sure that they are profiting from companies and sectors that are benefiting the world, rather than harming it.

How to invest in a fund

There are three main ways to invest in an ethical investment fund. These are:

• Directly – many funds allow you to invest directly through their website, though check the minimum investment required.
• Through a platform – you might want to invest through an online platform, which can make it easier to invest in multiple funds. For example, the Big Exchange, which is an Ethical Consumer Best Buy, allows you to invest in a range of ethical funds, with a minimum investment of only £25. See our guide to Stocks and Shares ISAs for more on the Big Exchange, or read our article on direct ethical investment platforms.
• Use an ethical financial advisor – it might be worth getting an expert opinion on how to invest in a way that meets your moral and financial expectations. Read our article on choosing an ethical financial advisor for more information on this.

Choose Active over Passive funds for ethical investing

An active fund will be managed in an involved, hands-on way. The fund manager will rely on their knowledge and predictions to buy and sell holdings.

A passive fund requires less human management, and usually tracks an index or buys into other funds. For example, a passive fund that tracks the FTSE 100 Index would automatically buy and sell shares depending on which companies are in the FTSE 100.

There is much debate around which brings the best returns but, from an ethical standpoint, we recommend actively managed funds, as passively managed funds usually have less human oversight and so are more likely to invest in unethical companies.

There are passively managed funds investing in sustainable/ethical indexes, but the exclusions and policies that govern these indexes are often weak.

Our recent fossil-free investment funds report found that Exchange Traded Funds (which generally follow an index) were the worst scoring type of investment fund.

Risk with ethical investment funds

Investing is essentially gambling without the negative social stigma attached to it, so your money is at risk. Sadly, investing ethically is not always synonymous with investing profitably – if only the world worked in such a way!

Some funds are riskier than others, and it is these funds that generally claim higher potential gains. However, if you want to choose a lower risk investment fund, opt for one with a large portfolio, particularly one with fixed-rate investments, such as bonds.

We look at the performance of ethical investment funds below.

Direct ethical investing

You may wish to take a riskier (but potentially more ethical) approach and invest in a company or crowdfunder directly. There are a number of good platforms that focus on ethical investment opportunities, such as investing in renewable energy farms or community housing projects:

• Abundance Investment
• Energise Africa
• Energy4All
• Ethex
• Triodos (Crowdfunding investments)

For more information, see our article on Direct Ethical Investment Platforms.

Choosing (and supporting) an ethical fund manager

When you put money into an investment fund, your money is not just supporting the companies in which the fund holds shares, but some of it is actually paying the fund manager.

For this reason, you should think about the ethics of the asset manager, and you might want to ask questions such as:

• Do they engage with companies and vote in a way that you agree with?
• Do they exclusively manage ethical funds, or is their ethical fund merely one good apple among an orchard of rot?
• Do they award their directors excessively?
• Do they pay their tax?
• Are they employee owned?

Financial performance of ethical investment funds

There has long been a view in the investment world that ethical investing isn’t profitable, but this perception goes against the facts.

A meta-study of ESG (Environmental, Social and Governance) fund performance from 2015, which combined the findings of more than 2200 primary studies, found clear “evidence for the business case for ESG investing” and suggested that “the orientation toward long-term responsible investing should be important for all kinds of rational investors in order to fulfil their fiduciary duties and may better align investors’ interests with the broader objectives of society.”

The Global Impact Investing Network’s (GIIN) Annual Impact Investor Survey 2020 also found that “portfolio performance overwhelmingly meets or exceeds investor expectations for both social and environmental impact and financial return.”

However, ethical investing does not guarantee return and, as another report by the GIIN points out, “as in mainstream investing, impact investment returns vary widely.”

The difference in financial performance can be seen in the table below. Be warned: past performance doesn’t necessarily indicate future performance!

*Data from www.trustnet.com
** Data from Impaxam.com 31/1/23
*** As of 6/3/23

Ethical rankings of investment fund brands

How well do the 20 brands of ethical investment funds we reviewed perform in our ethical ratings for carbon management, environmental reporting, product sustainability and transparency?

Logged in subscribers can see the detail in the scoretable above. 

Carbon and environmental ratings

Only two companies received our best rating for Carbon Management and Reporting, which is represented in the Climate Change column.

One received a middle rating, and all others scored worst.

To be awarded a best rating we expected the whole company/asset manager, not simply the fund, to meet a number of stringent criteria. These included reporting on their current carbon emissions, setting targets in line with international agreements, and not being involved in investing in new fossil fuel development, particularly coal. We also wanted to see a credible, detailed discussion of how they had made emissions cuts in relation to investments so far, and how they would make them in the future.

