Ethical ETFs

Find out about ethical ETFs, why investors choose them and what the key risks are.

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Increasingly investors want their investments to do more than simply make a profit. They want reassurance that their investments will be put to good use – to support companies that are making the world a better place, rather than propping up difficult industries, such as tobacco or fossil fuels.

Defining ‘ethical’ is no small task and ethical funds come in plenty of shapes and sizes: there are SRI (“socially responsible”) funds, sustainable funds, climate change funds and ESG funds (environment, social and governance). Confusingly, all of them do things slightly differently.

What are ethical ETFs?

Ethical ETFs aim to invest with a conscience. This may be by excluding all ‘sin’ areas, such as weapons, pornography, gambling or tobacco or by giving higher weighting to the top performing companies on various ethical criteria, such as carbon emissions, gender diversity or social impact. Others will specifically focus on a single ‘ethical’ area, such as climate change or clean energy.

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.

Which are the best ethical ETFs?

Top three by five year performance – Source: ETF Database to 1 November 2021:

Fund name (Ticker)5 year performance1 year performance (to 1 November 2021)Link to invest
Direxion Daily Semiconductor Bull 3x Shares1512.55%173.21%Invest now
Capital at risk
ProShares Ultra Technology903.15%107.75%Invest now
Capital at risk
ARK Next Generation Internet ETF620.37%35.90%Invest now
Capital at risk

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How to invest in ethical ETFs

Ethical ETFs trade on exchange 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?

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

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

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