Ethical investments: where is your money really being invested?

With no common standard of what ethical investment means, well-meaning investors are getting caught out by not-so-sustainable funds.

Ethical investment should be all-so-simple: it’s about investing your money in a way that supports your values – or at least doesn’t contradict them.

A recent survey by Boring Money found that 60% of all investors wanted to avoid arms manufacturing, tobacco and gambling.

Very few of those investors have acted on this desire, however: ethical funds account for a tiny 1.3% of Investment Association funds.

Now Nutmeg, the company that spearheaded robo-advice – where a computer picks your investments for you – will build you an ethical portfolio.

It isn't the first robo-advice platform to do so, but Nutmeg has also come up with a scoring system to figure out how ethical your portfolio really is.

It's taking on one of the oldest and biggest problems facing anyone who wants to invest: how do I know how if my ethical investments really are that ethical?

Ethical investment, like all types of investment, could cost you money. This guide is a look at approaches to investment, not advice on which funds to pick.

This article is part of a wider series on investing, covering all areas from stocks and shares to buy-to-let, peer-to-peer and alternative investments. Click here to view the full guide.

The problem with ‘greenwashing’

Working out a fund's ethical credentials is anything but straightforward.

Funds use dozens of labels, such as ‘ethical’, ‘sustainable’, ‘ESG’, ‘green’ and ‘impact’, yet there are no rules governing what they actually mean.

Without agreed definitions, it’s easy to get tripped up.

Earlier this year I invested in a fund (a collection of stocks and securities) called the Vanguard Socially Responsible Investment European Stock Fund.

Recently, I decided to have a look at the actual companies my money had gone into. It turns out both Royal Dutch Shell and booze giant Diageo are in the top 10 holdings.

Now many people are ok with investing in these companies and that’s a personal choice: it’s the use of the ‘socially responsible’ label that I take issue with.

That Vanguard fund was also criticised by financial advisers Castlefield, which complained that “simply using the term “ethical” or “sustainable” in the name of a fund does not make it so.

"This distorts the definition of thoughtful investing to use it as a misleading marketing tool rather than a way of investing in sustainable businesses.”

The European Commission has also warned of ‘greenwashing’, where funds promote themselves as ethical without investing accordingly.

Beginner investors like me depend on funds and ready-made portfolios from robo-advice platforms because we don’t have the time or knowledge to pick individual stocks.

Investment is confusing enough, without trying to figure out whether an ‘ethical’ fund really is what it claims to be.

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Don't label, score

James McManus, head of ETF research at Nutmeg, isn't a fan of branding funds as ethical or otherwise.

“It’s easy to label something but that doesn’t help consumers understand, or compare, or be empowered to make a better decision.”

Instead, Nutmeg gives its portfolios an ethical score out of 10, of which 7 or above is ‘very good’. There are also subscores for environmental, social and governance factors, such as a carbon intensity or the proportion of women on a company’s board.

“One of our customers’ top concerns is the idea of greenwashing,” explains McManus. “That’s where this concept of concrete insights came from.”

Having data that shows the benefits of ethical funds – such as carbon emissions – also helps investors justify the slightly higher fund costs, says McManus.

“A lot of the customers we spoke to weren’t that interested in sustainable investing until they knew exactly where they stood today.”

Opinion: it’s too difficult to invest your money ethically

Is your portfolio ethical?

Nutmeg works out its scores using thousands of data points from industry researcher MSCI and this incurs a cost.

Nutmeg is among the more expensive robo-advice investment platforms in the market: Wealthify, Wealthsimple and Plum can build you an ethical portfolio with lower charges.

But there are other, simpler ways to judge whether a fund or portfolio reflects your values.

Fund manager Kames Capital has run ethical funds since the 1980s. Its ethical funds exclude certain types of companies, an approach sometimes referred to as ‘dark green’ investing (Nutmeg and many funds also do this).

“It’s not for us as a product provider to say what is and isn’t acceptable,” says Ryan Smith, Kames’ head of ESG research. Kames’ decision not to invest in weapons and animal testing, amongst others, comes from surveys of its investors.

More recently, fund managers including Kames have launched ‘sustainable’ funds which don’t exclude as many companies but instead prioritise or reward good behaviour.

Taking a more liberal approach to screening gives you more companies to choose from and more ability to diversify, argues Smith.

One such example is Legal & General’s ‘GIRL Fund’, which puts more money into FTSE 100 companies with more women on the board – although these companies include tobacco, alcohol and fossil fuels.

When it comes to ‘ethical’ vs ‘sustainable’ investing, Smith cautions “we don’t think one approach is harsher” and notes that many sustainable funds also exclude certain industries.

Checking a fund

If you’re considering investing in a fund, the provider should explain how it picks funds and whether it excludes certain industries on its website.

Many funds use the United Nations’ Principles for Responsible Investment for guidance, although these are mainly concerned with good governance of business rather than actively fighting climate change or social problems.

Many funds disclose their top 10 holdings on their website and this may reveal unwelcome surprises, although it isn't comprehensive.

You can find other ethical fund ratings on Good With Money and Morningstar, although you should check the criteria they’re using to make sure you agree.

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Change is coming

Everyone has their own values and it’s easy to become overwhelmed when trying to pick an investment that matches yours.

Critics of ethical investing often claim that the industry’s inability to agree on values means it will never become the norm.

However, things are beginning to change. The European Commission is developing a set of rules for environmentally-sustainable funds, which they plan to roll out between 2019 and 2022.

From October next year, UK pension schemes will have to disclose whether they take environmental, social or governance factors into account.

And with more data available on companies’ ethical credentials, ‘greenwashing’ fund managers will have fewer places to hide, argues Nutmeg’s McManus.

“A couple of years ago people weren’t looking at gender pay gaps. Now that gender pay gap data is available, should you be incorporating that into your investment analysis?

“These data sets are getting more accurate, you’re getting higher quality data and that’s only going to improve.”

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