Many funds received a Product Sustainability mark because the featured fund was fossil fuel free, but fell down in the carbon category because they were found to invest in fossil fuel companies in other funds under their management.

There are other environmental issues too, which we rate companies for when compiling our guides.

For our Environmental Reporting column we now look specifically for evidence of companies reducing environmental impacts in other ways too, because environmental issues include more than carbon emissions and climate change. It should not be hard for a company to score middle in this column, as the bar is set pretty low, just drawing out those who say something from those who say practically nothing. However companies cannot score a best if they invest in fossil fuels.

This meant only a few managed a best rating (but several more did manage a middle rating. For example Sarasin had established a Natural Capital Working Group, acknowledging “the dependence of financial capital on natural capital such as clean air, land and water”, and is aiming to better incorporate this into its sustainability analysis, while Janus Henderson detailed how it engaged with companies it invested in, on issues such as sustainable sourcing of soy and palm oil, or water risk, especially in high-stress areas, and how they are reducing water intensity.

Those that had no discussion of reducing other environmental impacts of their investments in their sustainability reporting were Abrdn, Liontrust, Quilter, Rathbones, Royal London, SVM, and Vanguard.

Transparency and voting

When we examine investment funds, we rate them against the usual criteria that we apply to other companies, such as tax and directors’ pay. But we also want to rate them on the companies they invest in. However, this information is not always available, which is part of the reason for our transparency rating.

Most investment companies will hold a large amount of assets, some of which will be held as shares in companies and diversified across a range of sectors to avoid risk. To get a best Ethical Consumer rating for investment transparency and not be marked down, a company must meet the following three criteria:

1. A clear ethical investment policy restricting all assets in at least three key problem areas such as: coal/carbon, deforestation, indiscriminate weapons, human rights abuses, and animal abuse.
2. Full disclosure of companies invested in.
3. Full disclosure of voting (also known as stewardship) at company AGMs (it should be at least annually).

Only a handful of companies scored best. This does not mean that all of their investments were absolutely beyond criticism, but that they had more developed restrictions than the others (on animal testing for example), as well as full disclosure of investments and voting. 

Legal & General and AXA also scored best as they disclosed full voting records, thereby listing the many companies they invested in. They also both had some restrictions that applied to all assets around investments in coal, deforestation and weapons. Legal & General had partnered with Tumelo, using their technology to give investors more input into voting on issues at companies they invested in.

Companies with a middle rating lost half marks across six of our categories to show their likely impacts. Where we could find no or very minimal information, companies got a worst rating. We penalised their lack of transparency by deducting half marks across most of our categories.

This does not mean that they are definitely investing in all the sectors for which we deducted marks, but it is likely and they aren’t transparent enough for us to know with certainty. More details on how each company scored on this metric are available for logged-in subscribers on our website.

Product Sustainability mark

Ending our use of fossil fuels is one of the most important challenges of our time, and many people want to keep their investments out of fossil fuels. For that reason, we have awarded a Product Sustainability mark for funds that are free of fossil fuel investments.

But what does ‘fossil-free’ actually mean? Fossil fuels are still the lifeblood of the world economy and there are few, if any, companies that can claim to operate without any use of fossil fuels.

To complicate matters further, some companies working towards climate solutions still have involvement in fossil fuels – and sometimes their involvement cannot be immediately halted.

For example, Orsted, a leading renewable energy company based in Denmark, has been ordered by the Danish authorities to keep three coal stations open until 2024.

For that reason, it is difficult to formulate a strict but workable definition of ‘fossil-free’, especially if you want to support companies that are actively involved in moving to a low-carbon economy.

In November 2022, Ethical Consumer published a bespoke, in-depth report which examined the extent to which over 100 sustainable investment funds were divested from fossil fuels. To allow for nuance, funds could still be considered fossil-free even if they invested in companies such as Orsted that generated a small amount of revenue (5% or less) from fossil fuels.

We’ve used our Fossil-Free Investment Funds report to inform this guide to ethical investment funds. Any fund that scored 3.5 (out of 5) in our Fossil Free Investment Funds report has been awarded a Product Sustainability mark. The report is freely available on our research website.

Company Ethos

WHEB and Triodos both received Company Ethos marks for being certified B-Corps. Along with Impax, they also received a Company Ethos mark for only offering funds that were focused on ethical/impact investing (other asset managers offered a mix of ethical funds and standard funds).

EdenTree received a Company Ethos mark for its not-for-profit structure, Castlefield for being employee owned, and Royal London for being a mutual organisation.

Why invest ethically?

We explore some reasons why you might want to invest ethically.

The myth of 21x impact

You may have come across a claim by the pension campaign group, Make My Money Matter, that “Making your pension green is 21x more powerful at cutting your carbon than giving up flying, going veggie and switching energy provider.”

While we are in support of the Make My Money Matter campaign to get people to green their pension, we don’t believe this is the right way of understanding the impact of pension or investment funds.

How should we understand the impacts of our decisions – particularly those around our finances? Let’s take the fictional example of Mrs Jones, who is on a mission to do what she can to reduce her carbon impact.

Firstly, she decides to do her weekly grocery shop on foot rather than using her petrol car. Her decision results in her using less petrol, which means her carbon impact is lower than before. The cause and effect is direct and easily measurable.

Next, she decides to stop buying meat (which generally has a high carbon impact) and instead buys plant-based foods. The real-world impact of this choice is not as immediate as her first because the meat that she would have bought has already been produced. However, over time the grocery shop will react to Mrs Jones’ changing diet by supplying less meat than before, which in turn will mean less is supplied by the producer, leading to lower carbon emissions produced.

Although this impact is less direct and immediate than the first, it is fair to say that Mrs Jones’ decision contributed to a reduction in carbon emissions.

Finally, Mrs Jones decides to green her investments by selling the shares she owned in a fossil fuel company and using the money to buy a stake in a renewable energy company. According to Make My Money Matter’s logic, this action would cut Mrs Jones’ carbon impact significantly because she is no longer responsible for the high carbon impact of the fossil fuel company.

The problem with this logic is that the carbon impact of the fossil fuel company has not reduced as a result of Mrs Jones selling her shares – the ownership of this impact has simply been passed to someone else. It is not right to claim that she has cut carbon because no carbon has actually been cut!

While Make My Money Matter’s ‘21x’ statistic may encourage people to green their investments, there is a danger that it might also make people complacent about other actions that have very direct impacts.

If you think that other actions pale in comparison to greening your investments, why bother reducing your daily intake of Brazilian grass-fed beef?

Associated impact

After reading the above, you might wonder why you should bother investing ethically, but there are several important reasons. The first is what we might somewhat cautiously call ‘associated impact’.

Some, if not most, of the positive impact associated with a product can be attributed to the end user (the person who buys and uses the electric car). But we can also attribute impact to others in the value chain, notably: those that run the company (the workers/managers) and the owners (shareholders).

Having a share in a company does not mean you can claim full responsibility for its impacts, positive or negative, but you are becoming part of the wider network that allows it to function and survive, so it is fair to say that your investment has an associated impact.

Expressing support for a sector

By purchasing shares you are expressing support for that company and the industry it represents – similar to how your vote at an election is a vote of confidence for a specific candidate and their wider political party.

When a company’s shares are in high demand, this is generally interpreted as a sign that it is healthy and its future prospects good. This makes it easier for that company to raise capital in future. By the same logic, when no one wants to buy a company’s shares, it may be difficult for it to raise capital in future.

As such, maintaining a buoyant share price is important for a company’s longevity. If a significant number of investors choose to shun or divest from a particular company or sector, it will make it more difficult to operate in future. According to research into the oil and gas sector across thirty-three countries, published in the Journal of Economic Geography, divestment can reduce access to capital for fossil fuel companies and make further exploration more difficult.

A company’s share price can also drop dramatically, such as following a controversy. This was the case in 2020 when the share price of fast fashion retailer Boohoo dropped 18% following revelations about poor working conditions in its factories. Some investors, including Aberdeen Standard Investments, sold their shares, while the Boohoo PR team no doubt went into overdrive in order to stop all the other horses from bolting.

Voting and engagement

If you own shares in a company, you get the right to vote at their AGMs and other meetings – the more shares you own the more influence you have. This gives you power to vote on matters such as who runs the company day-to-day (if you don’t like what the director is doing you can vote them out) and what should happen to any profits made (should they be awarded as director bonuses or should they be used to finance the company’s carbon-reduction plan?).

If you own a significant number of shares, as investment funds often do, you will likely be able to engage with companies throughout the year, especially if you are a long-term investor, as many of the best ethical funds are. For example, an investment fund might pressure a company by threatening to withdraw its investment if that company doesn’t start reporting on its carbon emissions by a given date.

Asset managers should be transparent about how they have engaged with a company so that consumers can assess whether they are engaging and voting in a way that they agree with. Of course, engagement doesn’t necessarily yield results: one small, iconoclastic fish in a big, conservative pond will struggle to have significant influence. For this reason, asset managers should also report on the outcomes of their engagement, to show what effect, if any, they have had – signatories of the UK Stewardship Code are required to do this.