Ethical Investment Funds: Choosing The Right Option

Ethical investment funds are a type of investment vehicle that focuses on generating financial returns while adhering to a set of ethical principles. These funds aim to invest in companies or projects with a positive social and environmental impact, aligning investors' financial goals with their personal values. The main types of ethical investment include negative screening, environmental, social, and governance (ESG), socially responsible investing (SRI), and sustainable investing. Ethical investors consider the social and environmental consequences of investments, typically avoiding companies involved in controversial industries such as tobacco, alcohol, gambling, or firearms. ESG criteria are used to evaluate companies' ethical performance, including their environmental footprint, treatment of employees, diversity and inclusion policies, and corporate governance practices.

Environmental, Social, and Governance (ESG) funds

The environmental component might focus on a company's impact on the environment, such as its energy use, air emissions, natural resource use, and waste management. The social component might focus on the company's relationship with people and society, including issues that impact diversity and inclusion, human rights, employee health and safety, and community investment. The governance component might focus on issues such as transparency, ethics, compliance, shareholder rights, and the composition and diversity of the board of directors.

ESG funds have gained popularity with investors over time, and there are several types of ESG investments to choose from. You can invest in individual ESG stocks or choose from the growing number of ESG funds, including mutual funds and ETFs. When choosing an ESG fund, it is important to carefully read all the available information, understand the fees and expenses, and ensure that the fund's investment strategy and ESG approach align with your goals and values.

Some examples of ESG funds include:

• IShares ESG Aware MSCI USA ETF (ESGU)
• IShares Global Clean Energy ETF (ICLN)
• Putnam Sustainable Leaders (PNOPX)
• TIAA-CREF Social Choice Equity (TICRX)
• Parnassus Mid Cap Fund (PARMX)
• IShares ESG Aware MSCI EAFE ETF (ESGD)
• Invesco Solar ETF (TAN)

Socially Responsible Investing (SRI)

SRI investors select investments based on whether a company's revenue sources and business practices align with their values. For example, an investor passionate about the environment may choose to invest in green energy sources such as wind and solar companies.

SRI can be achieved through negative screening, where investors avoid owning securities sold by companies deemed not to be socially beneficial, and positive screening, where investors actively choose to support companies with positive social and environmental policies.

SRI investors can invest in individual companies or through a socially conscious mutual fund or exchange-traded fund (ETF). Mutual funds and ETFs have the advantage of providing exposure to multiple companies across sectors with a single investment.

When building an SRI portfolio, investors should decide how much help they want, open an investing account, outline their values and priorities, and research their investments carefully.

There are several SRI funds available, including:

• IShares ESG Aware MSCI USA ETF (ESGU)
• IShares Global Clean Energy ETF (ICLN)
• Putnam Sustainable Leaders (PNOPX)
• TIAA-CREF Social Choice Equity (TICRX)
• Parnassus Mid Cap Fund (PARMX)
• IShares ESG Aware MSCI EAFE ETF (ESGD)
• Invesco Solar ETF (TAN)

SRI has gained popularity in recent years, with a 2019 Morgan Stanley survey finding that 85% of individual investors are interested in sustainable investing. SRI funds have also outperformed their non-SRI counterparts in some cases, demonstrating that this approach can be both morally upstanding and profitable.

Impact investing

• An investor's intention to have a positive social and/or environmental impact.
• Investment with return expectations: impact investments are expected to generate a financial return on capital or, at a minimum, a return of capital.
• A range of return expectations and asset classes: impact investments can target financial returns ranging from below market to risk-adjusted market rate and can be made across various asset classes, including cash equivalents, fixed income, stocks, bonds, mutual funds, or microloans.
• A commitment to measuring and reporting the social and/or environmental performance and progress of underlying investments, ensuring transparency and accountability.

