Language is crucial when it comes to ethical investing. Terms such as “responsible”, “ethical”, “ESG”, and “impact” are used interchangeably but don’t necessarily mean the same thing.
There is no standardised umbrella term for ethical investing, which can make it difficult for investors. That’s why research is so important.
Ethical investing and greenwashing
The lack of uniform rules around what ethical investing requires becomes problematic, with many funds using ‘ESG’ (environmental, social and governance) as a marketing tool.
Investors need to think critically before choosing which investment strategy suits them.
The idea of ‘green-washing’ and ‘impact-washing’ may arise in ethical investing, with some funds claiming to have a robust ethical framework, but many are using the word ‘ethical’ as a marketing tool.
Investors should review how ethical investment products filter and define their screening (both positive inclusions and negative exclusions) of companies, and should also investigate how transparent their fund is around their investment process and portfolio holdings.
They should also look at the level of ESG integration, if a responsible investment committee exists, if they incorporate things as the United Nations Sustainable Development Goals, or if they look at a company’s balance scorecard or report on ESG objectives.
Many index providers such as MSCI have ratings methodology which helps investors identify ESG risks and opportunities within their portfolio.
Why do investors pick ethical ETFs
In the Australian ETF Universe, ethical ETFs increased a whopping 160% to $4.6b in FUM in June 2021.
We believe there are three key reasons driving this demand:
1. Ethical ETF Performance
MSCI research shows that companies with robust ESG practices had higher profitability, more stable earnings, lower volatility and less controversies (such as bribery, corruption and fraud).
However, there are other reports that have shown ethical super funds underperforming regular balanced funds over 10 years. While the evidence is mixed, over recent periods, it seems ethical investment is winning.
2. Impact investing
‘Impact investing’ refers to investing your money for the purpose of seeking positive social and environmental impact alongside a financial return.
When you invest for impact, you want your dollars to make an impact on things you care about. To make an impact, investors might change their portfolios to focus on financial products that divest from companies in industries such as tobacco, fossil fuels, and gambling. By moving their money out of these companies, some investors hope this means those companies will become less valuable as their share prices fall. This could lead to corporate policy change, reduced investment interest, and an overall decrease in demand for their services.
The challenge is that many active stock pickers could be buying in to seemingly ‘unethical’ companies, as their main motive is financial reward. An active investor may see falling share prices of an unsustainable/unethical company as an opportunity and, in turn, invest heavily into them.
Feeling intrinsically good is another reason many investors choose ethical investments.
Investors may feel some remorse, or believe it is immoral to profit from companies who engage in certain business activities. Regardless of performance or returns, their morals, ethics and sense of corporate responsibility are what drives their decisions.
Australian ethical ETFs
There are six passive broad Australian Ethical ETFs available on the ASX:
- BetaShares Australian Sustainability Leaders ETF (FAIR)
- Russell Investments Australian Responsible Investment ETF (RARI)
- Vanguard Ethically Conscious Australian Shares ETF
- VanEck Vectors MSCI Australian Sustainable Equity ETF
- SPDR S&P/ASX 200 ESG Fund
- iShares Core MSCI Australia ESG Leaders ETF
FAIR’s top 10 looks very different as they removed the big banks due to fossil fuel financing, whereas RARI and UBA hold the big banks.
Ethical investing: What investors should think about
- It’s important to review the ETF’s index methodology and ESG screening criteria to determine why certain companies have been selected.
- How active should the ETFs be with their criteria? For example, the BetaShares Global Sustainability Leaders ETF (ASX: ETHI) removed Facebook after the Cambridge Analytica scandal, and they also removed Tesla following it’s poor governance and concerns around labour conditions. Does this make it an active fund? With increased human oversight, there may be higher transaction costs of the ETF, but more alignment to ESG concerns.
How to investing in ethical ETFs
Sustainable ETFs listed on the ASX have increased 80% per year over the last five years. There is now $3.3b in money invested in ethical and sustainable ETFs, representing 3% of the overall Australian ETF market.
Like any investment, investors should the costs and risks that come with investing in ethical ETFs. Some sustainable or ethical ETFs cost more which means that they might underperform the broad index, while their different sector exposure means they will have more variable returns.
You can choose your ethical ETFs yourself, or you can choose a platform like Stockspot and let us build you a custom portfolio of sustainable ETFs.