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11.9.2023

What Are Ethical Investments and How Do You Make Them?

James O'Reilly
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What are ethical investments and how do you make them? In this article, we'll answer the whats, the whys, and the hows of 'ethical investing' to help you decide whether or not it's right for you.

When people are looking to invest their money, the two major focuses tend to be 'What will I get back in the form of income and growth on my money?' (return) and 'How safe is my investment?' (risk). Fewer people consider the third element, which is to ask whether an investment is aligned with my personal values and beliefs.

This question has given rise to 'Ethical investing,' a topic that is rapidly gaining ground in personal finance. But what makes an investment 'ethical'? How can you tell whether a specific investment is 'ethical'? And how can potential investors like you invest 'ethically'?

In this article, we'll answer the whats, the whys, and the hows of 'ethical investing' to help you decide whether or not it's right for you. Read on.

What Is 'Ethical Investing'?

Let's get started with a little nomenclature to address the wide array of terms that exist in this space. If you're looking to invest money in line with your values, you may be left feeling that terms like 'climate investing', 'sustainable investing', 'ESG investing', and 'impact investing' are used interchangeably. They are not.

These terms all sit under the broad banner of 'responsible investing' - defined by the Responsible Investment Association of Australia (RIAA) as "a broad-based approach to investing which factors in people, society and the environment, along with financial performance, when making and managing investments".

This creates important distinctions between the different 'responsible investments' available. For instance, an 'ESG integrated' investment is far less likely to take a proactive approach toward improving the working conditions of a listed company's employees than an 'impact investment'. The table below provides further detail on this:

Source: Responsible Investment Explained, RIAA 2023

But let's avoid confusion: for the purposes of this article, we will use the term 'ethical investing' in lieu of 'responsible investing'.

So 'ethical investing' or 'responsible investing' is an investment strategy where an individual investor considers ethical principles and moral beliefs as a guide before choosing one's securities and investments. Although ethical, your ultimate goal in investing should remain the same - to achieve strong financial returns in a low-risk manner.

...But—is it feasible?

Ultimately, the goal of ethical investment solutions is to support businesses and specific industries that create a positive change in society like sustainable energy, sustainable commerce, and at times investments integrated with ESG principles.

What are examples of ethical investments?

Here are a few examples of investments you can access in Australia:

1. Environmental, Social, and Governance Funds (ESG Funds)

A broad-based ethical approach to investing, ESG's decision-making is based on how securities and investments can affect the environment, society, and governance. This ensures that these factors don't affect investors' portfolios and investments from operational and reputational risks and the company’s overall performance.

By excluding (also known as 'screening out) companies which are shown to perform poorly against 'ESG' standards, ESG funds can provide investments which are better suited to an individual's ethical preferences.

2. Socially Responsible Investing Funds (SRI Funds)

Similar to 'ESG funds', 'SRI funds' exclude companies based on very specific criteria to avoid investing in controversial areas.

The most common companies to be excluded are those that are deemed to take advantage of other people: such as gambling, firearms, tobacco, alcohol distribution, and fossil fuel companies.

3. Impact Funds

Impact funds typically form part of the 'deep green' space in responsible investment, because they have a far higher focus on creating ethical change and supporting companies to commit to a given level of sustainable and ethical behaviour.

For this reason, 'impact funds' are best suited to ethical investors who are particularly passionate about ensuring that their money has minimal negative impact on people and our planet.

Note: Impact funds place equal importance on fund performance.

4. Faith-based or Religious-based Funds

Faith-based funds are invested in shares that align with religious values and ideals. Often these funds may strictly exclude investments that don't qualify the ethical standards, for instance, people of the Islamic faith may wish to avoid companies that derive profit from interest-based loans (e.g., all the banks in Australia like the CBA, ANZ, Westpac, and NAB).

What are the possible ethical issues in investing?

Investing, put simply, has the primary goal of making money. And in environments where there's money to be made, there will always be room for unethical behaviour. Here are some ethical risks that can be presented when investing money:

  • Lack of transparency. The extent to which investors have direct access to financial information, the manner in which the company is run, and the preferences of the company
  • Insider trading: A form of trust violation whereby someone with financially sensitive information seeks to profit from that information, often by buying or selling a company's shares before that news becomes public. This behaviour is illegal around the world and can result in heavy jail time.
  • Conflicts of interest. A person or company may have a relationship with another, which enables higher profits than should reasonably be obtained. This often inhibits their ability to behave ethically and act in the best interests of their customers or shareholders.
  • Manipulating the financial markets. Controlling (and perhaps sabotaging) the supply and demand of a specific item or commodity to influence the price of that item, in turn, generating higher profits than should fairly have been obtained.
  • Lack of environmental and social responsibility/consciousness: Companies involved in unethical trade such as logging, oil and gas extraction, and mining can cause great social and environmental issues.
  • 'Sin stocks': Shares in companies involved in activities that are considered unethical, such as alcohol, tobacco, animal cruelty, gambling, adult entertainment, or weapons. 'Sin stocks' practically describe any investment that produces money by exploiting human weaknesses and and/or violating human rights.
  • Conflicting religious beliefs. Some shares and investments may not align with an investor's religious beliefs and values.

