A Beginner’s Guide to Understanding the Fundamentals of Ethical Investment Funds

Ethical investments are investments in companies that, in addition to making a profit, seek to make positive environmental, social, and governance (ESG) changes. On the other hand, ethical investment funds are exchange-traded funds (ETFs) that aim to get a financial return while upholding ethical principles.

This guide covers the fundamentals of ethical investment funds and brings to light everything you need to know about ethical investing.

What is an Ethical Investment?

Source: corporatefinanceinstitute.com

In the 1960s, an ethical investment usually meant avoiding tobacco and alcohol companies. In 2024, it is much more nuanced. Broadly, an ethical investment is an investment that, apart from making a profit, seeks to do better (and as little harm as possible) for society.

For example, an ethical investor might avoid putting their ethical investment funds in an industry that can cause harm, such as gambling, tobacco, and alcohol. A more socially conscious investor may invest their funds in a company with high environmental and social standards. Such standards are known as environmental, social, and governance (ESG) criteria; and are usually used by more rigorous ethical investors to make investment choices.

The fact that some investment funds are considered ethical does not mean that all other investments are risky or corrupt. Rather, with ordinary investment funds, the chances of your money funding some activities that go against your ethics are high.

What Factors Does ESG Investing Consider?

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As stated above, ESG stands for ‘environmental, social, and governance.’ These factors break down as follows:

1: Environmental Factors

Environmental factors include a company’s carbon footprint, contribution to other greenhouse gases, sustainability, and overall environmental impact.

2: Social Factors

Social factors include employment equality, gender diversity, employee health and safety, and product safety concerns and liability.

3: Corporate Governance

Governance refers to a company’s corporate behavior and involves factors such as the compensation of employees and board executives, tax strategy and accounting standards, and shareholder rights.

Are ESG Funds Ethical?

ESG funds are unethical because they focus mainly on maximizing profit and give little to no importance to how a company’s practices affect its employees, customers, and the environment.

A true ethical investment fund will penalize a company if its behavior causes more harm than good, regardless of the financial consequences the company may or may not face.

If you are looking for an ethical fund, you should be wary of any fund that advertises itself as ESG. Ensure that the fund does not only care about maximizing profit but also about bringing social and environmental change.

Are Sustainable Funds Ethical?

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Sustainable funds are ethical.

Sustainability and ethicality are closely related. In the corporate context, sustainability refers to a company’s ability to operate long without its practices returning to bite it.

When we look at sustainability from an environmental standpoint, it refers to a situation where a company destroys its environment and eventually falls apart because its environment can no longer support it.

An ethical company is a sustainable company. If a company behaves ethically, its practices will seek to reduce its negative impacts on society and the environment, and the chances of people or the environment coming back to shut it down are slim to none.

Therefore, while sustainability and ethicality are different concepts, sustainable ETFs with a broad definition of sustainability are more likely to invest in companies that behave ethically.

On the other hand, sustainable ETFs that focus on environmental sustainability and ignore other aspects of sustainability may only choose companies that are environmentally sustainable but are unethical.

What Are Single Theme ETFs?

If you are looking for an ethical fund because you want to support a particular cause, you may want to turn your attention to ETFs that zero in on a specific issue.

For example, if you care about female leadership in the workplace, you should look into ETFs that provide exposure to companies with female leaders. A single-theme fund is a good fit if you are aware of the different issues out there but want to focus on just one issue.

Contrarily, if you want to support several causes at once, you may want to look into a generalist ethical fund. A generalist ethical fund focuses on different issues and weighs their ethical impacts on humanity.

How Do You Choose An Ethical Investment Fund?

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As an ethical investor, you can choose an ethical investment fund by considering the following factors:

  • Investment Philosophy and Process

By looking at their reporting, you can tell whether a fund manager has embraced ethical investing or is putting on a façade.

A fund manager’s reporting should tell you how they implement ESG considerations into their portfolios. If, after looking at their reporting, you feel as though it is an “add-on,” you should refrain from investing in the fund as it may not take an ESG investing approach.

Contrarily, if the fund produces a detailed report of practices and processes, it is a good indication that ethical investing is baked into its strategy.

  • Research and Data

Before choosing a fund, you should consider whether it relies on third-party or in-house ESG research. You want a fund that relies on in-house ESG research as this gives a fuller understanding of the companies they invest in and demonstrates mastery of ESG investing.

  • Level of Transparency

If you want your money invested ethically, ensure that you see a fund’s entire portfolio: not just the top ten holdings. This way, you can check out all the underlying companies and confirm whether their values align with your own and whether their practices are aimed at promoting the greater good.

  • Company Directors and Signatories

Fund managers running ethical investments should be signatories of the UN Principles for Responsible Investment (UNPRI). This shows a public commitment to ethical investing.

Start Your Ethical Investment Fund Today

This guide has covered the fundamentals of ethical investment funds, discussed the factors that ESG looks at, discussed the ethicality of ESG and sustainable funds, explained what single-theme ETFs are, and outlined factors to consider when choosing an ethical investment fund.

Armed with all this information, we are confident that you can start investing ethically and choose a company that seeks to make a profit (for the sake of its stakeholders) and promote the greater good. Start an ethical investment fund today and be the change you wish to see in the world.