Savers are going wild for green and ethical investments – there’s no doubt about it. Two in every three pounds invested in September went into funds considered ‘green’ or ‘responsible’ – a total of £1.6 billion in one month alone.
Some are choosing to invest in funds that stay well away from fossil fuels. Others are putting their savings and pension money in funds that won’t touch armaments, tobacco or alcohol companies.
Funds that aim to have a positive impact on the world are also surging in popularity. But while these funds may be saving the planet, they are often costing the investor.
Ethical: Savers are going wild for green and ethical investments – there’s no doubt about it
Green and ethical funds tend to be more expensive overall than traditional alternatives. The difference in cost may only be a basis point here or there, but over time it can add up. Unless these funds outperform traditional options, they will leave savers worse off financially. So is it possible to invest in a way that benefits the planet and society – without paying over the odds?
WHY IS IT MORE EXPENSIVE TO MAKE GREEN INVESTMENTS?
Finding the companies that do good – or at least don’t do harm – and that will also grow savers’ wealth requires expertise. It’s not as straightforward as building an unconstrained portfolio that doesn’t take these factors into consideration.
Until recently, green and ethical investing have been largely the domain of active fund managers, who hand-pick companies with these mandates.
Fund managers take time to check the ethical credentials of companies in which they invest, measure their impact and sort between companies that dubiously claim they are environmentally friendly and those that really are.
All of this research is invaluable – but inevitably investors pay for it. Ongoing charges for this type of fund can easily reach close to one per cent in some cases.
There are no standard definitions of terms used by companies and the investment industry such as ethical, SRI (socially-responsible investment), green or ESG (environmental, social, governance). As a result, funds with a manager to pick through the confusion and nuance still dominate.
Dzmitry Lipski is head of funds research at wealth platform Interactive Investor. He says: ‘As ESG standards are still evolving and investors are puzzled by different ESG definitions, active fund managers take the lead in this game, doing their own detailed in-house analysis and using it as a key selling point.’
WHAT ARE THE CHEAPER OPTIONS, IF ANY?
Rising numbers of asset managers are also offering passive ethical and green funds. Passive funds tend to be much cheaper than active, because they do not rely on fund managers to construct them.
Instead, they invest in an index of companies put together by a ratings agency. The index may, for example, invest in the biggest global companies, but exclude those not considered socially responsible or those that make most of their profits from fossil fuels.
Passive funds tend to screen out companies that are considered to do harm, rather than seek out those that actively do good. Some investors see this option as a light touch version of green and ethical investing.
HOW DO LOW-COST ‘ESG’ FUNDS WORK?
Vanguard offers a number of low-cost ethical and green funds. The Vanguard SRI European Stock Fund is one example.
Costing just 0.14 per cent, this fund invests in large and mid-sized companies in developed markets in Europe, and promotes environmental and social characteristics by excluding companies based on the impact of their conduct or products on society and the environment.
BlackRock also offers a number of low-cost choices. One example is its Select ESG fund, which is part of its low-cost MyMap range. This costs just 0.17 per cent and keeps charges down by tracking several indices.
It considers a range of themes when selecting its investments, including climate change, pollution and wealth, corporate governance and environmental opportunities.
Interactive Investor has recently added the awkwardly-named UBS MSCI UK IMI SRI ETF into its ACE 40 list of its favourite ESG funds. This fund invests in UK companies of all sizes that have a lower carbon exposure than average and that have high ESG performance. It has an ongoing charge of 0.28 per cent.
WILL MY FUND REALLY MEET MY GREEN VALUES?
Passive funds are more likely than active to include companies that may not fit your ethical or environmental criteria. That’s because indices are put together using data supplied by companies, which is often far from perfect.
Index construction also varies considerably – each index provider will have a different methodology for rating and ranking the ethical and green credentials of firms.
Finally, a single passive fund will often invest in hundreds or even thousands of companies, which inevitably come under less scrutiny than the handful of companies held in an active manager’s portfolio.
Take the funds listed above, for example. The Vanguard fund, while promoting environmental and social characteristics, has holdings in Shell, BP, Rio Tinto and Diageo.
The BlackRock fund, for all its ESG considerations, invests in Gazprom, China Steel, Chevron and British American Tobacco.
DOES IT PAY TO HOLD SOME ‘UNETHICAL’ STOCKS?
Some investors may be surprised to find these sorts of companies in their SRI or ESG fund. But it’s not uncommon.
Clare Reilly is chief engagement officer at online pension provider PensionBee. She says: ‘It’s essential that you look under the bonnet to check what you are actually investing in – many indexing approaches will still include tobacco and oil companies.’
However, many asset managers say that holding these companies – which may not align with your values – may be more powerful than simply ditching them.
Fong Yee Chan, Vanguard’s head of ESG strategy for Europe, says: ‘Holding and engaging with companies is more effective than excluding or reducing the allocation in your portfolio. Through engagement, you can try to influence their strategies. We try to work with companies, but if that does not work we can vote against board or director appointments.’
Nick Hutton, head of UK iShares and Wealth at BlackRock, says that passive index funds have a duty to track the whole index – they cannot just drop individual companies from them. However, he believes that as the world’s largest investor, BlackRock is in a ideal position to engage with firms to change their practices.
‘If you look at some of the biggest companies that might be a bit surprising, they may actually be putting significant resources into improving their operations and cleaning them up,’ he adds.
James McManus is chief investment officer at investing platform Nutmeg, which offers a socially responsible portfolio made of low-cost funds.
He believes that rather than acting as a restraint, the inability of a passive fund to pick and choose companies may even work to its advantage.
‘At Nutmeg, we believe the stewardship wielded through passive investing is more powerful, precisely because one cannot sell and walk away,’ he says.
CAN I INVEST IN A THEME… LIKE CLEAN ENERGY?
Some investors use exchange traded funds (ETFs) as a low-cost way to gain exposure to particular themes in ethical and green investing. ETFs also follow an index and tend to be cheap, but they are listed as shares and therefore can be easier to trade.
There are a growing number of ETFs that invest in niche areas of ethical and green investing. For example, there are ETFs that invest just in clean energy, battery production or solar energy.
CAN YOU GET CHEAP ACTIVE FUNDS YET?
There are a few funds that combine both active management and low fees. The BMO Sustainable Universe MAP range, for example, has five funds with an ongoing charge of 0.39 per cent. Portfolio manager Simon Holmes explains that they are able to keep costs down due to economies of scale; BMO has offered a number of sustainable products for many years. ‘As well as reporting on returns, every quarter we show investors the impact their money has had,’ he adds.
As the number of green and responsible funds blooms, increased competition is pushing down costs. Lipski points out that fees for ESG funds are falling faster than for conventional funds.
The industry is also undergoing dramatic transformation. Companies are getting better at reporting their credentials; fund managers are getting better at asking the right questions; and indices are being honed. In time, the landscape should be much easier for investors to navigate.
In the meantime, investors of all – but especially low-cost green and responsible funds – need to check the holdings of funds they invest in. Independent wealth expert Adrian Lowcock says: ‘Fund managers are making improvements so it makes sense for investors to be patient, diversify and ask questions.’
