Investing ethically via passives

This article is part of
Guide to ethical investing

Investing ethically via passives

Part of the appeal of passive investing is it is generally a low cost way of getting exposure to asset classes and indices.

There are certainly passive products available for investors which have an ethical or sustainable remit but whether they are indeed as low in price as other passive strategies is up for debate.

Unlike other asset classes and themes, there are some limitations when it comes to using passive strategies to get access to ethical and environmental, social and governance (ESG) investments.

In September, the MSCI launched the MSCI Factor ESG Target Indexes, which are designed to help investors incorporate environmental, social and corporate governance factors into their investment process.

New ways to invest ethically are being introduced all the time.

For many, and unsurprisingly it is usually those who work in the active management space, passive is not an effective or efficient way to invest ethically. 

David Osfield, co-manager of the EdenTree Amity International fund, acknowledges: “The active management industry is facing increased scrutiny that rightly questions the value-add of active managers, particularly those that consistently deliver sub-index performance with uncompetitive fee structures. 

“While the active versus passive debate is a much broader topic to consider, there is one area where I believe that active management has a definitive edge – ethical and sustainable investing.”

He explains: “Much has been made of some passives beginning to incorporate underlying ESG criteria in order to create ethically sound passive products, but we believe this approach is inherently flawed. 

“While it might be possible to apply certain ESG criteria to passive funds – specifically the exclusion of companies operating in certain industries, such as alcohol or tobacco production – the reality of constructing portfolios entirely from negative screening is that the approach is largely commoditised, more subject to factor imbalances, and lacks a more comprehensive framework to identify the opportunities that companies can offer.”

Active over passive?

John David, head of Rathbone Greenbank Investments, says when it comes to ethical investing he has not found the passive route as attractive as active.

“On balance, we feel active investment, backed by well-resourced and established teams, provides a better overall fit with many clients, who may be looking for their investment to avoid many of the companies that may otherwise find their way into passive investment strategies,” he notes.

But he recognises some products have been able to combine robust screens with lower ongoing costs. 

For example, passive investing via trackers and exchange-traded funds (ETFs) has grown dramatically, Mr David observes.

“While the size of the broader ETF market is huge, historically there have been very few ethical ETFs. This is now changing, and the likes of iShares and others are providing solutions for regional allocations to SRI ETFs in Europe, US, Asia and Japan.