What is Ethical Investing?
Ethical Investing – also known as Sustainable and Responsible Investment (SRI) or Environmental, Social and Corporate Governance (ESG) – refers to the practice of using your ethical principles as the primary filter to select how you will invest your money. It aims to exclude profiting from activities that are considered harmful to society and the environment. This type of strategy invests in organisations, companies and projects that are committed to operating in a way that is sustainable for the future.
This is typically done by filtering out harmful activities (negative screening) and proactively seeking to invest in companies that are committed to making a positive impact through their environmental, social and governance (ESG) practices (positive screening).
Negative screening: most ethical funds will screen the so-called ‘sin stocks’, such as tobacco, gambling, weapons and adult entertainment. Other issues screened might include animal testing, intensive farming, nuclear power, genetic engineering, deforestation, and poor human or labour rights. The activities screened and the screening criteria used varies between fund providers.
Positive screening: aims to identify those companies demonstrating or showing commitment to achieve the highest standards of practice in the areas of environmental impact, social justice and corporate ethics. Only organisations that score highly across these three areas will be eligible to receive investors’ money. In this way, ethical investing gives you, as an individual, the power to allocate capital towards companies whose practices and values align with your own personal beliefs.
Ethical plans combine negative screening with proactive selection based on ESG scores, as well as qualitative, human consideration of a wide range of other factors that contribute to a commitment to future sustainability.
Performance of Ethical Funds
Ethical funds have the potential to perform well over the long term, but their performance will differ to that of more conventional funds. If areas that ethical funds can’t invest in are performing well, ethical funds could underperform compared to unrestricted funds. But ethical funds could do well if these areas suffer a setback.
Many areas where ethical funds can’t invest, like tobacco and some healthcare businesses, tend to be the ones that make money whatever shape the economy is in. Ethical funds have to invest more in cyclical businesses, like those in the technology or financial sectors, whose share performance tends to mirror the health of the economy. Profits and dividends rise during the good times but suffer during downturns.