Ethical investing is hot right now, with ever more fund managers offering products focusing on environmental, social and governance (ESG) issues. Research by Morgan Stanley shows that 84% of millennials (today’s 20 to 35-year-olds, roughly), see taking account of ESG impact as a “central goal” when it comes to investing. But it’s not just the younger generation. Apparently, nine out of ten wealth managers (who typically deal with a much older age group) believe that the Covid-19 outbreak has resulted in greater investor interest in ESG investing, according to an FT/Savanta survey.
This interest isn’t just limited to traditional actively-managed funds. Plenty of money is finding its way into various types of ESG exchange traded funds (ETFs). According to industry consultant ETFGI, the sector enjoyed record net inflows of $28.53bn through to May this year, with cumulative inflows of a record $82bn into ETFs globally. Meanwhile, data from Morningstar shows that the number of “sustainable” funds launched in the UK jumped from 98 in 2009 to 396 in 2019 – more than tripling within a decade.
Inevitably, this profusion of funds has created lots of new jargon – see below for a basic guide. But regardless of the type of fund used, ethical investors have enjoyed strong performance in recent years. Funds investing in the socially responsible investing (SRI) or ESG “leaders” of the MSCI All Country World index have beaten the parent index over the year-to-date, three and five years. That persisted even during the pandemic – 80% of global ESG ETFs listed in Europe have beaten the MSCI World index during that time, according to Morningstar.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
There are intuitively sensible reasons as to why a focus on ESG issues might make sense for investors. The damaging impact of major environmental or governance scandals on share prices is clear. Big stories in recent memory include oil major BP’s Gulf of Mexico disaster, and car manufacturer Volkswagen’s “Dieselgate” scandal, each of which saw their share prices fall by 20%-plus in a single day. MSCI has also found that “companies with good ESG ratings tend to be more profitable, better quality and lower risk”. The push to cut global carbon emissions has been a prime driver of ESG but since the pandemic many investors have also been focusing on social outcomes – “employee wellness” and accounting practices in particular, according to Deutsche Bank.
The ESG ETFs to invest in now
So if you go down the ESG route, what are your options when it comes to funds? The key is whether you prefer passive index trackers (mostly ETFs) or actively-managed funds. Active funds can take a more focused approach, perhaps targeting only those businesses with an immediate direct impact. The danger with that approach is that fund managers take what are called “idiosyncratic risks” – potentially picking the wrong company, at the wrong price. For instance, many clean energy funds emerged in the last decade, but ended up investing in poorly managed and capitalised businesses that failed to take off. Passive funds by contrast avoid these selection issues, by quantitatively screening the whole universe of stocks and only selecting those businesses which pass a “screen” of key measures.
That said, just to confuse matters Fidelity has recently launched a range of actively-managed ESG ETFs, investing in US stocks (LSE: FUSR), European businesses (LSE: FEUR), and global equities (LSE: FGLR). All have ongoing charges figures (OCFs) ranging between 0.30% and 0.35%. To be included in the ETFs, companies must exhibit a positive fundamental outlook and strong sustainability credentials based on the firm’s sustainable ratings.
One range of ETFs popular with many advisers are those from UBS, working with index provider MSCI. The UBS MSCI ACWI Socially Responsible Hedged to GBP UCITS ETF (LSE: AWSG), for instance, provides access to large and mid-cap equities across 23 developed and 24 emerging markets that have outstanding ESG ratings while excluding companies that have negative social or environmental impacts. It also hedges the effect of foreign currency movements between developed markets and the pound. More broadly the MSCI SRI range looks to invest in the top 25% best-scoring companies across each sector (after some business exclusions).
What’s in your ethical passive fund?
As with many things in the financial industry, ESG funds come with a great deal of jargon. What does it all mean?
ESG-filtered funds: these proactively screen for businesses with a high ESG rating.
Sustainability or SRI funds: these combine both a “positive” screen (businesses you want to own) alongside a “negative” screen (businesses you want to exclude). Many exclude alcohol, tobacco, gaming and weapons businesses, while other variations include fossil-fuel-free (or reduced) funds, which exclude businesses involved in fossil fuel production.
Low carbon/climate change funds: these focus specifically on businesses with a record of generating low carbon emissions.
Thematics: these are sector-based funds which invest in certain global themes such as water, forestry and clean energy.
Equality-based funds: many of these focus on encouraging global gender equality
Green bonds: these are issued by firms and organisations to finance a specific low- or zero-carbon project.
The key distinction for the purposes of most investors is probably the difference between ESG and SRI funds. The former look to screen through a wider market to maximise a return based on various ethical criteria, but profit or capital gain remains the primary objective. The latter, by contrast, look to balance financial and social outcomes, with the financial outcome (in other words, the return to the investor) frequently a secondary consideration.
David Stevenson has been writing the Financial Times Adventurous Investor column for nearly 15 years and is also a regular columnist for Citywire.
He writes his own widely read Adventurous Investor SubStack newsletter at davidstevenson.substack.com
David has also had a successful career as a media entrepreneur setting up the big European fintech news and event outfit www.altfi.com as well as www.etfstream.com in the asset management space.
Before that, he was a founding partner in the Rocket Science Group, a successful corporate comms business.
David has also written a number of books on investing, funds, ETFs, and stock picking and is currently a non-executive director on a number of stockmarket-listed funds including Gresham House Energy Storage and the Aurora Investment Trust.
In what remains of his spare time he is a presiding justice on the Southampton magistrates bench.
The 30 house price hotspots
While we have seen house prices sliding, these sought-after locations have seen prices jump by at least 5% over the previous 12 months
By John Fitzsimons Published
Working parents will be entitled to 15 hours free childcare for two-year-olds from next year
The government has extended free childcare hours to working parents of two-year olds but it won’t be automatic so make sure you don’t miss out
By Marc Shoffman Published
M&S shares shift from frumpy to fabulous as pre-tax profits are up by 56%
M&S is performing strongly and has announced it will pay a dividend for the first time since the pandemic.
By Dr Matthew Partridge Published
The rise and fall of Sam Bankman-Fried – the “boy wonder of crypto”
Why the fate of Sam Bankman-Fried reminds us to be wary of digital tokens and unregulated financial intermediaries.
By Jane Lewis Published
Three defence stocks set to flourish in an era of instability
A professional investor tells MoneyWeek where he’d put his money. Tom Bailey highlights three defence stocks that look promising.
By Tom Bailey Published
EasyJet shares are volatile but enticingly cheap
The EasyJet group has shrugged off the cost-of-living crisis, restarted dividends and shares look good value.
By Dr Matthew Partridge Published
The fallout from the war on landlords
Investors fleeing the market and the rise in rents are affecting us all.
By Charlie Ellingworth Published
Eight small-cap trusts to bet on
Funds investing in market minnows are out of favour, but the cycle will turn. Here are the best bets.
By Max King Published
Trust in US TIPS to beat inflation
In an inflationary market TIPS, the US Treasury Inflation-Protected Securities are most compelling says Cris Sholto Heaton.
By Cris Sholto Heaton Published
What is Vix – the fear index?
What is Vix? We explain how the fear index could guide your investment decisions.
By Dr Matthew Partridge Published