Whose ethics anyway? The grey areas of ethical ETFs

Many investors feel inclined to invest in what’s believed to be ethical, sustainable, or simply ‘good’. But whose ethics make an investment ethical, and is there such a thing as a truly ethical investment?

I sat down with Andrew Linden, Sessional Lecturer at the School of Management at RMIT University and contributor to The Conversation, to dive a little deeper into the grey areas surrounding ethical investing—in particular, ethical or environmental, social and governance (ESG) exchange-traded funds (ETFs).

Note: for more info on what an ESG ETF actually is, see our previous article here.

What might be some of the issues in the ESG ETF market?

“The short answer is that ethical investing is an incredibly problematic concept, and it’s been problematic for a long time.

“So-called ethical products are actually far from it”

“Like any flavour-of-the-month strategy that’s related to product-selling, ethical ETFs can make claims that aren’t defensible. I’ve been concerned for a long time about the fact that so-called ethical products are actually far from it.

“When it comes to ETFs, they suffer from the same problem most ethical products suffer from—what is the screening process? What’s the methodology used to build the actual index? It’s very much bound up in the basic problem around community ideas of what’s acceptable and ethical, and around morality; an amalgamation of some shared idea plus individual ideas that are different.”

What might go wrong in constructing an ethical fund?

“The problem with constructing an ethical fund is that it’s always going to be subject to some fuzziness around the edges about what should be kept in and left out. For example, in long-term products like pension or super funds, they’re not very flexible around what people consider to be ethical. There are some unethical companies that are always relatively predictable, like tobacco, where it’s been evident for quite some time that the wider community believes it to be a deadly product despite it being legal. It becomes easy to say you’re not interested in investing in a product like that.

“The same could be said around products and climate change. It’s been clear now for a long time that if your goal was to invest ethically, you wouldn’t be investing in carbon products. The problem is that when you construct an ethical index that includes what people might consider to be ethical, there’s always going to be room for imposing on another unethical area. Who’s to say that your fund is ethical unless it’s vegan? The whole idea behind creating these indices becomes fraught with problems.

“Pandemic or not, ethical investing is still a hugely controversial area”

“Some of these so-called ethical funds make gobsmackingly misleading claims. If you were to include technology stocks in your portfolio, which are in many ethical funds, it would make sense to, because they don’t have any connection to carbon. But many are serial offenders when it comes to multinational tax avoidance. Some ethical funds get that way by being quick and dirty.”

Is a truly ethical ETF possible?

“You might be able to create a really good, robust ethical ETF, but that would require an absolute laser-like focus to make sure that companies are sticking to their claims. If you were to look at the garment industry for example, or retail, plenty of very credible clothing lines can basically be implicated by modern slavery if they rely on any extended supply chains. Context is so important.”

Do you think the screening process might improve if ethical ETFs continue to climb in popularity?

“I hope that might be the case. The more popular an idea becomes, the more people latch onto it. There may be a core group of people doing it really well and a very long tail-end of people looking to make a dollar out of the flavour-of-the-month. That’s the danger.”

What do you think might the COVID-19 pandemic teach us about ESG investing?

“It’s showing that there are a lot of latecomers to ethical investing. It’s definitely changing people’s ideas around the viability of heavily financially-engineered public companies, however. Pandemic or not, ethical investing is still a hugely controversial area. Finding a truly ethical ETF requires a lot of expertise and a lot of patience.

From the margins to the mainstream, ethical investing has experienced an intense market boom. Though responsible in practice, the working definition of ‘ethical’ is still subject to malleability.

It’s a problem of definition and of competition: everybody wants to invest ethically, but no-one wants to lose money.