From recycling our rubbish or going vegan, to using the car less often, many of us are making small changes to our daily lives to reduce harm to the planet.

But choosing to go green on our pension investments could have a far greater impact, as the institutions managing our money may include both heavy investors in fossil fuels and those seeking environment-friendly alternatives.

“Our research indicates that moving a £100,000 pension pot with a traditional portfolio with oil and gas companies to a positive impact portfolio is the equivalent of taking five or six cars off the road a year,” says David Macdonald, founder of The Path, a firm of advisers that specialises in positive impact investing.

“It is significant. People are waking up to the fact they can make a monumental difference by changing their investment strategy so it is well tuned to the planet,” he says.

The growth of funds invested along ESG principles — environmental, social or governance — has been rapid in recent years. Global ESG-linked funds took in nearly $350bn last year, compared with $165bn in 2019, according to data from Morningstar. Net assets held in UK-domiciled ESG funds went from £29bn at the beginning of 2017 to £71bn by the end of 2020, including active and passive funds.

Driving this trend is the wider choice available to investors wanting to align their money with their values.

“Ten years ago, if you were interested in investing [according to one’s values], then your only real choice was to screen out the ‘sin stocks’ like alcohol, tobacco and weapons,” says Jeannie Boyle, executive director at EQ Investors, a wealth management firm which specialises in positive impact investing.

“But over the past few years, the thinking has shifted from how can we simply take out what is negative to how can we allocate our capital towards companies making positive changes for society and the environment.”

A greater choice of funds means individuals seeking more sustainable investments can make a more rigorous selection as they will have a growing range of better- and worse-performing managers.

But making the right decision can nonetheless be highly challenging: there is little standardisation in the way funds are described, putting inexperienced investors at risk of buying something that isn’t quite what it says on the tin.

Last month, for instance, Aegon Asset Management issued a warning to bond investors that they were at risk of becoming victims of greenwashing as the global issuance of green, social and sustainability bonds — so-called “labelled bonds” — has surged in recent years.

James Rich, a senior portfolio manager at Aegon Asset Management, said: “In the absence of a common industry standard, issuers of labelled bonds can be prone to false promises,” pointing to missed reports or poor tracking of outcomes.

FT Money outlines how to make your pension investments more sustainable and be alert to greenwashing.

Getting started

A good place to get started is to get to grips with the investment jargon, which can be baffling.

Cutting through the jargon

ESG investing — environmental, social and governance — covers a wide range of ethical priorities. Square Mile Investment Consulting and Research breaks down the market into five main areas.

Ethical exclusion: Avoids industries and company practices that harm people or the planet. For example, it excludes companies making tobacco products, armaments or producing or distributing fossil fuels.

Be aware criteria vary, so check that they meet your needs but don’t be over-prescriptive as you may limit your choice of investments.

Responsible practices: Considers companies’ operational practices and supports “best practice”. For example, investment in a retailer which requires suppliers to treat its employees well and seeks to reduce its environmental impact.

Be aware — you may be exposed to controversial industries, since the objective is to encourage improvements within companies.

Sustainable solutions: Seeks to invest in companies providing solutions to social and environmental challenges and believes in the financial benefits of doing so.

Be aware — sustainable funds invest in specific sectors and their performance will deviate from a benchmark index.

Impact investing: Aims to invest to make a wider positive social or environmental impact as well as meeting financial needs, such as companies addressing healthcare needs, generating renewable energy and improving energy efficiency.

Be aware some impact funds are highly focused on specific sectors, often with smaller numbers of stocks, potentially increasing their volatility.

Climate focused: These funds embrace both climate-aware investment and climate solutions.

Be aware — funds may invest in transitioning fossil fuel providers, or in companies providing solutions to climate change.

“Responsible investment” is a catch-all term, used by asset managers, to broadly describe funds which invest to make a positive change, either to the environment or for society. 

Within this umbrella term are four broad investment approaches: ethical exclusion; responsible practice; sustainable solutions; and impact funds.

