Ethical investment funds: a practical UK guide

What are ethical investment funds?

How would you like to make a return and know that you’re only invested in respectable companies that help make the world a better place? That is the ethos behind ethical investment funds. These portfolios allocate capital according to an agreed set of principles and values. For example, some will simply avoid companies that are involved in controversial areas such as tobacco, weapons, gambling or alcohol. Others take a more proactive approach by investing in businesses that contribute to social or environmental progress, such as improving water quality, advancing renewable energy, or reducing carbon emissions.

Ethical vs ESG vs sustainable vs impact

One of the problems is that this area is full of jargon. You’ll hear a variety of phrases used to describe ethical investment funds, such as environmental, ESG, sustainable and impact. While they’re often used interchangeably, there are key differences. It’s essential to understand them so you know exactly what you’re buying.

In the past, funds were sometimes labelled as dark green or light green, with light green indicating a lighter-touch approach to sustainability. However, these classifications are now largely historical and have become less relevant as the sector has expanded and adopted clearer, more straightforward terminology. Let’s take a look at some of the main terms you’re likely to encounter today.

• Ethical: Investment decisions are based on certain morals or beliefs. A key motivation will be avoiding harm, meaning managers tend to shun areas such as weapons and tobacco.

• Environmental: These funds focus more on reducing damage to the planet. Companies involved in controlling pollution and developing clean technologies will be of interest.

• ESG: This stands for ‘environmental, social and governance’. This is an umbrella term that gives investors insight into how responsibly a business operates on various metrics.

You can read and watch more about what ESG actually means in our guide to ESG investing.

• Sustainable: Funds with a sustainable focus aim to make a long-term difference, so they look for approaches that are aligned with this goal. A good example would be renewable energy.

• Responsible: This is another broad area. The term ‘responsible’ has different connotations but often refers to corporate responsibility, such as how well a company engages with investors.

• Impact: These funds are designed with a clear goal in mind—to make a measurable, positive difference. Their focus is often on achieving specific social or environmental outcomes, and they must be able to demonstrate that impact in tangible ways. For example, a fund might aim to reduce carbon emissions and provide evidence of how its investments contribute to that reduction.

• Green: There was a time when green funds were the focus of attention for ethically-inspired investors. Today, they concentrate on environmental objectives, such as climate goals.

For the purposes of this article, the term “ethical” will be used as an umbrella term encompassing responsible, sustainable, and ESG investment approaches.

UK rules you should know

Nearly 90% of global individual investors are interested in sustainable investing, according to a survey by Morgan Stanley*. It’s one of the reasons why fund groups are so keen on this area. However, regulators have become increasingly concerned about the so-called greenwashing. This is when organisations give false impressions of their ethical credentials. For example, it may give the impression that its products are very eco-friendly, when the reality is that the business only pays lip service to the concept.

In the UK, the Financial Conduct Authority (FCA) has introduced measures to improve the transparency of sustainable investment products. Firms must now ensure their sustainability references are fair, transparent and not misleading, and proportionate to the sustainability profile of the product and service.

The FCA has also introduced four investment labels for products with sustainability objectives:

• Sustainability Focus: These concentrate on the sustainability of people or the planet. For example, the production of energy from solar or wind.

• Sustainability Improvers: They will invest in assets that aim to improve their sustainability. An example would be companies on a path to net zero.

• Sustainability Impact: Their focus is on backing solutions to sustainability problems, such as the generation of renewable energy and better social housing.

• Sustainability Mixed Goals: The final category is for funds investing in a mix of assets that either focus on sustainability, aim to improve this over time, or achieve a positive impact.

The role of the UN Sustainable Development Goals

Many ethical and sustainable funds draw inspiration from the UN Sustainable Development Goals (SDGs) — a set of 17 global objectives designed to end poverty, protect the planet, and promote prosperity for all. Established in 2015, the SDGs provide a common language for measuring and comparing positive impact across different sectors and regions.