How Can I Ethically Invest?

If you're looking to ensure that your money is aligned with your personal values, we salute you! Our team at Northeast Wealth is passionate about ensuring that our investment portfolios are invested in a manner that considers both people and the planet.

Through our journey, we've identified that falling for too-good-to-be-true promises with amazing investment returns can be easy. If you don't want any financial support and you're seeking to 'go it alone', here are some of the best ways to help you invest ethically (and on your terms):

1. Invest in mainstream investment funds

The Responsible Investment Association Australasia (RIAA) has developed a Responsible Returns tool to help investors search for ethical investment options based on the specific factors that are of value to them. Choose two causes you want to support, two issues you don’t like, and the specific types of shares or investment products you're looking for. The search tool will then display a list of providers who have investment products that fit your requirements, narrowing your options to make your investment seamless.

2. Purchase a subscription with a responsible investment research house

If you're looking to build a portfolio of individual stocks, it can be hard to identify which companies have well-set, responsible investment goals and even harder to evaluate whether they are adhering to these goals.

An external research company such as Morningstar Sustainalytics or Ethos ESG can help you properly understand how suitable any desired company is when compared with your own individual ethical preferences. Although this option comes at a cost, we feel that it's great value if you're committed to investing responsibly.

3. Invest in ethical superannuation funds

There are a number of Australian super funds that have a true focus on ethical investing, such as Australian Ethical or Future Super. This may ensure that you have a simple solution for your superannuation without having to engage with a financial advisor or do piles of your own research.

We do note, however, that many very popular superannuation funds are now in the habit of staking claims about their ethical investment preferences, which may far exceed the work they are actually doing in this space. Diligence is key and if in doubt, avoid them.

What are 'ESG' Investments?

ESG stands for 'Environmental, Social, and (Corporate) Governance'. 'ESG investing' is a framework that is widely used to assess a company’s behavior, risk management, and opportunities. This framework is often taken advantage of by socially conscious investors to screen their prospective ethical investments like clean renewable energy and ethically sustainable products.

What are the differences between 'ESG' and 'ethical investing'?

ESG and ethical investing are not the same. ESG is a type of investing that grew out of responsible investing and corporate social responsibility.

  • ESG — is a broad-based framework developed to help manage sustainability when promoting ethical conduct and fostering mindful consumerism. This is increasingly becoming prevalent in the corporate sector. There are ESG funds, ESG scores, ESG rating agencies, and ESG reporting frameworks.
  • Ethical investing — The goal of ethical investing is to support companies and products that have ethical practices (that integrate personal values, societal concerns, and environmental considerations into investment decisions), deprive companies that don't, and ultimately generate great financial returns.

More and more investors are looking not just for greater return on investment (ROI) but also prioritizing leaving a positive impact on the world.

Ethical Superannuation

An ethical superannuation fund is a kind of super fund where providers narrow down their funds exclusively on ethical companies to generate income. This means that they only invest in companies that meet certain criteria for social and environmental standards that demonstrate these values.

Ethical Banking

Often linked to other movements like fair trade, ethical consumerism, and even social enterprise, ethical banking refers to how certain investments and loans negatively and positively affect our society and the environment.

Ethical banking also involves various and similar aspects like ethical funds investment, impact investment, socially responsible investment, and corporate social responsibility.

Advantages & Disadvantages of Ethical Investing

Here are some of the advantages and disadvantages of Ethical investing:

Advantages of Ethical Investing

  • Sustainable returns
  • De-risking your ethical investment portfolio
  • Investing based on your personal preferences and ethics

Disadvantages of Ethical Investing

  • Can limit your investment options (e.g., it's hard to get exposure to sectors like mining if investing ethically)
  • The risk of greenwashing - where a company or fund overstates its responsible credentials to appear more suitable for an investor

Why is ESG Controversial?

Investing in ESGs is controversial for various reasons, namely:

  • One person's investment wishes may be contradictory to other investors' morality, beliefs, and values
  • Guidelines and standard definitions of ESGs often lack clarity, making it very difficult to evaluate
  • Exaggerated ESG efforts to attract unaware potential investors ('greenwashing')
  • A trade-off may exist in terms of pursuing greater financial rewards or reinforcing ESG efforts

Is Ethical Investing Worth It?

All benefits and factors considered, many signals point to the fact that ethical investing is worth it. Not only can you increase your wealth with ethical investing, you do so in a way that doesn't harm people and the environment.

We have more recently observed indicators that popular sustainable indexes have surpassed broader markets' performance over the last decade. We believe that this is a trend we'll continue to observe moving forward.

Source: MSCI. Note: Past performance is not a reliable indicator of future performance.

If you want to start your ethical investing journey and you need a financial adviser to guide you, we're ready to offer you support. At Northeast, we're committed to sustainable investments and a sustainable future. We've made a jump into 100% responsible investments because we know this is the future of wealth creation. To start that journey, get in touch with us today. We hope that you join us in our aspiration to create a zero-compromise to long-term investment.

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