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Think you're ethical? Your ISA and pension might not be

By Mike Narouei, Content Producer at Boring Money

16 May, 2019

You diligently recycle, you walk rather than take the car, you waved a banner on the Extinction Rebellion march. How can you be sure that your ISA or pension isn’t undoing all that good work?

At its heart, investment directs capital to businesses. Those businesses then use it to grow. If you’re directing capital to businesses that pollute the environment, or use child labour, then you are helping sustain those businesses and encouraging them to grow.

This will often be happening behind the scenes. Your workplace pension, for example, may be invested in the default fund unless you have made an active choice to switch it. This will not automatically be invested ethically. That said, there is almost certainly an ethical choice among the options, so you need to be proactive.

As well as default choices, there is also the problem of ‘greenwashing’. This is when funds put eco-friendly branding on a conventional fund and overstate its environmental credentials. There is increasing pressure on fund managers to beef up their green credentials, so many may exaggerate the ESG criteria they use or the role it plays in the selection of investment funds.

So how do you know that what you’re getting is properly ‘ethical’?

It is important to draw the distinction between funds that will actively screen out companies that don’t meet their ethical criteria, funds that are looking for companies that make a positive impact, and funds that simply agree to engage with companies with poor practice.

In this latter case, the fund manager will invest in the most ethical mining company, for example, but they will still be invested in a mining company, and that may not be some people’s idea of ethical. Equally, they do not guarantee that their engagement with companies works, just that they will engage. As such, the portfolio may still include companies that don’t behave well. This isn’t necessarily bad – many fund managers argue that it is the most effective way to bring about change in ‘bad’ companies, but investors need to know what they’re getting.

Ethical investment funds need ethical managers

You have to make sure your ethical manager walks the walk. Michelle O’Keefe, a manager of the Baillie Gifford Positive Change fund, says:

“Some of the headline stuff isn’t actually there. How much is just reporting and how much is baked into the way a company does business? Some of that you can tell by digging down into company materials, or actively engaging with companies to really understand their strategy.”

She says that the UN Sustainable Development Goals (SDGs) have been really helpful in setting parameters for ethical investment. These are 17 goals covering poverty, inequality, climate, environmental degradation, prosperity, and peace and justice. Fund managers claiming to be ethical should be signed up to these principles and clearly incorporate them into their work.

An impact fund may be the best bet

What is an impact fund? ‘Impact’ funds look for companies that help meet certain goals, whether that be reducing poverty or climate change. The Baillie Gifford fund, for example, targets social inclusion and education, environment and resource need, healthcare and quality of life, and poverty reduction. M&G has a similar fund, which invests along the UN’s SDG lines.

Third party providers are increasingly offering an ethical score for funds – the Morningstar Sustainability ratings, for example, grade funds on how they are managing environmental, social and governance risks in their portfolio. These ratings aren’t a catch-all, but they do provide some insight into how a fund manager stacks up on ethical grounds.

Darius McDermott, managing director of Chelsea Financial Services, says:

"First you have to look at the investment criteria of the fund and make sure it is aligned with your idea of 'green', then you need to make sure the fund manager adheres to those criteria. Whereas a few years ago ESG factors were the domain of just a handful of ethical funds, 95% of fund manager presentations now include an ESG slide.

“In some cases it is because managers are recognising that good practice can lead to better outcomes for companies and their share price, but in other cases it is managers not wanting to be left out of what is becoming an increasingly popular trend. So if I see an ESG slide I now make sure I question the manager about how it fits into their process in practice to make sure it is a genuine inclusion."

Some fund groups are going green because they believe it, and some are going green because they have to. Make sure you’re with a manager who cares as much as you do.