Ethical ETF

Meaning of ETF (Exchange Traded Fund)

An exchange traded fund or ETF is a fund which invests in stocks in a particular sector or stocks which comprise a particular index.  There are also ETFs which invest in particular commodities or currencies.

Themed ETFs

Exchange traded funds based on themes are a recent phenomena.  Instead of investing in a particular index or sector, these funds follow popular themes for investing.  These themes may be based on ethical, economic or demographic criteria.  Those ETFs whose investments are based on ethical standards are called ethical ETFs (Exchange Traded Funds).

The popularity of the themes draws investors to these ETFs.  Increased investor interest pushes up the share prices of these companies.  The resulting capital infusion will lead to these companies performing well and giving good returns to the investors of the themed ETFs.

Ethical Investing

There are many investors who want to refrain from investing in industries associated with tobacco, alcohol, nuclear weapons, child labor and so on.  There are others who do not want to invest in countries whose governments follow questionable policies.  Some want to stay away from industries which pollute the environment.

When environmental, social and governance issues form the basis of the investment decisions of the investor, it is called ethical investing.  The other terms used are social investing, socially responsible investing or SRI, values based investing and so on.

In addition to the desire to invest ethically, many of these investors also feel that companies which do good, perform well.  By rewarding companies which follow high ethical standards, these investors encourage other companies to do the same.

Ethical ETFs (Exchange Traded Funds)

There are indices which are formed after screening and filtering out companies associated with unethical behavior.  Exchange traded funds which track and invest in companies comprising these indices are called ethical ETFs.

Criteria followed by an investor when investing in Ethical ETFs:

Before making any ETF investment, an investor studies the following-

  • Whether the overall cost of investing is low
  • Whether the management is professional
  • Whether the companies and the sectors to which they belong hold promise

Before investing in an ethical ETF, the investor has to consider one more point –

  • Whether the ETF management strictly adheres to the expected ethical standards when investing

Passively Managed vs. Actively Managed Ethical ETFs (Exchange Traded Funds)

Ethical ETFs, true to their name, need to lobby with companies to do better in the ethics department.  Actively managed ethical ETFS would surely make more effort to persuade companies to follow ethical policies than ethical ETFs which track screened indices and are passively managed.

Focus of Ethical ETFs

Ethical ETFs may either have a broad focus that is they may invest in companies basing their decision on a range of ethical and moral parameters or they may have a narrow focus restricting their screening to one particular criterion.

A clean energy ETF would be an exchange traded fund with a narrow focus as it is designed to deliver returns by investing in companies that focus on green and renewable sources of energy.

Points to remember when investing in Ethical ETFs (Exchange Traded Funds)

  • Expense ratios of ethical ETFs are much higher than ETFs which follow market indices
  • If investors have a diversified portfolio across industries and sectors, a new investment in an ethical ETF may overlap with other investments
  • Ethical ETFs may be quite liberal while making investment decisions and may not strictly stick to the claimed ethical standards.

Ethical ETFs (Exchange Traded Funds) are good avenues of investment for people who wish to do ethical investing. While a single investor would not be able to influence companies to follow ethical policies, ethical ETFs by the sheer size of their investments can successfully persuade companies to follow ethical standards.