Typically, Ethical ETFs are a subset of Australian and international share ETFs.
Currently, the majority of “ethical” ETFs invest in shares of companies considered to be more ethical than average. You should be careful and mindful before buying into one of these ETFs because their definition of “ethical” could be completely at odds with your definition of the word.
How do they choose what’s ethical and what’s not ethical?
Index-style ETFs and fund managers typically take two different approaches to determine what is — and what isn’t — an ethical investment. However, at the highest level, investors can use “negative” or “positive” filters to upgrade or downgrade companies:
- Positive filters increase the ethical rating of a company. For example, a company which has an ESG (environment, social and governance) policy would rank more positively than one that doesn’t have an ESG policy.
- Negative filters downgrade the ethical rating of a company. For example, a company involved in pornography, cluster munitions, tobacco, pokies, coal mining or those with ties to criminal activity (human trafficking, wage fraud, slavery, corruption, etc.) would be avoided.
Most index/passive ETFs use a rules-based approach to ethical investing. Meaning, the ETF’s issuer doesn’t make the decisions on what’s ethical or not, they typically rely on a third-party provider for ‘ethical ratings’ or they just use a blanket rule (‘no mining companies’).
Active fund managers can afford to take a different stance because they actually study the company’s actions and operations. For example, a company that has been included in the coal mining sector might be ruled out by some ETFs because ‘that’s not a very ethical industry’. However, on closer inspection, the company might not be a mining company but it might provide services to the mining companies — making them more or less efficient.
As you can see, it’s important to study how the ETF/fund thinks about ethics and the rules they use before getting swept up in the marketing gimmicks — there are a lot of them!
