Millennial Money: When ethical funds aren’t so ethical

Millennial Money: When ethical funds aren’t so ethical

Do you really know what you’re buying with ESG assets?

The younger generation are a caring bunch. We’re worried about climate change, get angry when companies abuse human rights and want to know that our money isn’t funding those kinds of companies.

That makes us prime targets for a growing crop of ethical funds that claim to strip out the corporate baddies from the goodies, leaving us with morally gleaming portfolios that we can feel good about while earning stock market returns.

Who wouldn’t feel fairly warm and fuzzy about owning a “global gender equality” fund (exchange-traded fund provider Lyxor offers just that) or an ETF that promotes water sustainability around the world?

Funds with environmental social and governance (ESG) screens offer portfolios of global stocks but kick out companies that make controversial weapons or invest in the gambling industry, for example. In the US, investors can even answer the question “What would Jesus do . . . in the stock market” with the Global X S&P 500 Catholic Values ETF and James Biblically Responsible Investment ETF. (According to those fund portfolios, they should buy Amazon and Apple).

But millennials need to check their ethical funds carefully before jumping in. There are times when a provider’s idea of “ethical” may be unrecognisable from their own.

“An ‘ethical’ strategy has no set definition, and investors can often be faced with a myriad of options,” says James McManus, investment manager at online wealth manager Nutmeg. “In their most basic form, strategies operate on an exclusion basis only, removing companies with large operations in industries deemed unethical, such as tobacco, weapons, gambling.

“Other methodologies choose to reward better behaviour by tilting towards stocks with better ratings than their peers. It’s really important to pay attention to the index construction and screening that is taking place in order to understand what will and won’t be included in the portfolio.”

If you don’t pay attention, you might end up with unexpected stocks in a sustainable fund. For example, would investors expect to hold oil stocks when buying iShares MSCI Emerging Markets Socially Responsible Investing UCITS ETF? Possibly not, but there are four such companies in its portfolio.

The issue is not with the fund. It is only following the rules of its benchmark, the MSCI Emerging Markets Socially Responsible Investing index. The problem lies with investors’ definition of “ethical”. Does it mean avoiding fossil fuels? Excluding arms companies?

Does it mean avoiding companies such as Sports Direct following its pay scandals, or stripping Facebook of your investment as punishment for harvesting, and selling, your data?

Or does ethical or sustainable investing mean funnelling money towards companies genuinely enacting change, via renewable energy projects, for example, or clean water initiatives?

Investors need to do their homework when it comes to funds promoting ESG investing or socially responsible investing (SRI). They are not a homogenous group but failure to do due diligence could leave you with a portfolio featuring things you really didn’t want to own.

For example, oil and gas company Total is the largest holding in UBS’s MSCI EMU Socially Responsible ETF. That is because the index it uses ranks companies based on data points such as corporate governance and accounting practices.

A giant oil company might be well run and boast a diverse board, giving it a high score on several ESG metrics, despite its impact on the environment. Another fund might lower the weighting of a stock in its portfolio based on where its earnings come from, but might not exclude it entirely.

“Not every investor has the same definition of harmful,” says Patrick Thomas, investment manager at Canaccord Genuity Wealth Management. “Funds cannot even agree a common definition of what constitutes exposure to tobacco. And what about a technology company making vaping or ‘heat not burn’ technology?

“We can all agree we do not like companies profiteering from addictive fixed odds betting terminals aimed at the less affluent but how do we feel about broadcasters offering gambling content after midnight?”

Millennials do want to use their money for good, according to survey data. According to a recent YouGov survey conducted in 2017, millennials were twice as likely as the overall investor population to invest in companies targeting social or environmental goals.

According to the survey, 13 per cent of 18-34 year-olds with a pension said they wanted that money to be invested ethically. Only 6 per cent of older people aged between 45 and 54 felt the same way.

ESG funds are a good option, but finding companies that are truly free from controversy is tricky. Most recently, big tech has taken a punishing. A raft of ethical funds kicked out Facebook towards the end of 2017, months before the high-profile data breach came to light.

According to index provider MSCI, warning lights had been flashing around Facebook’s governance and privacy policies since 2012.

In March 2018, MSCI said it had “called attention to the firm’s poor privacy and data security management practices” since 2012, noting the company scored “poorly on management indicators with regard to controls over user data sharing with third parties, data collection minimisation practices and audit oversight”. Facebook later said it was overhauling its policies on privacy and personal data.

There is another option when it comes to ethical investing — picking a fund with a specific theme. Those include funds that invest in renewable energy projects, or trusts such as Civitas, a social housing real estate investment trust, which supports UK social housing projects.

Each of these funds will have its reasons for putting itself in the “doing good” category. But bear in mind it could take more than the letters E, S and G to secure your own moral high ground.

Kate Beioley is a reporter on FT Money