When someone is considering ethical investing for the first time, the question they ask first (or worry about silently) is almost always the same: do ethical funds underperform?
It’s a fair question, and one the ethical investing industry has historically been bad at answering directly. The marketing tends toward “you don’t have to sacrifice returns to invest with your values,” which is partly true and partly oversold. The critics tend toward “ethical funds always underperform,” which is also partly true and partly oversold.
The honest answer is more interesting than either side suggests. Do ethical funds underperform is a question that depends heavily on the time period you look at, the type of ethical fund, and how you define underperformance. This post walks through what the data actually shows, the structural reasons behind it, and what it should mean for your own decision.
The short answer
Over very long periods (15 years and more), broadly diversified ethical and ESG-screened global equity funds have produced returns roughly in line with conventional global equity trackers, sometimes very slightly ahead, sometimes very slightly behind, depending on the period and the methodology.
Over shorter periods (1 to 5 years), the difference can be substantial in either direction, driven almost entirely by which sectors are in or out of favour during that window. Ethical funds tend to be underweight some sectors (oil and gas, tobacco, weapons, mining) and overweight others (technology, healthcare, renewable energy). Whichever side the market is rewarding at any given moment will determine whether ethical funds appear to be ahead or behind.
After fees, ethical funds typically give up a small but real amount (0.05% to 0.20% per year for ESG-screened trackers, more for actively managed sustainable funds).
The honest summary: ethical investing doesn’t reliably cost you returns over the long term, but it doesn’t reliably help either, and in any given short period the gap can move in either direction by several percentage points.
What the data actually shows
A few of the more rigorous studies and findings worth knowing.
Morningstar’s ongoing research. Morningstar regularly publishes performance comparisons between sustainable and conventional funds. Their 2023 update found that, over a 10-year period, the median sustainable fund had broadly matched its conventional category average, though with meaningful variation between fund types and time windows. ESG-screened global trackers tracked their conventional equivalents very closely. Active sustainable funds varied more.
MSCI ESG indices. The MSCI World ESG Leaders Index and the MSCI World SRI Index, two of the most widely tracked ESG benchmarks, have produced returns very close to the standard MSCI World Index over rolling 10-year and 15-year periods. The differences are typically less than 1% per year, and the direction varies.
The 2017-2021 outperformance period. During this period, ESG funds notably outperformed conventional equivalents in many markets. The reason was largely sectoral. Technology and healthcare, which tend to score well on ESG metrics, had a strong run, while fossil fuel companies, which ESG funds usually exclude or underweight, performed poorly. ESG funds benefited from being on the right side of these sector moves.
The 2022-2023 underperformance period. The pattern reversed. Energy stocks rallied sharply on the back of the war in Ukraine and rising oil prices. Technology stocks struggled with rising interest rates. ESG funds, by virtue of holding less energy and more tech, underperformed during this period.
Recent stabilisation. In 2024 and 2025, the gap has been more modest in either direction, with ESG and conventional funds trading places month by month without a strong consistent trend.
The pattern, in plain English: ESG fund performance versus conventional funds is mostly determined by which sectors happen to be in favour, not by any inherent flaw or virtue in the ethical investing approach itself.
The structural reasons behind the variation
To understand the performance picture, it helps to see what’s actually different about ESG fund composition.
Less fossil fuel exposure. Conventional global trackers typically have 4% to 8% in oil, gas, and mining companies. ESG-screened versions usually exclude or significantly underweight these sectors. When energy stocks do well (as in 2022), this hurts. When energy stocks do badly (as in 2018-2020), this helps.
Less tobacco, alcohol, gambling, weapons. Smaller sectors but each can have outsized periods. Tobacco was a top-performing sector for decades before falling out of favour. Defence stocks rallied sharply in 2022-2023.
More technology and growth. ESG screens tend to favour large technology companies, which often score well on environmental metrics (low direct emissions) and labour practices. When growth and technology lead the market, ESG funds benefit.
Slightly higher fees. ESG-screened global trackers typically charge 0.05% to 0.20% more than their conventional equivalents. Over decades, this is a meaningful drag, though small.
More turnover. Some ESG indices reconstitute more frequently than conventional ones, particularly when companies are added or removed for ESG reasons. This adds modest transaction costs inside the fund.
The net effect of these structural differences is usually a small handicap (perhaps 0.10% to 0.30% per year on average) offset by sector tilts that vary in direction over time. Over any given decade, the market is unlikely to favour ethical funds by exactly the amount needed to offset the fee drag, so you’ll see ESG funds either beating conventional ones (when sectors cooperate) or losing to them (when sectors don’t).
