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Can you be passive and ethical too?

October 23, 2012
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Fads and fashions in the investing world come and go. But few would dispute that the growing popularity of passive investing and ethical investing are more than just passing trends.

Passive investing has grown exponentially in the US, and evidence is clear that more and more investors in Britain and elsewhere are waking up to the fact that active funds are too expensive and all too often don’t deliver sufficient returns to justify the charges they carry. 

Ethical investing, too, is on the increase. According to a poll carried out by YouGov for National Ethical Investment Week, around half of us would like to “make money and make a difference” at the same time. 

But what if you want both? If you want to enjoy the advantages of investing long-term in low-cost funds and have a positive impact on the environment and society?

Surely an ethical investor, by definition, is an active investor, and the ethical approach is incompatible with passive investing? 

Actually, no. It is possible to combine the two, and in fact the options for those who want to do just that are growing all the time. 

“Ethical investing and passive are fully compatible,” says Igors Alferovs from Barnett Ravenscroft Wealth Management, which advises its clients to invest exclusively in passive funds.

“When constructing a portfolio your starting point should always be getting your asset mix right. This will depend on your attitude to risk, your ability to tolerate the ups and downs of your portfolio, along with your need to take financial risk in order to achieve the financial goals that you’ve set. 

“If you want to invest in an ethical socially responsible manner, all you’re doing is restricting the universe of companies and countries you are prepared to invest in. Despite this you will still be left with more than enough suitable companies and countries to ensure you can adequately diversify your portfolio.” 

Many advisers point to figures which suggest that those who refuse to invest, for example, in defence, betting and tobacco companies, ultimately pay a price for their clear conscience in the form of lower returns. In fact, studies have repeatedly shown that the returns from ethical and comparable mainstream investments are remarkably similar

In the end, as with all types of investment, Igors Alferovs says the first and most important thing to is to find out what you’re being charged. 

“The availability of ethical and socially responsible investment vehicles is on the increase, but most are still managed by traditional investment companies with an active management approach,” he says. 

“This means high annual charges and costs which eat into your investment returns.”

Actively-managed ethical funds ‘screen’ individual stocks. Either they positively screen and actively invest in companies committed to the well-being of their employees, customers, society, the environment and so on; or they negatively screen, and weed out so-called ‘sin’ stocks. Whichever approach they adopt, they invariably charge a premium for it. 

But, says Igors Alferovs, there are passive alternatives.

“One of the main advantages with a passive investment management approach over an active strategy is lower charges and costs. Every pound saved on charges and costs is an extra pound in your pocket. 

“Fortunately for the investor who wants to invest ethically, it’s also possible to benefit from a passive investment strategy, because diversified, low-cost socially responsible investment vehicles are now available.” 

Among the options to consider are the FTSE4Good Index Series, the Domini 400 Social Index and the KLD 400 Social Index. 

But beware companies charging a premium for specialist index funds. The Co-operative, for example, charges 1.5% on its FTSE4Good Tracker fund, and Legal & General charges 1.15% for its ethical trust fund. 

Those examples might be cheaper than some heavily-marketed, actively-managed ethical funds, but are very pricey compared to non-ethical tracker funds, which can charge as little as 0.2%. 

The lesson then is this: by all means follow your conscience, but be as vigilant about value for money as you would with any other investment

And if the investment industry really is serious about showing its responsibility to the wider world, one of the most effective ways to do it would be to reduce the profits it makes from investors who want to make a positive difference. 

Always consult a financial advisor before making a major investment decision.

Image copyright: Boudewijn Berends

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