If you’ve ever tried to invest in line with your values, you’ll have noticed something frustrating. The financial industry uses about a dozen different labels for what looks, on the face of it, like the same thing. Ethical funds. ESG funds. SRI funds. Sustainable funds. Impact funds. Responsible investing. Green investing. The terms are often used interchangeably in marketing material, and yet they can mean very different things in practice.
The honest answer to what is ethical investing is that it’s an umbrella term for several distinct approaches, each with different goals, different methods, and different track records. Understanding the differences matters, because picking the wrong type of “ethical” fund can leave you holding investments that don’t actually align with what you care about. This post walks through the main approaches, the regulatory landscape, and the honest critique that the marketing brochures tend to skip.
The four main approaches
Ethical investing isn’t one thing. It’s at least four overlapping things, and most funds combine elements of more than one. Here are the categories worth knowing.
1. Negative screening (exclusion)
The oldest and simplest form of ethical investing. The fund starts with a broad market index and excludes specific industries or companies. Common exclusions:
- Tobacco
- Alcohol
- Gambling
- Adult entertainment
- Conventional weapons
- Controversial weapons (cluster munitions, landmines, chemical and biological)
- Fossil fuel extraction
- Companies with poor labour records or governance scandals
This is what most people think of when they hear “ethical investing.” The fund still tracks something close to the broader market, but with the worst offenders removed.
The advantage is simplicity. The fund still owns hundreds or thousands of companies, costs barely more than a conventional tracker, and the screening rules are usually clear and verifiable.
The limitation is that exclusion alone doesn’t necessarily change anything in the real world. If you sell a tobacco stock, someone else buys it. The company itself is unaffected. You’ve made a personal statement, but the climate isn’t measurably better for it.
2. Positive screening (inclusion)
The opposite approach. Instead of excluding the worst, you actively select the best. The fund identifies companies with strong sustainability practices, good governance, healthy treatment of workers, and so on, and tilts toward them.
This is where the term ESG (Environmental, Social, Governance) usually comes in. ESG investing rates companies on these three dimensions and weights the portfolio toward those scoring highly.
The advantage is that ESG-tilted portfolios encourage capital to flow toward better-behaved companies, which can reduce their cost of capital and reward good practice. In theory, this creates a real-world incentive for companies to improve.
The limitation is that ESG ratings are notoriously inconsistent. The same company can score very differently on different rating providers’ scales, depending on what’s measured and how it’s weighted. Tesla has been excluded from some ESG indices despite making electric cars; oil majors have appeared in others because they have strong governance practices. The gap between “ESG-rated” and “doing good” is wider than the marketing implies.
3. ESG integration
A subtler approach used by many mainstream fund managers. Rather than running a separate ethical fund, the manager incorporates ESG considerations into ordinary investment analysis. The argument is that environmental, social, and governance risks are real financial risks, and ignoring them produces worse investment outcomes.
A fund using ESG integration might still own oil companies, but only the ones managing the energy transition responsibly. It might still own banks, but only those with strong governance. The screen is less absolute, more analytical.
The advantage is that this approach treats ethics as part of investment quality rather than a separate consideration. It can apply to almost any fund, not just specifically labelled ethical ones.
The limitation is that “we consider ESG factors” is so vague it can mean almost anything. Many mainstream funds now claim ESG integration without making any meaningful changes to their actual portfolios. This is one of the main areas where greenwashing concerns have grown.
4. Impact investing
The most direct approach. Impact investing aims to produce a measurable, positive real-world outcome alongside a financial return. Examples include:
- Funds that invest specifically in renewable energy infrastructure
- Microfinance funds that lend to small businesses in developing countries
- Social housing investment trusts
- Healthcare funds that target underserved populations
Impact investing is often more concentrated than other approaches, with fewer holdings and more specific themes. Returns can be lower than market average (though not always), and access for ordinary retail investors is more limited.
The advantage is that the link between your money and the real-world outcome is direct and measurable. If you invest in a fund building solar farms, your money is literally building solar farms.
The limitation is that impact funds often charge higher fees, hold less diversified portfolios, and may underperform broader markets over long periods. They suit a slice of an investor’s portfolio rather than the whole thing.
What is ethical investing in the UK regulatory picture
UK regulators have spent the last few years trying to clean up the labelling problem, with mixed success.
