Ethical ETFs

How do ethical ETFs work?

Ethical ETFs will aim to match one of the key ethical indices, such as MSCI ESG Leaders or S&P ESG or Dow Jones Sustainability range. The indices will be compiled using a range of ethical, social, environmental or governance criteria. Often they will take the ‘normal’ MSCI World or S&P 500 index and reweight it. Rather than it being the largest companies that take the biggest positions in the portfolio, it is the most socially responsible.

There are also indices that specifically exclude certain sectors, such as the MSCI ex controversial weapons or Dow Jones Sustainability ex alcohol, tobacco, gambling and others. It is important to note that ‘unethical’ companies may still appear in some ethical ETFs, but just at a far lower weight than they are represented in normal indices.

The ETF may use different methods for replicating the index performance. Some will use full physical replication, buying into each stock in the index at the same percentage as it is represented in the index. Others will use sampling, buying representative companies with the aim of delivering the index performance. Finally, there is ‘synthetic replication’ where the ETF provider uses derivatives In general, physical replication is more transparent, but more expensive. Synthetic replication has greater counterparty risk and may be less accurate but is often cheaper.

How to invest in ethical ETFs

Ethical ETFs trade on exchanges like a normal share. As such, investors can buy them through a platform or broker.

Buying ethical ETFs is more nuanced than buying a standard ETF. Investors have to decide on their ethical parameters as well as which option is likely to give the best financial performance. That means looking at how the index is constructed and whether it meets your ethical goals. For example, do you want specific sectors to be excluded? Or do you want to target certain sectors? Are environmental or governance considerations more important to you?

Best ethical ETFs

Here are the top three ethical ETFs by five year performance based on JustETF to 1 June 2023:

Logo	Fund name (Ticker)	5 year performance	1 year performance (to 1 June 2023)	Link to invest
	iShares Global Clean Energy UCITS ETF USD (INRG)	112.94%	-6.73%	Invest with IGCapital at risk
	Lyxor MSCI Semiconductors UCITS ETF – Acc (SEMG)	107.81%	21.51%	Invest with InvestEngineCapital at risk
	iShares MSCI USA SRI UCITS ETF USD (SUUS)	92.75%	3.03%	Invest with FreetradeCapital at risk

Bottom line

Ethical ETFs offer a route to do good with your money, supporting companies that are behaving responsibly on the environment, treating their staff well and are managed with professionalism and integrity. This is becoming a popular way to invest, widely used among institutional investors such as pension funds. If you’re unsure which provider best suits your investment goals, you can compare the features from a range of platforms that let you buy ETFs in the UK.

Frequently asked questions

• Can an ethical ETF really make a difference?

  Governments can make commitments on carbon emissions or biodiversity, but there can be little progress without the corporate sector. Companies need incentives to act responsibly. By pushing capital to the most responsible companies and moving it away from companies that are acting poorly, investors really can make a difference. Companies are already making significant steps on climate change targets as shareholders exert greater pressure.

• Why does my ethical ETF still hold tobacco?

  ‘Sin’ sectors will sometimes still appear in ethical ETFs. Many ETFs simply reweight an index based on environmental, social or governance scores, giving the highest weight to the top-performing companies. So ‘unethical’ companies will still appear, but at a lower weight. Equally, some tobacco companies score highly on governance, which will bump up their overall scores. If tobacco (or any other sector) is a deal-breaker for you, there will be other options that specifically exclude it.

• What type of sectors tend to appear most in an ethical ETF?

  It depends on the approach. Areas such as technology tend to do well on carbon emissions, but score poorly on social considerations. Energy is weak on the environment and tends to have a lower weighting in ethical funds. Financials will often be well-represented. In general, however, investors aren’t taking a significant sector bet by investing in an ethical ETF. Most have a good spread of sectors.