Examples of SDGs that frequently influence ethical investment strategies include:

• SDG 7: Affordable and Clean Energy – supporting renewable power generation and energy efficiency.
• SDG 6: Clean Water and Sanitation – improving access to safe, reliable water sources.
• SDG 13: Climate Action – reducing carbon emissions and supporting climate resilience.
• SDG 3: Good Health and Well-being – expanding access to healthcare and medical innovation.
• SDG 11: Sustainable Cities and Communities – funding social housing and green infrastructure.

While not all funds will explicitly target specific SDGs, many use them as a guiding framework for defining their sustainability themes and measuring real-world outcomes.

Quick label matcher: pick the closest fit

Despite the introduction of labels, confusion still reigns, according to a survey of investors carried out by the Investment Association and The Wisdom Council. It was discovered that while 52% of investors were aware of these labels, vague wording and jargon remain the most significant barriers to investment in sustainable funds**.

Miranda Seath, the IA’s director of market insights, said: “Clear and accessible language is central to giving investors confidence in their decision making – and this must remain front of mind for fund managers, advisers and regulators as label uptake increases.”

Here’s our quick guide to which label may suit your needs.

How ethical funds actually invest 

Ethical investment funds work in a variety of ways. We have already explained how some will avoid certain areas, while others will actively choose companies in particular areas.

However, there are other differences.  For example, a fund may use thresholds, rather than a complete ban. This could mean a company could still be held if it generated, say, less than 10% of its revenue from fossil fuels.

You can broadly split ethical funds into four distinct categories.

1. Negative screens

They will exclude companies involved in controversial areas such as weapons production, tobacco, alcohol, and pornography. These are often referred to as sin stocks.

2. Positive screens

These funds actively seek investments that make positive social or environmental contributions. Their focus is on finding companies that are doing good.

3. Faith-based 

Following a religion will obviously impact the kind of investments you are willing to consider. A prime example would be Shariah-compliant portfolios.

4. Theme-based 

Finally, some funds focus on one specific area or goal. For example, the portfolio may concentrate its efforts on improving water and waste, for example.

Of course, not every ethical fund will fit neatly into one of these four boxes. There will be hybrid portfolios that embrace a few areas. That’s why it’s important to know precisely how a particular fund works and what it invests in, so you can make a call as to whether it meets your needs.

Types of ethical funds 

There are plenty of ethical investment funds in the UK, so what do you need to know – and how can you make an informed choice?

Firstly, it’s essential to acknowledge that being ethical is an investment approach and not an actual investment. This means ethical investment funds can be found in many areas. There are equity funds that are suitable for ethical investors. Some will explore these themes through globally-listed companies, while others will focus on those with a UK or regional bias. You can also invest ethically through bond portfolios. These include funds that back individual companies by investing in their debt.

In addition to actively managed funds, there are also passive portfolios that track the performance of a specific market or sector, typically using an ethical or sustainability screen. However, the definition of what counts as “ethical” or “responsible” in a sustainable ETF can be much broader than you might expect. As a result, you could find your portfolio includes companies such as McDonald’s or Coca-Cola, businesses that may not align with your personal values. For investors who want greater control and a more targeted approach to sustainability, actively managed funds are often the better option.

Performance, risk and fees & what to expect

While moral values are influential, there are other factors to consider when trying to find the top-performing ethical investment funds.

1. Manager track record

Do the managers at the helm have a demonstrable track record of successfully running an ethical portfolio over various time periods?

2. Portfolio construction

Does the fund have biases? For example, is it overweight in a particular sector, or diversified? Is it more of a growth-oriented portfolio?

3. Fees involved

Ensure you understand the charges. Actively managed funds can have ongoing charges of up to 1.5%, whereas passive portfolios are typically cheaper than active.

9-point due diligence checklist

Here are nine factors you need to consider when looking for the best ethical investment funds.

