Why does it cost more to invest ethically?

Investing ethically can cost a little more – here’s why.
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When it comes to investing, you can expect to pay fees whether you’re using a DIY platform or an investment management service that does all the legwork for you. Typically, a percentage will be taken out of your total investment either on a monthly, quarterly, semi-annually, or annually basis. How much you’ll need to pay will depend on the type of service you’re using and the way you invest. Generally speaking, if you’re investing ethically and buying active funds, the bill would likely be higher – here’s why.

 

What are active ethical funds?
Before we dive in, it’s important to understand how active ethical funds work. If you’re looking to invest ethically, you’ll find that there are many routes you can take. You can either pick individual investments based on your personal beliefs, or you could invest in ethical funds – think of them as hampers full of sustainable investments – which are managed by investment professionals, known as fund managers, and funds can come in all shapes and sizes. In other words, each fund has its own ethical aims and policy, and as an investor, it’s always a good idea to do some research before you commit.

Most ethical funds will remove activities that are considered harmful to the environment and society – this is what we call ‘negative screening.’ The activities that get excluded will vary depending on the fund’s policy. Some will remove ‘sin stocks’ that include weapons, gambling, tobacco, and adult entertainment. Others will take the process a bit further and screen out a wider range of activities, such as fast fashion and deforestation. What’s more, funds will also apply different exclusion thresholds, with some completely excluding harmful sectors and others choosing to invest in companies profiting from controversial activities, provided that no more than 10% of their overall profits derive from such activities. The argument for this among fund managers is that if less than 10% of a company’s profits come from a harmful activity, their involvement in it can be seen as negligible.

Ethical funds don’t just exclude controversial sectors, some of them will also seek companies that are committed to doing good. Fund managers will typically measure the ethical impact of each organisation they’re looking to add to the fund, and they’ll use a list of criteria to do that – these criteria can be grouped in three categories: Environmental, Social, and Governance, or ESG. This gives fund managers a framework when assessing companies. For instance, with ESG in mind, they’ll check things like how much waste an organisation produces, how diverse its workforce is, and how transparent it is when reporting to the public. Then each company will get an ESG score and the better this rating is, the more likely it’ll be included in the fund.

Now, how do we distinguish between passive and active ethical funds? Passive funds will use a fixed ESG score to screen companies, meaning only the ‘best-of-breed’ organisations will be selected, leaving out companies that are working hard to improve their practices. An example would be an oil company who’s investing heavily in renewable energy. The other limit of passive ethical funds is that they don’t always monitor companies and they may end up with organisations that do too little and let their ESG standards slip over time. On the other hand, active ethical funds tend to examine things in more depth. Fund managers will consider companies that may not be quite there but are willing to change their practices and policies to be more sustainable. But it doesn’t stop here, after selecting companies, active fund managers will keep a close eye on them to ensure they maintain their high standards and keep doing good work. And if they hold enough shares in the company, active fund managers have the power to push for change and influence ESG policies using their voting rights.

 

So, why does it cost more to invest ethically?
Using active ethical funds tends to cost a bit more than investing in passive funds simply because they involve a greater amount of work. Think about it, to ensure companies maintain their ESG score, active fund managers will need to spend time monitoring their activities and undertaking thorough research, as well as carrying out due diligence. Ultimately, you’re asked to pay a bit more for the quality of the service you’re getting, and although it’s never pleasant to be charged a bit extra, we believe investing in active funds is the only way to have a portfolio that is truly ethical. But at the end of the day, it’s all up to you and whether you’re willing to pay higher fees to do your bit for the future.

 

How to invest ethically
Investing ethical is easy – but before you commit, remember that with investing, returns aren’t guaranteed and there’s a risk you could end up with less than you initially put in. With robo-investors, like Wealthify, you get to choose how much you want to invest and the investment style that suits you – you can be Cautious, Adventurous, or somewhere in between. Then, all you need to do is toggle the ethical switch ‘on’ and our investment team will pick the right mix of active funds for you and make any adjustments to your Ethical Plan to keep it on track with your risk level and goals.

 

Please remember the value of your investments can go down as well as up, and you could get back less than invested.

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