“Traditionally, it was thought that money and morals don’t mix, but in recent years the whole fund management industry has come to recognise that not taking account of social and environmental factors can end up costing you money,” says John Fleetwood, director of responsible and sustainable investing at Square Mile Investment Consulting and Research.

“There are different ways of approaching this, with a whole spectrum of investments. These are not mutually exclusive, but it’s helpful to identify which approach best resonates with you.”

Before you take the plunge and start picking stocks or funds, experts say it is important to cover the investing basics such as assessing your appetite for risk and setting clear goals about what you will or won’t tolerate in your portfolio.

“I have worked with investors who are so motivated by helping the environment that they wanted to invest their whole fund in renewable energy or save the oceans, for example,” says Boyle. “But the portfolio has to have diversification. This is basic.”

Macdonald of The Path says investors should be clear about their investment moral red lines, such as fossil fuels or fashion companies.

“Until you are clear on where your own boundaries are you may end up with a product that is incompatible with your views, as some funds have fuzzy, or unclear, investing boundaries.”

Picking the right investment

Once you’ve worked out your priorities, you can start to consider fund choices. As of August 2020, there were about 300 sustainable and responsible funds available to retail investors in the UK, ranging from actively managed to passive index trackers.

“Responsible investment has evolved from being a niche consideration with relatively few options to encompassing a full spectrum of strategies with outcomes to meet all investment objectives, from income to capital growth and everything in between,” says Fleetwood.

Funds are available in the UK which offer exposure to nearly all asset classes, from mainstream equities and bonds to alternatives such as infrastructure, as well as to differing world regions and themes such as renewable energy or water and waste management, he adds.

The most popular funds have billions of pounds under management and are offered by household name companies such as Vanguard and Baillie Gifford. Square Mile has analysed the market for sustainable and responsible investments to identify the funds with the largest assets under management (see table).

Largest ESG funds by assets
Fund nameFund size ('000)
Pictet Global Environmental Opportunities £          6,237,910
Pictet Water £          6,064,730
Nordea Global Climate and Environment Fund £          5,470,950
Rathbone Ethical Corporate Bond £          2,117,710
Vanguard ESG Developed World All Cap Equity Index £          1,248,410
Aegon Ethical Equity £             567,000
Baillie Gifford Positive Change £          2,352,730
Impax Environmental Markets PLC £          1,276,660
Triodos Global Equities Impact £             891,645
Vontobel Sustainable Emerging Markets £          7,339,550
Nordea Emerging Stars Equity £          5,001,200
Legal & General UK Property £          2,865,660
Pictet Clean Energy £          3,354,570
BNP Paribas Energy Transition £          2,789,710
Greencoat Wind £          2,477,170
Click here for the full version of this table (PDF download) Source: Square Mile Investment Consulting and Research

The growth of ethical and sustainable investing has sparked a debate over whether investors sacrifice returns when choosing these funds. However, research by Morningstar, published in July 2020, examined the performance of a sample of 745 Europe-based sustainable funds and found the majority of strategies had done better than non-ESG funds over one, three, five and 10 years.

Fleetwood says there is growing evidence that funds which apply a “responsible” filter “have provided returns superior both to their benchmark and to their more traditional peers.”

Assess your portfolio

As a start, look at your employer’s pension plan to check what it is invested in. 

“Most workplace pensions will offer some sort of ethical or sustainable fund — outside the main default fund — but there isn’t a vast array of choice,” says Boyle. “These funds will charge more than the main default fund and may not fully align with what you are trying to achieve.”

The UK’s largest pension providers have committed by 2050 to be “net zero” or neutral on carbon emissions from their main pension portfolios, a pace seen as too slow by many climate campaigners.

But their initial moves in this direction are already apparent. Claire Walsh, a chartered financial planner and specialist adviser in ethical investment, says that Aviva, a big pension provider, has embedded ESG principles across its default funds and combines the risk management approach of lifestyling — reducing investment risk as the end of the pension term nears — with a responsible investment approach.

