There is a growing number of ethical investing options available, both as ETFs and within super funds. For most investors, the idea of investing ethically is appealing. The real question, though, is whether choosing ethical options are riskier or produce lower returns over time.
If the risk and future returns are the same, or even better, then I think many more investors would seriously consider ethical options.
That is what this blog is about: purely from an investment merit perspective, are ethical options worth considering?
“Ethical” vs “ESG” vs “sustainable.”
“Ethical”, “ESG” and “sustainable” all get thrown around in the same conversation, and it is no surprise investors end up confused. They are related, but they are not the same thing.
When most people say, “ethical investing”, they are talking about aligning investments with personal values. In practice, that usually means exclusions. Common examples are avoiding tobacco, weapons, fossil fuels, gambling, and companies with modern slavery exposure.
“ESG” stands for Environmental, Social and Governance. It is the broad umbrella term, and it goes beyond simple exclusions. It covers ethical and moral considerations, but it also looks at how a company operates: its environmental footprint, how it treats people (employees, customers, supply chains), and the quality of its governance (board oversight, incentives, transparency, shareholder rights).
“Sustainable” is typically used in a more specific way. It is less about personal morality and more about directing capital toward solutions that support a more sustainable economy, such as renewable energy, lower emissions, cleaner production, and reduced waste.
Beware: no generally accepted framework
The core challenge with ethical investing is that there is no single, widely accepted framework for how it should be applied in a portfolio. That is why products end up wearing different labels and why two “ethical” funds can be very different.
In my experience, most investors tend to fall into one of two camps.
The “practical” camp
These investors generally want to do “the right thing” where they can, but they also recognise that trying to exclude every company that might harm the environment or conflict with personal values is rarely practical or cost-effective. They are open to including some ethical options but are not looking for perfection
The “strict approach” camp
This group has strong, non-negotiable views, often about specific industries (such as excluding tobacco) or their strict adherence is institutionally led e.g., churches. These investors have a very low tolerance for anything in the portfolio that cuts across their values, even if that limits diversification or makes implementation harder.
Which camp you fall into matters because it dictates the approach.
The strict approach requires a lot more work. Even large, reputable fund managers can’t always get it right. For instance, in 2024, Vanguard Australia was fined $12.9 million by the Federal Court for greenwashing – relating to misleading claims about the ESG exclusionary screens that is used.
My sense is most people sit in the first camp. For them, adding a deliberate ethical tilt can be enough to feel better about investing without taking it to extremes.
Use ethical products that stay close to the parent index
The foundational idea behind rules-based, passive investing is that consistently picking the winners and losers (via owning direct stocks or active funds) is basically like trying to find a needle in a haystack. So instead of trying to pick the needle, you buy the haystack. In other words, you own the whole index/market. Doing so gives you broad, diversified exposure by default. You hold the companies the index rules dictate, typically weighted by market capitalisation.
The main point here is simple: be very careful about straying too far from that approach because that is when you start taking unintended “bets” and becoming an active investor.
This is a key consideration when selecting an ethical fund. It is perfectly reasonable to use an ethical fund, but the first check should be whether the portfolio still behaves like the “parent” index it is trying to replicate. You want industry exposures and geographic exposures to remain broadly consistent with the traditional market-cap index, so you stay aligned to a rules-based methodology. For example, if you are considering a global ethical fund, then it makes sense to compare sector and country exposure in that fund to the MSCI World Index.
Ethical funds are not really designed to beat their parent index. The goal is to give you essentially the same market exposure as a traditional index, while excluding companies that fail the ethical screens. If it is implemented well, an ethical overlay does not materially change the portfolio’s risk profile, so the probability of future returns being materially lower than the parent index should be relatively low.
Ethical companies are likely to attract more capital
One thing worth separating out is the investment case versus the ethical case. Even if you strip the ethical-piece away, there is a reasonable factor-based argument that “ethical” businesses may attract a larger share of capital in the future.
