How to make sure your ethical investments aren’t harming the planet

Sustainable investing has to be one of the few positive trends of this pandemic.

The economic recovery – here in the UK at least – has been firmly pinned to greener industries through a series of commitments, policies and new approaches that some experts suggest would have taken another five years to achieve without Covid-19.

Ethical bank Triodos reports that the pandemic is specifically motivating more than a fifth of investors to explore ethical funds.

Almost nine in 10 investors are interested in the concept of environmental, social and governance (ESG) investments, according to separate research by chartered financial planner The Private Office (TPO).

With the average UK ethical fund outperforming the average non-ethical fund and the FTSE All Share over the last 10 years, some £80bn flowed into sustainable funds in the first half of 2020 alone as retail and institutional investors placed greater emphasis on demanding a greater focus on ESG principles, including stewardship, ethics and the environment.

Unsurprisingly, the number of ESG-related funds has increased by 40 per cent in the past year.

But transparency is a huge issue. Barely one in 10 people is really confident that they understand where their money is invested, Triodos has found.

So where do you start?

“There are broadly three ways in which people can push for a greener future without gluing themselves to the floor outside Downing Street – through who they vote for, what they consume and where they invest,” says Laith Khalaf, financial analyst at investment platform AJ Bell.

“Funds take different approaches to responsible investment, which means investors do have to do a bit of extra homework to check the fund they choose matches up with their ethical goals.

“Environmental goals are often married with societal concerns and governance standards to create funds which sit under the ‘responsible’, ‘ethical’ or ‘sustainable’ umbrella.”

Ethical funds typically fall into one of three buckets: funds that aim to do no harm, funds that aim to do some good, and specialist funds.

“Funds that aim to do no harm screen out any ESG transgressors. Typical examples of exclusions include gambling companies, arms manufacturers, fossil fuel producers and tobacco companies,” says Khalaf.

“Funds that aim to do some good actively seek out companies which are making positive contributions to society and the environment, and specialist funds target specific areas of ESG like clean energy or gender diversity.”

Traditional tracker funds don’t have ESG screens and simply allocate money to stocks in the index passively, but some funds do track ethical indices produced by the likes of FTSE and MSCI.

“As ESG issues rise up the priority list for company boards, we can expect an increasing number of companies to fall into the investable universe for ethical funds,” Khalaf suggests.

Knowledge and power

But that poses problems for investors keen to do the right thing but with limited knowledge to base it on.

“When you look under the bonnet, a lot of so-called ethical funds look very similar to other funds, so there is a real risk that much of the time it is simply a branding exercise," adds Keir Ashman, pensions and investments specialist at Bancroft Wealth.

"As investors - and consumers more generally - become ever more sceptical of ‘greenwashing’, fund managers are going to have to find ways to build trust with socially-conscious investors.”

“ESG funds are no longer the preserve of the most moral-minded investors, and due to their performance over recent years have been attractive for anyone looking to maximise their financial growth.”

While there is a growing assumption that investors are increasingly clued up, the truth is that half have never even heard the term ESG, for example.

Dean McSloy, partner and ESG specialist at TPO, says: “We are seeing new funds launching all the time, accompanied by huge marketing campaigns, but it feels like education needs to happen at a more fundamental level.

“Many of these investors have an appetite to invest in ESG funds, but they’re being missed somehow. We need to lose the jargon, explain clearly what these funds really invest in, and where the benefits lie – now and in the future.

“Huge levels of wealth could be working harder to ‘do good’ for society and the planet with just a little rethinking. The industry needs to start giving consumers the information they want, rather than the information we think they need.”

Pick your own

While they get around to it, Ashman suggests: "Look for the use of independent sustainability ratings, such as Vigeo, Sustainanytics, FTSE Russell, and DowJones Sustainability.

“Understand the philosophy that underpins the fund or portfolio. How are companies chosen and funds picked? What are the asset managers trying to achieve in the long-term? Do they have a strong track record in this area? This should be clear in the literature they supply.”

Watch out for portfolios that have simply been tweaked from an existing portfolio rather than built from scratch, as this indicates they have been built quickly to meet consumer demand rather than being based on genuine philosophy.

Review the way asset managers report on the performance of funds, Ashman adds.

“For example, do they monitor the extent to which they have addressed sustainability challenges rather than just reporting on growth? Ask if they are willing to be transparent about the makeup of their fund or portfolio, or do they just give the names of the top contributors?”

Meanwhile, various consumer investor groups are trying to counter the risk of greenwashing by doing the kind of deep dives that few people have time for in real life, regardless of how strongly they feel about investing to do real good as well as deliver real returns.

Fine detail

For those committed to investing in ESG, for example, consumer watchdog Ethical Consumer last week produced its latest, somewhat controversial, rankings of the best- and worst-performing funds based on their ethical performance, including carbon reporting.

It named the FP WHEB Sustainability Fund and the Triodos Pioneer Impact Fund as best buys due to good financial performance, being fossil-free and demonstrating a clear commitment to carbon reduction targets in line with international agreements, and for having fossil fuel-free investments.

But the watchdog pointed out that some of the most highly regarded ESG funds still didn’t have clear exclusions policies, and others were owned by companies that also managed unethical funds.

In terms of the impact on climate, Ethical Consumer criticised the LF Heartwood Growth Sustainable Multi-Asset, Legal & General Ethical, Liontrust SF European Growth, Royal London Sustainable Leaders, and SVM All Europe SRI funds for still investing in fossil fuels, either directly or indirectly.

Concerns were also raised about carbon management and reporting among some of the funds named in the report – either because they or their parent companies don’t appear to have specific emissions reduction targets, or because they don’t include some of the direct or indirect emissions from their investments in their reporting.

A spokesperson for Royal London Investment Management (RLIM) points out that: “RLIM’s sustainable range of funds excludes companies which engage in fossil fuel extraction but does invest in utility companies with a bias towards renewable energy.

“We presume that the report refers to us holding SSE, which is the largest developer of renewable energy in the UK.”

Benjamin Matthews and Matthew Toms, investment managers at Heartwood Investment Management, note that their fund is a multi-asset with a specific risk target, while the other funds criticised in the report are single asset class funds with market benchmarks.

“We are a fund of funds, not stock-pickers, meaning we do due diligence on funds, not underlying stocks. We do not have a blanket screen on fossil fuels, but take a ‘best in class’ approach,” they say, adding that they invest less than traditional funds in fossil fuels and invest heavily in renewable energy and energy efficiency stocks.

“Divestment when it comes to the energy sector is not the only approach one can take to have a positive impact,” they add.

Handelsbanken Asset Management, the asset management arm of Svenska Handelsbanken AB, which owns Heartwood also stated that it “both measures and publicly discloses the carbon footprint of its funds. The company also annually publishes a climate report on both asset management and asset ownership in accordance with the recommendations of the Task Force on Climate-related Financial Disclosures.

"This report informs stakeholders about work related to climate change, exposure to climate-related risks and opportunities, as well as the company's ongoing sustainability work.”

The Independent approached all five funds criticised in the report for a comment.