Several Exchange Traded Funds (ETFs) invest only in public companies that these funds identify as "ethical". Many of these ethical ETFs focus on different asset classes, and one can construct a diversified portfolio comprising ethical ETFs. Ethical investing is also referred to as 'Socially Responsible Investing', 'Sustainable Investing' or 'Environmental, Social and Governance (ESG) Investing'.
The advantages of investing in ethical ETFs are:
- You enjoy a sense of happiness when your investments are in line with your moral values.
- The increasing popularity of ethical investing incentivises a public company to act ethically.
The disadvantages of investing in ethical ETFs are:
- The returns can be lower because ethical ETFs have lower diversification and exclude certain high-performing public companies.
- The expense ratio of an ethical ETF is often relatively higher than that of a corresponding regular ETF.
- It might not be the most optimum investment approach for you when viewed from a purely commercial perspective.
- Eligibility criteria adopted by an ETF issuer to include a company in its ETF are subjective. For example, the action of one company may seem to be ethical to one ETF issuer while being unethical to another ETF issuer. Therefore, you should read carefully the eligibility criteria that each of these ethical ETFs follows to ensure that the eligibility criteria conform to your moral values. This analysis requires considerable effort from you!
- There is growing criticism that the eligibility criteria adopted for some ESG funds are biased, agenda-driven, or misleading. Some of the concerns raised by these critics are debatable; some might be valid. You need to be a knowledgeable investor to identify or understand these dynamics.
Alternative to investing in ethical funds
Many investors are not happy with the eligibility criteria adopted by various ESG funds for multiple reasons. So, QuietGrowth suggests to these investors an alternative to investing in ethical ETFs. This alternative is to invest in regular ETFs and donate to a charity of choice an amount equivalent to:
(a) the savings accrued due to lower expense ratios of regular ETFs; and
(b) the higher returns, if any, enjoyed due to the higher performance of regular ETFs.
Refer to the related knowledge resource: