What is an ethical pension investment?
Ethical values are now weaved into our social fabric, from reducing the impacts of climate change to recycling and less consumption of single-use plastic. It comes as no surprise then that it has also found its way into the realm of investments either through an individual’s choosing or through regulatory drivers such as the October 2019 ESG requirement legislation and climate change disclosures recommended by the Task Force on Climate-related Financial Disclosures.
Ethical investments go beyond monetary returns, as it also puts a premium into the environmental, social, and governance ROI of such investments. Individuals who engage in socially responsible investing base their choices primarily on which ones align with their values and personal priorities.
Investments in this sphere are growing in popularity—and for good reason.
In the UK, 7% of new investors within the 18 to 34 age range have chosen to invest in ethical funds or products in 2019. When COVID-19 hit last year, Triodos Bank’s 2020 survey found that 22% of investors are now exploring ethical funds, while 39% of Brits believe that ethical investment can help us avoid future pandemics. At this rate, it’s predicted that this market will grow by 173% by 2027, potentially reaching £48 billion.
If you’re thinking of securing your retirement income while also supporting a cause you believe in, then ethical investments could be the way to go. However, like any other investment, you first need to understand where your money is going, the process involved, and how to make the most of it.
How do ethical investments work?
While ethical investing can be approached in a number of ways, there are three top strategies often employed in this space. The pension fund manager will pick one or choose a combination of these approaches, depending on the objectives and investment criteria:
- Exclusion — This approach completely avoids investments that do not meet certain standards like companies that produce goods or services that may damage the environment (e.g., tobacco, oil).
- Preference — This approach does not avoid any companies or sectors. Instead, the investment manager closely looks into each sector and assesses the best company that passes their benchmarks, regardless of industry.
- Engagement — This involves actively engaging businesses so they will promote more socially responsible practices (e.g., reducing carbon footprints, and diversity in the company’s leaders).
What different types of ethical investments are out there?
Ethical investments come in many names, including socially responsible investment (SRI), environmental, social, and governance investment (ESG), sustainable development goals investment (SDG) or Sharia. They all fall under the ethical investment umbrella, but they differ in their objectives:
- SRI — Socially Responsible Investing only invests in companies that are considered sustainable. The criteria are broad, as this type of portfolio screens the best companies to invest in regardless of the industry they belong to. It may include, for instance, companies in the oil sector that show more environmental responsibility than others (e.g moving to a greener source of energy).
- ESG — These are investments that take into account the environmental, social, and governance factors of a business. The environmental aspect judges the organization’s interaction with the physical environment, including its carbon footprint and usage of renewable resources, as well as the activities they do to reduce its impact. The social factor, meanwhile, dives into the inclusivity and diversity in both their in-house and client-facing policies (e.g., labour standards, data security, human rights, etc). Lastly, corporate governance looks into the organization’s structure and fair treatment of its staff.
- SDG — These are investments that have a broader ethical focus, based on the United Nations’ 17 Sustainable Development Goals. These goals promote peace and prosperity, while also including several factors like ending poverty, better access to healthcare and education, affordable clean energy, and tackling inequality in its many forms, among others. Since the UN’s Member States adopted these goals in 2015, global ethical funds were inspired to include the same goals as part of their criteria when assessing their investments.
- Sharia — These investments only choose organizations that follow practices considered permissible or halal based on Islam’s Sharia Law. There are two key criteria for Sharia investments. First, ROIs should be based not on interest but on the actual share of profits made by the company. Second, investments should not be made with organizations that produce or sell products like alcohol or pork, as well as those in the gambling, nightclub, or pornography industries.
6 factors to consider when investing in an ethical pension
According to Moneyfacts, ethical funds proved to be resilient even in the face of the pandemic, with funds growing upwards of 4.3% compared to non-ethical funds seeing an average of 1.5% loss in the past year.
When it comes to pensions, however, ethical investment is not just about what brings in the more lucrative returns (although that is an important consideration). Ethical investing is also about moving your money to portfolios that align with your own values and causes you support. When going into this investment, there are six things to take into consideration:
1. Start With What Matters to You
Ethical investing has come a long way since it started, which means you’ll now find several options available. Since you can’t really invest in everything, start with your own ethical priority.