What this means for your decision
If you’re considering ethical investing and you want to be honest with yourself about the performance trade-off, here’s how to think about it.
Don’t expect ethical investing to make you richer. The historical evidence doesn’t support a reliable performance bonus from holding ethical funds. The case for ethical investing is values-based and emotional, not financial. Anyone who tells you otherwise is selling something.
Don’t expect ethical investing to make you significantly poorer. The drag, after fees, is typically small (in the range of 0.05% to 0.30% per year on average). Compounded over decades, this matters, but not catastrophically. On a £100,000 contribution stream over 30 years, the difference might be £20,000 to £40,000 less in the final pot. Real, but not life-changing.
Be prepared for short-term variance. In any given year, ethical funds may underperform or outperform conventional ones by 2% to 5% based on sector composition. If this would bother you, ethical investing isn’t the right move. If you can hold through both directions of the gap, the long-term outcome will be close to (but slightly behind) the conventional equivalent.
Pay attention to fees. Within ethical investing, the difference between a low-cost ESG-screened global tracker (0.18% to 0.25% OCF) and a fully active sustainable fund (0.75% to 1.50% OCF) is far larger than the difference between either of those and a conventional tracker. If you choose ethical investing, lean strongly toward the cheap ESG-screened options unless you have very specific reasons to want a more focused approach.
Define what success looks like. “I want to invest with my values” is a different goal than “I want to maximise returns.” Be clear about which you’re prioritising, because they sometimes conflict, and you’ll make worse decisions if you’re not honest with yourself about the trade-off.
If you’re new to investing entirely and trying to decide whether to start with an ethical or conventional approach, Simple Investing for Absolute Beginners covers the foundational principles that apply to both approaches. The fundamentals (low costs, broad diversification, regular contributions, long time horizons) matter just as much for ethical investors as for anyone else.
The argument the data doesn’t quite settle
There’s a more subtle case for ethical investing that the performance numbers don’t directly address: that ESG-rated companies, on average, are run more competently than poorly-rated ones, and that this should produce slightly better returns over the long run regardless of sector trends.
The argument has some support in research, but it’s far from conclusive. ESG ratings are notoriously inconsistent across providers, the link between ESG scores and underlying business quality is contested, and many studies showing ESG outperformance suffer from data and methodology issues.
The honest position is that the academic evidence on whether ESG factors genuinely improve risk-adjusted returns remains mixed. Some studies suggest a small benefit. Others suggest no significant effect. None suggest a large reliable advantage.
For an ordinary investor, the practical implication is that you shouldn’t expect a meaningful performance edge from ethical investing, but you also shouldn’t fear a major performance penalty. The decision should rest primarily on your values rather than your return expectations.
A practical framework
If you’re trying to decide whether ethical investing is right for you, the questions worth asking:
1. How important is alignment with your values? If the answer is “extremely,” the small expected fee drag is probably worth paying. If the answer is “moderately,” you might prefer a hybrid approach (a conventional tracker as your core, with one or two ethical satellites alongside).
2. Can you accept short-term underperformance without changing course? Ethical funds will underperform conventional ones in some years. If this would tempt you to switch back, it’s better to stay with conventional funds from the start.
3. Are you choosing the lowest-cost ethical option? The fee difference between a 0.20% ESG global tracker and a 1.20% active sustainable fund is far larger than the difference between either and a conventional tracker. Don’t pay extra for active sustainable management unless you have specific reasons to.
4. Are you confusing alignment with impact? Owning a fund that excludes oil companies doesn’t directly affect oil companies; someone else buys what you don’t. The case for ethical investing is mostly about not personally profiting from things you find objectionable, plus very gradual cost-of-capital effects on excluded industries. Both are legitimate, but neither is a direct lever on real-world change.
| New to UK investing and want to get the foundations right before deciding on an ethical approach? Simple Investing for Absolute Beginners takes you from zero to a properly invested ISA in plain English, covering the principles that apply equally to ethical and conventional investing. [ Find out more → ] |
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The honest answer to whether ethical funds underperform is that they’re broadly competitive with conventional alternatives over long periods, with meaningful variation in shorter windows driven by sector composition. Ethical investing isn’t a free lunch, but nor is it the costly mistake some critics suggest. Decide based on your values, accept the small fee drag, and don’t expect either virtuous outperformance or dramatic underperformance over the long run.
This article is for information and education only and does not constitute financial advice. Investments can fall as well as rise in value and you may get back less than you invest. Past performance is not a reliable indicator of future results.