Want to invest ethically and cheaply? Find a responsible tracker fund

Ethical tracker funds are a low-hassle, cheap way to invest and at best do some good in the world, and at least attempt to avoid doing harm.

Many investors prefer passive funds because although they only match index performance, they are far cheaper than actively-managed funds which try to outdo the market. Active funds often still underperform despite charging a lot more.

Financial experts explain cost-conscious investors will find ethical trackers a bit more expensive than traditional ones, but still less pricey than active funds operating in this area.

Ethical investing: Using your money to do some good in the world, or at least avoid doing harm

‘Responsible investments and tracker funds have been among the most popular ways to invest in recent years, and responsible trackers are where these two mega-themes collide,’ says Dominic Rowles, a specialist analyst at Hargreaves Lansdown.

‘The number of people investing in tracker funds with a responsible twist has ballooned, and they frequently feature among the most popular funds on our platform.’

He adds that the number of Hargreaves clients holding an ESG – environment, social and governance – passive fund has risen some 1,669 per cent over the past three years.

Laith Khalaf, head of investment analysis at AJ Bell, says: ‘Investors who want to invest ethically but passively are now spoilt for choice compared to just a few years ago.

‘The huge swell of interest in responsible investing has led many index providers to produce ESG versions of their standard indices, and passive providers have then bridged the gap to investors buy building funds which replicate those indices.’

What should investors consider when choosing an ethical tracker fund

People who want to align their portfolios with their personal principles might feel active investing suits them better, suggests Maike Currie, investment director for personal investing at Fidelity International.

But she notes that passive ESG funds can get you exposure to companies aiming to have a positive impact on society at a lower cost.

Laith Khalaf: Huge swell of interest in responsible investing has led many index providers to produce ESG versions of their standard indices

‘Most popular indexes that passive funds track will have a sustainable alternative – such as the FTSE4Good index, which is made up of FTSE 100 companies which meet the sustainability criteria.

‘Alternatively, some will track indexes tailored around certain themes.’

Currie says investors should consider that they will have less control if a company included in one of these indexes begins to veer from its sustainability objectives.

‘Whereas an active fund can simply divest from that company, a passive can’t. That said, the providers of those passive funds can still engage with companies to ensure they continue to meet ESG standards.’

Rowles, who is the lead ESG analyst at Hargreaves, says responsible tracker funds all invest slightly differently.

‘Some use an exclusions-based approach and won’t invest in industries like tobacco, munitions and coal. They could do this by tracking a screened index, like the FTSE4 Good, or tracking an index that hasn’t been screened, like the FTSE All-Share, and investing in all of the companies in that index that meet their criteria.

‘Other trackers invest in all of the companies in a given index, but adjust the size of their investments depending on how well each company scores against a set of environmental, social and governance-related criteria.

‘You should check each fund’s investment criteria and make sure it invests in a way you’re comfortable with. Some exclude some pretty big companies from the index, so your return could be different from the index too.’

Khalaf says: ‘The idea of a mechanically selected portfolio will have some appeal to ESG investors, for whom a rulebook which dictates what sort of stocks are in and which are out makes a lot of sense.

‘However this does then throw the spotlight on to the construction of the underlying index, and investors need to have a look under the bonnet to make sure they are happy with the way the index assesses companies for ESG credentials.’

Dominic Rowles:  Some ESG trackers exclude some pretty big companies, so your return could be different from the index too

He adds that it’s important not to let the perfect be the enemy of the good, because you are unlikely to find an index or fund that totally aligns with your ethics, though you can probably get pretty close.

‘Picking an ESG tracker fund does therefore need a bit more elbow grease than simply investing in a plain vanilla tracker fund, which makes it a bit more like selecting an active fund than a passive one.’

Keeping the cost of ethical investing low

‘The reason for investing in passive ESG funds are much the same as those for investing in tracker funds more generally – because they tend to be cheaper than active alternatives,’ says Khalaf.

But he cautions: ‘The more specialist the ESG tracker you choose, the more you can expect to pay for it, and some funds wouldn’t look especially cheap compared to the broader funds universe.’

Rowles says: ‘Responsible trackers are usually cheaper than your average active fund, but they usually cost a bit more than traditional trackers.’

What ESG tracker options are out there

‘Passive providers like HSBC, iShares and L&G offer a range of passive funds offering exposure to ESG themes,’ says Currie.

‘Strategies for all investments and funds may vary, so it’s important to read the fund factsheet carefully.’

Currie notes the L&G MSCI World Socially Responsible Investment SRI Index (ongoing charge: 0.32 per cent), which tracks the MSCI World SRI Index, has been one of the most popular ESG funds among Fidelity customers in recent years.

As an example of a fund tracking a themed index, she says the iShares Global Clean Energy UCITS ETF (ongoing charge: 0.65 per cent) tracks the S&P Global Clean Energy Index, which comprises ‘companies in global clean energy-related businesses’.

Rowles suggests Legal & General Future World ESG Developed Index (ongoing charge: 0.15 per cent) as a good option if you want broad exposure to global stock markets, while being mindful of ESG issues.

‘It invests in almost 1,500 companies across the globe and aims to track the Solactive L&G ESG Developed Markets Index.

‘The index increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay.

‘It also reduces exposure to companies that score poorly on these measures. It’s also managed to achieve a 7 per cent reduction in carbon emissions per year.’

Rowles says the fund won’t invest in tobacco companies, pure coal producers, makers of controversial weapons (cluster munitions, anti-personnel mines and chemical and biological weapons) or persistent violators of the UN Global Compact Principles, which cover human rights, labour, the environment and anti-corruption.

He adds: ‘This is more expensive than some other global trackers, but we think it’s a reasonable price to pay given the additional ESG analysis that takes place.’