The Financial Conduct Authority’s Sustainability Disclosure Requirements (SDR), fully in effect since late 2024, introduced four formal sustainable investment labels:
- Sustainability Focus (funds that invest mainly in sustainable assets)
- Sustainability Improvers (funds invested in assets that aren’t yet sustainable but are credibly improving)
- Sustainability Impact (funds aiming for measurable positive outcomes)
- Sustainability Mixed Goals (funds combining elements of the above)
Funds using these labels must meet specific criteria and disclose what they’re doing. Crucially, funds that don’t meet any of the criteria cannot use sustainability-related terms in their marketing without significant qualification.
This is an improvement over the previous free-for-all, but it’s not a complete solution. Some funds simply rebranded to avoid using the labels. Others use the labels but interpret the criteria liberally. As an investor, you still need to read what the fund actually holds rather than relying on the label alone.
The honest critique: greenwashing is real
It’s worth being direct about something the ethical investing industry tends to play down. A meaningful chunk of “ethical” funds available to UK retail investors don’t actually do much that’s ethical.
Several common patterns:
Overlap with the conventional market. Many large ESG funds hold roughly the same companies as conventional global trackers, with small tilts. The top ten holdings in a major ESG global tracker are often Apple, Microsoft, Nvidia, and similar mega-caps that also dominate ordinary index funds. The differences are real but smaller than the labels suggest.
Inclusion of ethically dubious companies. ESG ratings sometimes give high scores to companies most ordinary people would find questionable. Defence contractors, fossil fuel majors with strong governance, and companies with serious labour issues in their supply chains have all appeared in funds marketed as ethical or sustainable.
Selective metrics. A fund might score well on environmental metrics while scoring poorly on social ones, or vice versa. The label “ESG” doesn’t tell you which letters the fund is actually emphasising.
Marketing-led rebranding. Several large fund families relabelled existing funds as “sustainable” or “ESG” between 2018 and 2023 with relatively minor changes to their actual holdings. The new SDR rules are intended to crack down on this, but enforcement is gradual.
The takeaway isn’t that ethical investing is fake. It isn’t. There are genuinely thoughtful ethical funds doing real work. The takeaway is that the label on the front of a fund is a starting point, not a guarantee. You still need to look at what it actually holds.
How to think about ethical investing for your own portfolio
If you’re considering an ethical approach for your own ISA or pension, a few practical questions:
1. What do you actually care about? “Ethical” isn’t one thing. Are you primarily concerned about climate? Animal welfare? Workers’ rights? Tax avoidance? Different concerns lead to different portfolios. Be specific.
2. How important is performance vs alignment? Ethical funds have, on average, performed broadly in line with conventional trackers over the last decade, but with meaningful variation. If returns matter more, lean toward broad ESG-integrated funds with low fees. If alignment matters more, lean toward more focused thematic or impact funds.
3. Are you willing to read fund documentation? Picking a genuinely ethical fund means reading the actual prospectus and holdings list, not just the marketing. If you’re not, you’ll likely end up holding something that doesn’t quite match what you wanted.
4. Is it part of your portfolio or all of it? Many people split the difference: a broad global tracker for most of their portfolio, with an ethical fund alongside for the part where alignment matters most. This avoids putting all your eggs in funds whose ethical credentials may shift over time.
If you’re new to investing entirely, getting the foundations right matters more than getting the ethics perfect. Simple Investing for Absolute Beginners covers how to set up your first ISA, pick a sensible fund, and start investing in plain English. You can always layer ethical considerations on top once the basics are in place.
A simple framework
For most readers thinking about ethical investing for the first time:
- Decide what specifically matters to you. Climate, weapons, tobacco, governance, something else. Be specific.
- Look at what’s available in the UK. A handful of mainstream providers (Vanguard, iShares, HSBC, Royal London) offer ethical/ESG global trackers with reasonable costs.
- Read the holdings list, not just the marketing. A fund’s top 20 holdings tell you more than its name does.
- Decide on the proportion. All-in, partial, or supplementary.
- Accept the trade-offs. Slightly higher fees, slightly different performance, no perfect alignment with your specific values.
| New to investing and not sure where to start, ethical or otherwise? Simple Investing for Absolute Beginners takes you through the foundations of UK investing in plain English, including how to think about funds, fees, and ISAs. [ Find out more → ] |
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Ethical investing isn’t a clean, simple choice the way the marketing makes it sound. It’s a series of trade-offs about what you’re willing to compromise on, how much you trust labels versus underlying holdings, and how directly you want your money to connect to real-world outcomes. Done thoughtfully, it can let you align your investments with your values without sacrificing much in financial terms. Done casually, it can leave you holding funds that don’t really match either your values or your expectations. The difference is mostly in how much homework you’re willing to do.
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. Sustainability and ESG fund labelling rules are subject to ongoing regulatory change.