She adds that Nest, another workplace pension scheme, has divested from tobacco and considers climate-related financial risks within its investment process for its default funds. “Both providers also have very good ethical funds,” she says. 

Royal London has a long history of using its shareholdings to influence good corporate behaviour, she says. But innovation is also taking place outside the big providers. Cushon, a fintech company which describes itself as a “disrupter”, this year launched a “net-zero” pension. However, this is only available if your employer chooses Cushon for your workplace scheme.

Legal & General offers a fossil fuel-free pension fund, in large part as a result of consumer demand.

DIY portfolio options

Savers who don’t want to wait for their workplace pension to offer more responsible options could open a personal pension, or a self-invested personal pension (Sipp), to craft their own ethical portfolio.

Most large insurers and asset managers, and new pension consolidators, now offer ethical investment options, or have a pre-screened list of ethical funds, to spare customers the legwork of doing their own research.

Interactive Investor, the investment broker, produces a rated list of ethical investments, the ACE40, a selection of ethical collective investment vehicles. Becky O’Connor, head of pensions and savings at Interactive Investor, says renewable energy and environmental stocks and funds have proved popular with clients.

Many pension holders just don’t want fossil fuels in their portfolio at all,” she says.

Holly Mackay, founder of Boring Money, a consumer finance website, said such shortlists were useful for pension savers who are happy to pick and choose their funds and investments.

Moral Money

For news and analysis about the fast-expanding world of socially responsible business, sustainable finance, impact investing, environmental, social and governance (ESG) trends. See Moral Money

Charles Stanley Direct, the investment broker, also has a list of its preferred eight sustainable funds, she adds, while AJ Bell Youinvest is the first investment platform to build its own one-stop shop — the Responsible Growth Fund — which people can hold in a pension for a total annual fee of 1.25 per cent.

For those still building their pensions and looking for a simple path to ticking the green box, Mackay believes Nutmeg and PensionBee have the best current offers in the market.

“Nutmeg has quite detailed information available on how it screens and builds its socially responsible portfolios. And PensionBee offers a fossil-free option in its pensions,” she says.

Typical fees for passive ethical and sustainable funds can range from 0.15 to 0.25 per cent a year and 0.75 to 1.15 per cent for actively managed funds.

However, investors can expect to pay a slight premium for being morally minded, due to the extra levels of due diligence involved.

“As an example, the L&G UK Index Fund is available for a 0.1 per cent charge, however if you choose the Legal & General Future World ESG UK Index the annual charge is 0.15 per cent,” says Nathan Long, senior analyst at investment broker Hargreaves Lansdown.

“Both funds give exposure to the UK stock market, but the ESG version comes at a premium. The increased cost is, of course, small and could easily be dwarfed by a difference in investment performance, but it shows that extra cost is inevitable with additional complexity.”

Sorting the green from the greenwash

Experts warn that those dipping into the market without the help of a professional financial adviser face a plethora of jargon.

“At the moment there is no common standard in how funds are described,” says Dean McSloy, partner at The Private Office, a firm of chartered independent financial advisers.

“There are funds that badge themselves as ESG or ‘sustainable’ and ‘responsible’ but there is no easy way to establish how ESG or ethical those funds are. You’d really have to dig underneath and look at the all the holdings,” he says.

An added challenge is that regulations do not require asset managers of UK funds to disclose all their holdings, so customers may not realise if they are breaking their own investment principles.

Boyle of EQ Investors says the universe of ethical funds has expanded significantly over the past two years, but some strategies had simply been repackaged to highlight their ESG credentials.

“Anyone looking to invest in passive funds needs to understand the index they are tracking,” she said.

Experts predict that money will continue to pour into ESG funds as investors look to align their values with their finances. “We know from our own research that pension holders want their pensions to build a healthy planet as well as providing healthy returns,” says Richard Curtis, the film director and co-founder of Make My Money Matter, a campaign group.

“The public has this huge weapon in their armoury when fighting for the planet. Now is the time to use it.”

Copyright The Financial Times Limited 2023. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Follow the topics in this article