Ethical investing explained - Which? (2024)

What is ethical investing?

Ethical investing is an umbrella term for all approaches to investing that consider values as well as financial returns.

The term also covers issues including, but not limited to, climate change, workers rights, gender equality, arms, tobacco and gambling when selecting companies and other assets.

Traditionally, ethical investing meant not investing in certain companies that contravened your beliefs.

More recently, however, it's expanded to include focusing companies that make a positive real world impact, or investing in other companies in order to help them improve.

Here we explain the various approaches and how to avoid 'greenwashing'.

What makes an investment ethical?

From 31 May 2024, when the Financial Conduct Authority (FCA) ‘anti-greenwashing’ rule comes in, which will ban funds from using language like ‘sustainable’, ‘green’, or ‘responsible’ without the means to justify it.

Here we've detailed the main approaches, which can be mixed and matched:

Exclusionary

Where you don't invest in companies or assets that contravene your goals. For example, your fund may decide not to invest in companies that extract fossil fuels.

Similar to the FCA's Sustainability Focus fund label (see below)

• Pros:you know that your money won't be going into certain industries
• Cons:you've got fewer companies to choose from, and those remaining may have a neutral rather than positive impact

Impact

Where you invest in companies to produce a measurable real-world impact. For example, your fund may invest in companies that make wind turbines to increase the percentage of power generated by them.

Similar to the FCA'sSustainability Impact fund label.

• Pros: your money should have a real-world impact
• Cons:you've got fewer companies to choose from and the real-world impact might not be achieved

Stewardship

Where you invest in companies to make them more positive, via votes at annual general meetings. For example, your fund may invest in fossil fuel producers to encourage them to spend more on renewable solutions and reduce their fossil fuel operations.

Similar to the FCA's Sustainability Improvers fund label.

• Pros: you can invest in a wider variety of companies
• Cons: your money could be going into activities you're not comfortable with, and if in a fund, you're dependent on the fund manager to vote and put pressure on companies

How can you invest ethically?

If you've got limited time, or investment experience, you could ask a independent financial adviser (IFA) to choose investments for you, at a cost. Use an IFA that's part of the UK Sustainable investment and Finance Association.

A cheaper alternative is to use a robo-adviser platform, which offers a portfolio of funds based on your attitude to risk.

If you're happy to make your own investment decisions, you've got several options:

Picking shares

You could buy shares in individual companies with which you agree, but building a balanced portfolio this way is very labour intensive.

Bear in mind that investment platforms tend to charge transaction costs each time you buy or sell a share, so constant tinkering can damage returns.

Investment funds and trusts

Investment funds or investment trusts enable you to invest in hundreds or potentially thousands of companies at once.

Soon UK funds will be able to use regulator-backed labels (see below) stating what sort of ethical approach they take.

Actively managed funds, where a fund manager or team picks the investments, charge higher fees.

Passively managed funds tend to charge lower fees, but rely on indices and/or data to decide what to invest in.

Bonds, gilts and cash

There are a number of fixed income investments available for more risk-averse investors, such as green and ethical bonds.

The UK Government will also begin issuing green gilts, where proceeds are directed towards a range of environmental projects.

If part of your portfolio is in cash, choose a savings account with a more sustainable provider, using our rankings.

New FCA sustainable fund labels

Fund managers will be able to use fund labels from 31 July 2024 that identify their fund as one of the following:

• Sustainability impact - funds that invest in assets directly making a positive impact
• Sustainability focus - funds that invest in assets meeting a robust, evidence-based standard of sustainability
• Sustainability improvers - funds that invest in assets that have the potential to meet a robust, evidence-based standard of sustainability
• Sustainability mixed goals - funds with this label invest in a mix of the above styles.

At least 70% of the assets held in a fund must be invested according to the sustainability objective set out by the fund’s manager, which must fall into one of the above four categories.

The remaining 30% of assets can't be in conflict with the objective, although they don't have to meet it exactly. For example, a fund might need cash or other assets for liquidity.

Fund managers support the companies they're invested in to meet whichever sustainability objective they've set out.

For passively managed funds tracking an index, the index must itself align with the criteria of the label.

Which? Money Magazine

Find the best deals, avoid scams and grow your savings and investments with our expert advice. £4.99 a month, cancel anytime

Sign up now

Will ethical investments make you money?

There are no guarantees in investing, so you should only put in money you can afford to lose.

Investing in line with your morals won’t necessarily make you worse off than investing in a standard fund, and trying to compare the performance of ethical and non-ethical investments is increasingly irrelevant - due to the huge variety of ethical investments and approaches.

Instead, look at the individual company, fund or investment trust you're considering investing in and compare with the sector its in, for instance UK equities funds.

Do make sure that your portfolio is sufficiently balanced to shield you from market downturns. Also check you're not paying over the odds in fund fees.

How can you find out if a fund meets your ethical standards?

1. Read the factsheet- Every fund and investment trust will have a factsheet, which tells you some basics like how risky an investment is and, where relevant, what the fund’s ethical policy is. Some investment platforms will also spell out this ethical policy in their description of the fund
2. Read third-party analysis- You can search for funds or trust through your investment platform, through Morningstar or through Fund EcoMarket, a search engine for ethical funds. Also check how the fund manager has voted at company annual general meetings. Share Action often reports on this and many fund managers publish their voting decisions.
3. Check the labels - The Financial Conduct Authority is planning to introduce four labels to standardise the language used in this area - so you don’t get stuck investing in things you don’t agree with against your knowledge.
4. Ask a financial adviser - If you don't want to pick investments yourself, an independent financial adviser can help. Look for one who is part of the UK Sustainable Investment and Finance Association.