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What are ethical exchange-traded funds (ETFs)?
An exchange-traded fund or ETF is like a managed fund that's traded on an exchange, such as the Australian Securities Exchange (ASX) or Cboe Australia (CXA). When you invest in an ETF, you don’t directly own the underlying investments. Instead, you possess units in the ETF while the ETF provider owns and manages the actual assets.
What sets ethical ETFs apart is their focus on investing in companies that prioritise environmental and social responsibility. These funds let you support companies that prioritise sustainability and social responsibility, while enabling you to invest in different stocks. This way of investing matches the beliefs of some people who want to make a positive impact on the world.
But remember, not all funds that say they're ethical really are. Some of these funds might adopt the ‘ethical’ label but still invest in companies that hurt the environment or society. This practice is also called greenwashing.
Additionally, what one company sees as ethical might not match your understanding of what is ethical. For instance, some funds may refrain from investing in tobacco or alcohol producers due to their negative health impacts. However, they might invest in fossil fuels. To make an informed decision, consider reviewing the fund’s holdings and read the Product Disclosure Statement (PDS) closely to understand more about the fund’s objectives. This can help you determine if the fund's approach aligns with your values.
What is the meaning of ‘ethical’ in investing?
In investing, 'ethical' means picking options that match your own moral beliefs and values. Instead of solely focusing on returns or costs like traditional investors, ethical investors prioritise how investment options align with their moral beliefs. There are typically four common approaches to ethical investing:
Negative screening
Negative screening involves avoiding investments in certain industries or companies that don’t align with your personal beliefs or ethics. For instance, you may choose to avoid investing in stocks associated with activities like gambling or weapons.
Positive screening
This method involves seeking out companies that are dedicated to making positive contributions in the areas you support.
Integration of ESG factors
Many ethical investment funds are labelled as ESG funds. ESG stands for Environmental, Social, and Governance factors. Companies in these funds are assessed on their resource management, interaction with the society, and adherence to good governance principles.
Impact investing
Impact investing is an approach where you choose to invest in companies that are actively working on addressing significant global challenges.
Apart from these common approaches for filtering out ethical investments, some organisations in Australia could help you identify what may typically be considered an ethical or responsible investment. For instance, the Responsible Investment Association of Australia is one such organisation that evaluates and certifies ethical investment products in Australia and New Zealand.
How to identify which ethical ETFs to invest in
When it comes to investing in ethical ETFs, it's important to consider several factors to identify the right fund that aligns with your values and investment goals. Here are some key considerations to help you make an informed decision:
Understand the fund's approach
You can find several ethical ETFs listed on the ASX but it’s important to exercise caution to avoid getting greenwashed. Instead of simply relying on the ethical label given to a fund, consider learning more about it by reviewing its investment strategy and objectives.
Different ethical ETFs may have different approaches to investing. Some may exclude certain industries or companies based on ethical criteria, while others may prioritise companies with strong ESG practices. Understanding the fund's approach can help you determine whether it aligns with your values.
Review the fund’s investments
Besides researching a fund’s investment strategy, you should also consider reviewing the list of stocks it invests in. This will give you an idea of the type of companies or industries the fund supports. For instance, a fund might be supporting companies in the renewable energy sector, which is something you strongly support. At the same time, it might be investing in some companies involved in practices you don’t support, such as the alcohol or tobacco industry. By reviewing the fund’s investments, you can determine whether it aligns with your ethical values.
Consider the fund's financial performance
When you’re thinking of investing money, it’s important to consider more than just the ethical principles. Besides understanding a fund’s ethical strategy, consider checking how well the fund has done financially in the past.
Keep in mind that the main goal of investing is generating returns. You could try to find funds that prioritise both financial returns and ethical considerations, instead of giving up one for the other. This way, you can invest in companies that match your values without missing out on potential returns.
Assess the fund's fees
Like any investment, it's essential to consider the fees associated with investing in an ethical ETF. When comparing ETFs, you may want to check the expense ratio. This represents what the investment company charges you for running the fund. You’ll typically want to look for funds with low expense ratios, as higher fees could eat into your net returns.
If you’re unsure about which ETF to choose, you could consider speaking to a financial expert for advice tailored to your financial goals. If you're new to investing, you can also explore our beginner's guide to investing for some practical insights.
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