1. A clear, sustainable objective: What is its goal and is this measurable?
2. Understanding of the rationale: Why does the fund operate in this way?
3. Breakdown of holdings: What companies does it invest in – and why?
4. Engagement policy: Does it interact with management teams?
5. Sustainability thresholds: How are sustainability results measured?
6. Third-party verification: Are any claims made independently verified?
7. Portfolio concentration: Is the fund diversified or biased towards certain areas?
8. Label alignment: Does the fund carry an FCA label?
9. Consistency of approach: Does all the fund’s information tell the same story?

Building an ethical portfolio 

So, how can you build your own ethical portfolio?

Step one: preferences

Decide on what’s important. What values will shape your portfolio? Is there a particular label that best meets your investment objectives?

Step two: risk and return

How long is your investment horizon, and what is your attitude to risk? Remember, only ever invest what you can realistically afford to lose.

Step three: choose your structure

Decide how to build your portfolio. For example, you may prefer a core-satellite approach where the bulk of your money is in a core global equity fund, with thematic funds acting as satellites.

Step four: monitor

Just because you’ve made your decision doesn’t mean all the work is over! You’ll need to monitor the portfolio to ensure it’s behaving as expected.

If you’re not sure how to actually open an account and buy your first fund, our step-by-step explainer walks you through the mechanics of making an investment.

Tax wrappers & funding your plan 

Consider putting your chosen ethical investment funds inside a tax wrapper to help shield any growth from HMRC. Top of the list are Individual Savings Accounts (ISAs). You can invest up to £20,000 in each tax year, and you can choose different types of assets, including equities and bonds. Longer-term investors may find that Self Invested Personal Pensions (SIPPs) better meet their needs, as any contributions will get income tax relief. However, various restrictions apply.

Mini case-studies 

Here, we look at three different ethical portfolios that could be worth considering. One is equity-focused, one is bond, and one has a more thematic approach.

Liontrust Sustainable Future Global Growth

The managers of this fund use a thematic approach to identify key structural growth trends that will shape the global economy of the future. The development of personalised medicines and the transition to lower-carbon fossil fuels are examples of such future developments. They will then invest in the shares of companies around the world based on their view of long-term return prospects. Every investment must meet four set criteria: thematic drivers, sustainable credentials, sound fundamentals, and attractive valuations.

Rathbone Ethical Bond

This fund invests in quality investment-grade bonds and has a list of exclusions that includes mining, arms, gambling, pornography, and nuclear power. It has a four-step process that starts with idea generation. This is followed by the ‘four Cs plus’ of bond assessments: character, capacity, collateral and covenants. This covers the quality of the management team, the ability to pay off the debt, the assets offered as security, and the rules governing what the company can borrow. The ‘plus’ refers to conviction. Relative valuations are considered next before an ethical screen is applied. Prospective holdings will also need to demonstrate at least one positive ethical factor.

Regnan Sustainable Water and Waste

This is a thematic, global, high-conviction fund that focuses on finding companies that provide exposure to both the water and waste value chains. Potential companies can include those involved in pumps, valves, chemical treatments, filtering, organic waste, reusable materials and the disposal of hazardous waste. The team monitors around 350 companies within this investment universe and uses a combination of proprietary tools and external ESG research to construct a 35-50-strong stock portfolio. The strategy typically has a 60% water and 40% waste split, though the team has the flexibility to allocate 100% to either sector, based on bottom-up analysis and attractive opportunities.

Pros & cons summary 

We have covered a lot of ground in this guide, so let’s take a moment to consider the various pros and cons of investing in ethical investment funds.

Positives

• You will be (hopefully) making money in a way that aligns with your personal beliefs. If you can earn a return while helping the planet, then surely that’s a good thing?
• There are also other benefits. Backing ethical companies means there’s less chance of them suffering reputational damage in the future, which could impact their share price.
• Of course, there’s always the chance of influencing corporate behaviour, as ethical funds often engage in dialogue with companies about their practices.
• Ethical funds can tap into long-term structural growth themes, such as the global shift towards clean energy, improved resource efficiency, and sustainable innovation.