There is an old investing line: where money goes, returns flow. It is basically supply and demand. If more individuals and institutions direct capital toward ethical and sustainability themes, that buying pressure can push prices up for the companies seen as beneficiaries.
That can play out in obvious sectors like renewable energy. But it can also apply to businesses in traditional industries that operate in a demonstrably better way, such as a property developer focused on building 6-star NABERS-rated buildings.
Therefore, there is a legitimate investment thesis for holding some ethical exposure: not because it is morally satisfying, but because those businesses may capture a growing share of capital over time, which can support valuations and, potentially, returns.
Ethical past performance
The table below shows a selection of ethical ETFs and managed funds, alongside the closest comparable non-ethical ETF or managed fund option. The main takeaway is that performance is highly variable. This is a good reminder that you cannot rely on a product label or marketing language. You need to understand what the fund owns and how it is constructed and managed.
One clear standout in the data is Dimensional’s Sustainability strategy, which has materially outperformed. Dimensional’s edge has always been portfolio construction and implementation, so it is reasonable to think that this is contributing to the result.
I also looked at a selection of super funds, comparing each ethical option to its closest non-ethical equivalent. I only included funds with at least 10 years of performance history. The same pattern shows up: performance is all over the place. Therefore, you cannot conclude that ethical options are inherently better or worse than non-ethical options based on outcomes alone.
What do you potentially forgo?
I have previously written about the pros and cons of traditional market-cap indexing. My main concern right now is the growing dominance of the “Magnificent Seven” US tech companies. The value of these multi-trillion-dollar businesses have risen sharply over the past decade and, as a result, they now make up an outsized share of the major market-cap indices. The problem is not that they are “bad” businesses. The issue is that some are priced at very high multiples relative to their historical earnings growth (i.e., even acknowledging they have had strong earnings growth), which increases concentration and valuation risk inside what is meant to be a broadly diversified core holding.
That is why I have made the case for layering in factor and value-based strategies to manage that risk.
This is where ethical investing can become tricky from a portfolio construction perspective. Most ethical products still rely on traditional market-cap indexing. There are very few factor-based ethical strategies available. As such, if you are trying to build a portfolio entirely from ethical products, you may be forced into compromises. Those compromises can show up as higher portfolio risk such as valuation risk, and potentially lower future returns.
A practical example: around five years ago, we liked the UK market because it was cheap on historical measures. That valuation gap was the investment thesis. And it has played out well – over the past five years the UK market has been the best-performing developed market – better than the S&P 500 index (unhedged).
But if you are running a strict ethical filter, you can run into a problem: British American Tobacco is a top 10 company on the UK stock exchange. That makes it hard to add more UK exposure to a portfolio for clients that want to exclude tobacco.
This is the real limitation for ethically minded investors. Because there are so few factor-based ESG/ethical products, most solutions default back to traditional market-cap indexing. And when you want to tilt deliberately, for example, to increase exposure to a given geographical market, you may find there is no ethical option to do that.
The outcome is not necessarily that ethical investing is “worse”, but that the investment menu is narrower, and that can matter when you are trying to build a portfolio with intentional factor, valuation, and geographic tilts.
How to implement ethically without abandoning evidence-based indexing
The first thing I would say is you need to be careful when adding ethical options to a portfolio. The label is irrelevant. The specific ETF, managed fund, or super option you choose will determine whether the ethical exposure behaves as intended, or whether you accidentally take on concentration, sector, country, or style risks you did not intend.
The other issue is structural: most ethical products still rely on traditional market-cap indexing, just with screens. That means you inherit the usual weaknesses of market-cap indices (and sometimes amplify them), but you often cannot fix those issues inside the ethical product range because there are limited factor-based ethical options.
That is why a core–satellite approach can work well. Use ethical options for the core exposure (broad, diversified, market-like). Then use satellites to address the risks the core cannot manage well, such as excessive US mega-cap/tech concentration, lack of value or small-cap exposure, or geographic skews.