Is it reducing our carbon footprint? Is it helping to eliminate child labour? Do you want more renewable energy? If you don’t know where to begin but want to make an impact in changing the world, you can go through the UN’s Sustainable Development Goals and see which one (or more) speaks to you.
It’s important to keep an open mind, as it might be difficult to find organizations and businesses that follow exactly what you believe to be ethical. For instance, there are a lot of ethical funds invested in industries that are not 100% good for the climate (e.g., oil companies or car manufacturers that are working on pollution control or renewable energy).
Once you know what truly matters to you, decide if you want all your investments to be limited to these causes or if you just want part of your pension investment involved with these funds.
2. Know the Different Ways to Invest
Similar to any kind of pension investment, there are also different ways to invest in ethical funds:
- Creating your own ethical pension portfolio — You can choose the shares or bonds that you want your investment to be in. While the extensive research to check a company’s green credentials will take up a significant amount of your time, this is the best way to give you confidence that your investment will truly be aligned with what you consider as ethical.
- Invest through an exchange-traded fund — An exchange-traded fund (ETF) can keep track of and replicate the performance of a stock market index. As a passive investment, ETFs can also be cheaper than other funds, since you won’t have to pay someone to actively manage your investments. An ethical ETF also removes organizations that are involved with unethical practices (e.g., tobacco, firearms) and favors those that fall under ESG metrics.
- Invest through actively managed funds — You’ll be working with an investment manager who will actively buy and sell your investments as they aim to beat the market. Since their goal is to give you a good ROI while balancing it with social responsibility, their strategies can involve looking for the best ethical investments, completely filtering unethical companies, or a combination of the two.
3. Consult With IFAs
Doing the research on your own can be time consuming. There’s also the real possibility that you might end up taking unnecessary detours that would make building your pension portfolio more difficult.
To make the process easier for you, consult with an independent financial advisor (IFA). IFAs tend to be more costly, but they will look far and wide so they can give you a list of products across the market that will suit your preferences. Since they are independent, they are unbiased and can look at these funds objectively, as opposed to restricted financial advisors who can only recommend limited types of investments from a limited number of providers.
You can ask your friends and colleagues for IFA recommendations, but you can also check out online databases like Unbiased and VouchedFor.
4. Understand Your Workplace Pension
Most workplace pension schemes default employees into a limited range of funds. Some companies might offer ethical options, which can give you the freedom to choose whether you want all your funds allocated into ethical investing or just some part of it. However, with workplace pension apathy a prevalent problem in the UK, this fact may not be known to a lot of people.
As an employee, you can:
- Ask your company where your pensions are invested and if they have ethical alternatives
- Contact the trustees of your workplace pension scheme to better understand your pensions
- Talk to colleagues so you can collectively ask your HR for more ethical options
- Consider consolidating pensions from old jobs into a self-invested personal pension (SIPP), but make sure you read the fine print as you might lose some benefits from older schemes if you move to a new plan
5. Don’t Forget That This Is Still an Investment
While it does feel good to support a cause that can have ripple effects on society at large, remember that the primary goal of this investment is for your later life income. Losing sight of this goal can possibly affect your objectivity towards a particular investment, which could then affect your choices.
Approach this like all your other investments. Do your research, establish if the investment is truly ethical, and if you’ll get the desired value that will help you live a comfortable retirement. Work with an IFA, especially if you’re not well-versed in the industry.
6. Know the Potential Drawbacks
While there is little evidence of ethical funds not performing as well as conventional funds, you still need to be aware of potential drawbacks:
- Having restricted choices means less portfolio diversity — Since you’re only working with ethical funds, your choices will be limited, and a portfolio that’s not diverse carries a higher risk.
- Lower volatility — Since it’s less volatile, ethical investments can also see slower growth with not a lot of peaks compared to conventional funds.
- May require higher management fees — Working with financial advisors for ethical funds will cost you more, as they need more time to research the green credentials of any company.
Aligning Principles With Profits
The growing popularity of ethical investments demonstrates the reality that people now want to be active participants in societal change. Whether it’s in reducing the impacts of climate change, making healthcare more accessible, or being more diverse and gender inclusive, this type of investment will not only help you increase your later life income but also allow you to use your hard-earned money to move society towards a better future.