Negatives

• Now for the potential downsides. Excluding companies and sectors will shrink your investable universe, which can adversely impact diversification.
• In addition, some of these shunned areas could outperform during specific periods. The lack of exposure will negatively affect your returns.
• Not every ethical fund will be successful, and there’s always the risk of greenwashing. In addition, some niche portfolios can come with extra charges that may be a drain on returns.

How FundCalibre can help 

Researching funds isn’t easy at the best of times – and the challenge can be even greater when you’re trying to gauge a portfolio’s ethical credentials. That’s where FundCalibre can help. Its team of analysts has been scrutinising such portfolios for years, so they are well-versed in picking winners from losers.

Only the very best are awarded a prestigious Elite Rating. In fact, no more than 10% of funds in any sector will be given this level of recognition. FundCalibre’s analysis begins with AlphaQuest, our proprietary quantitative screening tool, which focuses on future performance by estimating the likelihood of a manager delivering superior returns. The managers of funds passing this test will be grilled by our team on crucial factors such as their investment philosophy and approach to portfolio construction.

Finally, all the research gathered is subject to peer review within the team before a final decision is made on whether it is worthy of inclusion.

FAQs about ethical investment funds

What is an ethical investment fund?

Ethical investment funds put their clients’ money to work based on specific moral principles. For example, it may want to avoid ‘sin’ stocks, such as those involved with alcohol.

How do ethical, ESG, sustainable and impact funds differ?

Ethical funds are based on moral values. ESG, sustainable and impact portfolios are broadly similar but will have more specific approaches.

What are the FCA’s sustainability labels and how do they help me choose?

The labels indicate a fund’s approach to ethical investing and give investors an insight into what they can expect from its holdings.

How can I spot greenwashing?

A lack of specific goals can indicate greenwashing, as well as holdings in questionable areas such as tobacco and arms manufacturers. The absence of third-party verification can also be a warning sign. Extra care should be taken when paying passives as the rules tend to be broader.

Do ethical funds perform better or worse?

This all depends on an individual fund’s mandate, sector biases, fees, investment time horizon, and the skills of its manager.

Are ethical funds riskier?

It depends on what they invest in and their approach to portfolio concentration. You’ll need to examine funds on an individual basis to gauge if they’re diversified and have suitable risk controls in place.

What fees should I expect with ethical funds?

It will depend on whether they’re actively or passively managed. Active portfolios tend to be more expensive than passive ones, as the expectation is that they’ll outperform.

Can I hold ethical funds in an ISA or SIPP?

Yes. You can hold them in Individual Savings Accounts (ISAs) and Self-Invested Personal Pensions. These are the most tax-efficient ways to hold ethical funds.

How do I check what a fund actually holds?

The fund provider usually provides detailed information on current holdings, the investment approach taken, recent performance, and voting reports via their website.

How does stewardship work in practice?

Explain engagement priorities, escalation paths, and example resolutions.

Do FCA labels guarantee impact?

While labels don’t guarantee a specific impact, the FCA does hold asset managers to very high standards when using them. Each labelled product must clearly demonstrate how it meets the relevant sustainability objectives and provide ongoing reporting to ensure transparency and accountability. Labels therefore improve clarity and set a higher bar for disclosure, but investors should still take time to understand how each fund defines and measures its goals.

What ethical themes are common?

Renewables, efficiency, water, healthcare access and social housing are among the most common ethical investment themes. Many of these areas also align closely with the UN Sustainable Development Goals, which provide a global framework for tackling issues such as poverty, inequality, and climate change through responsible investment.

How often should I review an ethical portfolio?

You need to double-check holdings at least annually to ensure a fund is not only performing as expected but also continues to meet your needs.

*Source: Morgan Stanley, 30 April 2025

**Source: FCA, 14 February 2025