How to be an ethical investor

What is ethical investing?

Painting the green picture

Investing doesn’t just have the potential to do good for your future – it can do good for everyone else’s too.

Enter ethical investing: a style of investing that puts your money towards companies and causes that are a cut above the rest in their ethical credentials.

‘Ethical’, ‘sustainable’, ‘responsible’, ‘green’ investing – whatever you might call it, it’s here to stay. Boring Money’s sustainable investing report found that 27% of investors already hold an ethical investment, while 64% would consider ethically investing in the future.

The interest and uptake of ethical investing has been largely driven by us, women who invest! In fact, according to Boring Money’s report, 45% of women who hold investments want their money to be invested ethically, compared to just 34% of men. But how can you tell which investments are ethical?

The E-S-G of investing

ESG stands for Environmental, Social and Governance. These are the core factors that companies and funds are measured on to establish an overall rating for how ethical they are to invest in.

For instance, a company with a low carbon footprint might score well on environmental impact, or ‘E’, while a company that positively affects people’s health might score well for social impact (‘S’). And a company with effective structures to ensure good corporate decision-making would probably rate highly on their governance (‘G’).

But calculating an investment’s ESG rating isn’t as straightforward as ethical investors would hope. Say, for example, a company scores very well on its environmental impact but poorly on social and governance issues, it may still carry an overall ESG rating that means it qualifies as an ethical investment.

The ESG rating of a company or fund, and whether it’s labelled as ‘ethical’ also depends on who’s doing the measuring. And that’s usually the fund manager choosing an investment for their ethical portfolio. Frustratingly, there’s no industry-standard approach that defines what an ethical investment is, so fund managers can have varying strategies for this.

What’s the risk of investing ethically?

Is ethical investing profitable?

Laith Khalaf, AJ Bell’s head of investment analysis, reminds us that “the point of ethical investing should still be to make a financial return. This distinguishes it from philanthropy, where people invest without any financial motive”.

Laith goes on to say that “there probably isn’t a definitive answer” as to whether ethical investments are as profitable as traditional investments. “There are times when ethical investments can perform better, and times when they can perform worse. For instance, ethical investments got a bit of a bump when Joe Biden was elected president. But in 2022 green investing fell behind more traditional investment strategies, because of high oil and gas profits”.

The key, as with all investing, is to do your own research and make sure you’re comfortable with the level of risk. All investments can go down as well as up in value, and it’s possible to end up with less than you put in.

Ethical by name only?

Due to the rise in popularity of investing for people and planet (not just profits!), a trend of naming funds that signal an ethical approach has swept the investment scene. But some funds aren’t always what they claim to be, and certain asset managers have been accused of ‘greenwashing’ their funds to lure ethical investors in.

Greenwashing is described by the Government as “misleading or unsubstantiated claims about environmental performance” made by firms about their products or activities. Though steps are being taken by the regulator, the Financial Conduct Authority, to protect investors from greenwashing, it’s important to look beyond the name of an investment to find out just how ethical it is.

How can you get started with ethical investing?

Due to its high demand, ethical investing is easier than ever to get started with. Most investment platforms and apps now offer funds and handy lists of investments that fall under an ethical, sustainable, or responsible banner.

For example, you can refine AJ Bell’s favourite funds list by those that are ‘responsible’. And once you’ve got a shortlist of ethical investments to choose from, you can dig a little deeper to make sure the investment strategy aligns with your values – or as much as possible.

Dig a little deeper

So this is where you put on your researcher hat!

We already spoke a little about the risk of greenwashing when investing ethically, but there are ways to try and avoid it. You can usually spot a greenwashed fund by checking its screening criteria (the investments it excludes from its portfolio and on what basis), and the top 10 investments it holds. Documents like the fund’s factsheet and key investor information can help you out immensely here.

The power of your pension

A good place to start if you want to invest more ethically is your workplace pension.

Make My Money Matter is a brilliant campaign built around taking the power of our personal finances and pointing them towards a greener future, through ethical pension schemes, funds and even choice of bank. Their 21x campaign helps people check and change their pension to a greener option, though it’s important to check this is the right choice for you, before making any big moves.

Learn more about ethical investing

We’ve only scraped the surface here! AJ Bell’s responsible investing guide tells you much more about the journey to becoming an ethical investor.

Read AJ Bell’s responsible investing guide

We don’t offer advice, so it’s important you understand the risks, if you’re unsure please consult a suitably qualified financial adviser. The value of your investments can go down as well as up and you may get back less than you originally invested.  

These articles are for information purposes only and are not a personal recommendation.