There are several ways to participate in impact investing:

• Investing in ESG funds: Environmental, Social, and Governance (ESG) funds consider companies' ethical governance, worker well-being, and environmental practices.
• Socially Responsible Investing (SRI): SRI takes ESG a step further by selecting or eliminating investments based on specific ethical guidelines.
• Donating to impact-investing non-profits: This involves blending charitable donations with investment capital to support higher-risk projects that may not be financially viable otherwise.
• Investing directly in private companies or funds with an explicit social mission: This can be done through venture capital investment or share purchases in companies focusing on areas like solar power or alternative fuels.
• Lending to a non-profit: This can be done through a non-profit loan fund, allowing lenders to pool their capital and spread their risk.

Some examples of impact investment funds include the Bill & Melinda Gates Foundation, the Soros Economic Development Fund, and the Ford Foundation.

Ethical screening and evaluation methods

Ethical screening is a key part of ethical investment, and there are several methods that can be used to ensure that investments are aligned with an individual's values.

Negative Screening

This method focuses on excluding certain industries and companies that are deemed unethical. This typically includes the sextet of sin, which refers to alcohol, tobacco, gambling, pornography, armaments, and nuclear power. Other sectors that may be excluded through negative screening include animal testing, fur trade, child labour, fossil fuels, weapons, and companies with poor labour practices.

Positive Screening

Positive screening is used to identify companies that demonstrate a commitment to high standards of environmental impact, social justice, and corporate ethics. Only organisations that score highly in these areas will be considered for investment.

ESG Factors

Evaluating a company's Environmental, Social, and Governance (ESG) practices is a crucial part of ethical screening. Environmental factors include carbon footprint, resource usage, and climate change policies. Social factors include employee relations, diversity and inclusion, and community impact. Governance factors assess leadership, executive compensation, shareholder rights, and transparency.

Best-in-Class Approach

This method involves selecting the 'least bad' companies within a sector. It can motivate companies in ethically challenging sectors to improve their practices. For example, by comparing with peers, a company can be encouraged to improve its environmental and social records to attract investment.

Values-Based Investing

Also known as negative screening, this approach focuses on excluding companies that do not align with an investor's values.

Integration

This method attempts to improve the risk/return profile by considering ESG risks in the investment process. Portfolios are constructed by selecting companies that score well on material ESG issues that are important for those companies' sectors.

Impact Investing

This approach explicitly deploys investment funds to directly achieve a desired outcome. Impact investors are typically more concerned with making a positive difference in the world or environment through the companies they invest in.

Ethical mutual funds

Environmental, Social, and Governance (ESG) mutual funds allow investors to invest in companies that align with their values and beliefs. These funds are defined by their environmental, social, or corporate governance-focused investing strategy.

There are several common approaches to ESG investing:

• Values-based investing, or negative screening, which focuses on excluding companies that do not align with the investor's values.
• Integration, which considers ESG risks and selects companies that score well on material ESG issues within their sector.
• Impact investing, which deploys investment dollars to directly achieve a desired outcome, such as making a positive impact on the world or environment.

When considering an ESG mutual fund, investors should evaluate the fund's quality, including its costs, risks, performance potential, and the experience of the investment team. It is also important to examine how the fund's objective and strategy align with your ESG preferences by reviewing its holdings.

• IShares ESG Aware MSCI USA ETF (ESGU): This fund offers large-cap stocks that operate in a socially responsible way, including tech companies like Microsoft and Nvidia.
• IShares Global Clean Energy ETF (ICLN): This fund focuses on clean energy stocks, investing in companies contributing to decarbonization and climate change mitigation.
• Putnam Sustainable Leaders (PNOPX): A traditional mutual fund that purchases companies demonstrating leadership in key sustainability issues, including familiar stocks like Apple and UnitedHealthGroup.
• TIAA-CREF Social Choice Equity (TICRX): Another traditional mutual fund with a $2,500 investment minimum, offering an expansive portfolio of nearly 450 stocks that consider environmental, social, and governance criteria.

Frequently asked questions