How to get started with ethical investments, and expert's tips on whether a fund is legitimate (2024)

Each week we ask an investment expert money questions focused around a particular theme.

This week we ask Jamie Govan, senior ESG investment manager at Aberdeen Standard Investments (ASI), about ethical investing.

Q: What should I think about before starting ethical investing?

Firstly, the approach to ethical investing should be the same as any investment, with consideration given to an investor’s risk profile. More specifically for ethical investing, think about your values and how they can be best taken into account through the investments you make.

While it is not the only approach, ethical investing typically relies heavily on negative screening, meaning certain underlying investments in funds are excluded because they are involved in activities that are typically not aligned with social and ethical values.

The portfolio will have fewer options on what it can invest in, and some fund managers take a stricter approach than others on what should be avoided.

For example, you can expect tobacco producers to be excluded from most ethical investment portfolios with a tobacco exclusionary screen. But the screening is unlikely to extend to supermarkets, which sell tobacco, as it is such a small part of their business.

Nevertheless, some funds may take a stricter approach and avoid all companies that have links with tobacco.

The scope of the ethical criteria is an important consideration. If we take the example of a negative screen for links to p*rnography, investors who want to avoid exposure to this sector would find the investment universe is not necessarily narrowed significantly as most companies in this space are more likely to be privately run and not publicly listed on a stock exchange.

However, savers who want to avoid any connections with animal testing may find a range of companies from multiple sectors (not just the healthcare sector) are excluded. So investors need to have an understanding of different industries and how this could affect their choice.

In the last 18-24 months, we have been asked significantly more around options for fossil fuel exclusion, particularly with regards to our sustainable investment funds (in which ethical funds are included).

Again, the scope may be relatively narrow in only avoiding oil and gas refineries, while others might also avoid oil and gas services companies.It’s really worth doing a bit of research before making a choice to know that the fund broadly meets your ethical requirements.

Q: How do I know the company / fund is legitimate?

The answer to this is simple. Check the Financial Conduct Authority (FCA) website at fca.org.uk/scamsmart. Its ScamSmart page has a warning list of companies and funds to avoid, and visitors can also search to see if an investment company or fund is legitimate.

Q: Should I be wary of mini bonds that promise a fixed, high return?

I would cite the old adage that if something is promising something that sounds too good to be true, then it often is. Be wary of a product that offers a guaranteed high return. Mini bonds have been advertised as offering high returns, but there can be an elevated level of risk attributed. If investors lose money there is normally no protection under the Financial Services Compensation Scheme (FSCS). So I would advise savers to take natural caution.

Q: What exactly should I be looking for in an investment company that manages ethical investments?

When thinking about investment companies that manage ethical funds, some of the aspects to consider are: how transparent they are around their ethical approach on the fund? how much detail is provided on the criteria applied to these funds? And what is the process used? It is perhaps also helpful to think about the company’s own approach to ethics more generally to get comfort that they walk the walk as – have they encountered any significant controversies around bribery, corruption, or financial irregularities in the past? Do they have a comprehensive Code of Ethics and what are the guiding principles of the business?

For funds, the landscape of ethical criteria is really broad. Some managers may exclude only some investments while others may be far more constrained in a bid to capture a wider range of ethical values.

Q: Should I expect lower returns from an ethical fund?

Many companies paying higher dividends can also be firms that ethical investors want to avoid, for example tobacco companies.It can be a challenge for a fund manager to find companies that don’t breach ESG criteria but have similar financial characteristics to companies traditionally offering big payouts to shareholders.

But there are companies that are permissible against ethical criteria that can offer the growth and/or income characteristics that investors seek.

We’ve certainly seen evidence that an ethical investment focus does not mean a saver’s returns are compromised over the long-term.It can also be complicated trying to attribute any difference in performance purely down to the ethical style of the investment – there are various other factors at play which can influence that difference.

Q: Are fees higher?

Historically some ethical funds have charged higher fees but this is no longer necessarily the case. There are examples of funds in our range where the fees are identical to the unconstrained equivalents. If there are fee differences, it is not down to the ethical approach but likely other factors such as, for example, the platform of delivery.

But on the whole there should rarely be justification for a significant difference. For example, our Europe ex. UK equity growth fund is priced the same as the Europe ex. UK ethical equity fund.

Nevertheless, it should be acknowledged there is more work for fund managers operating funds the ethical space, as they have to continuously review and verify investments to make sure they are not breaching the ethical criteria on the funds. Some of the information required for this is not always easily accessible.

Jamie Govan is a senior ESG investment manager at Aberdeen Standard Investments (ASI).

Do you have a question for an investment expert? Emailelizabeth.anderson@inews.co.uk