Active versus passive when investing ethically

This article is part of
Guide to investing for good

Active versus passive when investing ethically

For a while, the active versus passive debate in the asset management industry became quite heated.

Naturally, there have been plenty of people in the industry who say a combination of actively-managed funds and products that track an index at a much lower cost can work in an investment portfolio.

But there are many people in asset management who hold strong views about one or the other investment approach.

Article continues after advert

While this debate has cooled somewhat, advisers with clients who are considering how to invest ethically or sustainably may want to know whether a passive approach might well be a more efficient way of doing so than via actively-managed products.

Firstly, can it be done? In a word, yes.

“The decision to invest passively or actively should be independent of the decision to invest sustainably given that there are a number of both active and passive strategies that are strong from a sustainable investing (SI) perspective,” says Christopher Greenwald, head of sustainable investment research and stewardship at UBS Asset Management. 

“Passive SI can be an easier place for investors to start, as they are going to obtain similar risk and return profiles of the overall market while having a stronger sustainability performance.”

But he notes: “Active SI strategies have the advantage of being more concentrated and, thus, it is generally easier for clients to understand the role that sustainability plays in the investment process, which is reflected in a more limited set of portfolio holdings.”

Mr Greenwald explains the performance of passive strategies is generally in line with the underlying benchmark, and the performance for active SI managers varies across different funds, “just as it varies across managers of traditional active funds”.

Price and simplicity

Passive strategies have the obvious advantage of being cheaper but, for many, there are limitations that can only be overcome by investing in an active fund.

Julia Dreblow, founder of sriServices and Fund EcoMarket, points to some of the pros and cons.

“Clearly, passives have the edge when it comes to price and simplicity – but their simplicity is also their greatest challenge in the SRI market,” she suggests.

“Values-based judgements and factoring in information about how company management is responding to a diverse range of ESG [environmental, social and governance] risks and opportunities requires case-by-case consideration – and the ability to respond to clients’ questions when asked.” 

She says: “Passive funds are generally not well-equipped to handle such things and are generally expected to invest in areas that are unpopular with ethically minded investors.”

John David, head of investments at Rathbone Greenbank Investments, observes there are few passive ethical funds, and says those that do exist are often based on responsible investment indices, “which may not be sufficiently ethically-screened for some investors”.