6 min read
An ethical ETF is an exchange traded fund that aims to invest in an ethical manner. For example, if the ETF is focused on investing in ethical stocks, it could aim to invest more in companies that are trying to be socially responsible - i.e. do more good (and less bad) for society.
This is where things get a little bit tricky. The word “ethical” can mean different things to different people. People have different notions of what is and isn’t ethical that can stem from roots as deep as what religion they were raised in, or as shallow as a Facebook post they read last week. A challenge that ethical investors often have is making sure that the goals of the fund that they invest in align with their own ethical perspective. However, there is one common core of ethics that cuts across different religions and cultures the world over which is – treat others as you would like to be treated. Be kind to your fellow human beings. This is also known as the “Golden Rule.” Using this principle, an ethical investor can try to select an ETF which aims to invest in companies that simply treat people well.
Recently, ETFs have gained the ability to be organized as Benefit Corporations. Benefit Corporation funds have a special goal in their founding documents to not only try to make money for investors, but also to create a public benefit, which can include trying to maximize the value created for customers, employees, and society as well. These kinds of funds have a mission that may be better aligned with the mission of ethical investors. If you want your fund to have a mission beyond just making you money, you should look at the public benefit mission of these benefit corporation ETFs to see how well they align with your ethical investment goals.
The concept of sustainability is closely related to ethics. Sustainability in the corporate context refers to the ability of a company to operate for a long time without its actions coming back to hurt it. Environmental sustainability refers specifically to the environmental component of sustainability, where companies that destroy their environment are ultimately hurt because their planet (or even just their part of it) eventually becomes unable to support them anymore. One could say that an ethical company is more likely to be sustainable. If a company behaves ethically, it will aim to reduce its negative impact on other people (including their environment) and it may be less likely to have those people (or the environment) come back to put a stop to its operations later.
So, while they are not the same concept exactly, sustainable ETFs that define sustainability broadly enough will likely invest in companies that behave ethically. Meanwhile, sustainable ETFs that only focus on environmental sustainability (and ignore other elements of sustainability) may choose from a smaller subset of companies to invest in or could potentially include companies that are sustainable from an environmental perspective, but are unethical (and therefore likely unsustainable) from a social perspective. Beware. Definitions of sustainability can vary.
ESG stands for the Environmental, Social, and Governance issues that relate to business investment and management decisions. Many ESG funds today are focused mainly on how financially material ESG risks impact the profitability of the companies they invest in. Such funds cannot be considered ethical in the strictest sense because they are exclusively focused on maximizing profit; if a company can hurt someone and get away with it without hurting their own profits, this will not be a big negative factor for that company according to those funds. A truly ethical fund would try to penalize the company for bad behavior regardless of whether there is a financially material consequence for the company or not. If you are looking for an ethical fund, you should look very carefully at any fund that advertises itself as ESG to make sure that they care not only about the impact of the world on the companies they invest in but also the impact of the companies they invest in on the world.
If you’re searching for an ethical fund because you have a particular cause that you want to support, you may want to look into certain ETFs that have a very narrow focus. For example, someone who only cares about female leadership in the business community may want to look into an ETF that provides exposure to companies that have female CEOs. However, this approach has a big drawback, in that people typically have ethical interests that go beyond a single issue that may be top of mind for them at a particular moment in time.
For example, an ethical investor may come to the table with the intention to invest based on a single ethical issue – war. This investor hates war because many people die each year from military conflict, and this is ethically repulsive to them. The investor could try to find a “peace” or “anti-war” themed ETF to scratch this itch. However, this investor may not know that typically under 100,000 people die each year from all military conflicts globally, while about 800,000 infants die each year around the world from the misuse of breastfeeding substitutes like formula. So if they hate war, they may want to hate breastfeeding substitutes about eight times more.
There may be a set of investors that are fully aware of the different issues out there and only want to invest in a single theme – for that kind of investor, a single theme fund may be a good fit. However, other investors may unintentionally miss out on the bigger picture. For those investors, a generalist ethical fund that does the research into a variety of different issues and weighs their relative ethical impact on humanity when making investment decisions, can help to avoid an accidental myopic focus on just one issue.
Of course, when buying any investment product, it is important to understand its fees, risks, and financial goals. Once you’ve figured out what kind of ethical fund you’re looking for you still need to make sure that you carefully read the fund’s prospectus to understand how they intend to invest your money, what the risks involved are, and what they are charging you for it.
Under no circumstances should any information or materials provided above be used or construed as an offer to sell, or a solicitation of an offer to buy, any securities, financial instruments, investments, funds, ETFs or other financial products or services. Furthermore, no information or materials provided above should be construed or relied upon as investment, legal, accounting, tax or other professional advice or in connection with any offer or sale of securities.
About the Author
James Katz is a veteran quantitative equity analyst and data scientist with a passion for socially responsible investing. He founded Humankind Investments in order to bring a more analytical and metrics-based approach to the field. Before founding Humankind, James worked in the ETF industry as a quantitative equity analyst and data scientist for Vanguard. He holds a PhD in Business Administration from Stanford University's Graduate School of Business and a BA in Psychology and PPE (Philosophy, Politics and Economics) as well as a BAS in Computer Science from the University of Pennsylvania. James is a CFA charterholder.