What are sustainable funds and how can labels help you choose one?

What are sustainable funds?

For investors seeking both financial returns and a positive impact, the sustainable investing landscape has often been confusing. Different fund names, a variety of terms, and a lack of agreed standards created something of a maze. 

Investors frequently find it difficult to fully understand terms like ‘ESG’ (environmental, social and governance), ‘green’ and ‘sustainable,’ and determine whether the claims around them are legitimate. 

While there are still complexities in this area, a set of sustainability labels for UK-domiciled funds has brought much-needed clarity to this part of the market. These are known in the industry as SDR (Sustainability Disclosure Requirements) labels, and they are designed to aid investors in their decision-making and to help ensure funds meet a particular standard of sustainability. 

Overseen by the UK financial regulator, the Financial Conduct Authority, there are four labels that provide greater understanding for this type of investing. Labelled funds must meet a high standard and provide evidence to back up claims of positive environmental or social impact investments. 

Investors prioritising sustainable investing should therefore be able to make easier comparisons between products and have greater confidence a fund meets their needs. 

The four labels are:

1. Sustainability Focus: Funds investing towards positive environmental and social outcomes by investing in assets that already meet a robust, evidence-based standard of sustainability. A popular example is funds investing in companies that provide sustainability solutions, or that have activities linked to the UN’s Sustainable Development Goals.
2. Sustainability Improvers: Funds investing in assets not considered sustainable today, but which have a strategy to make meaningful improvements. The fund must also advocate for improvement in the investments too. An example could be shares in an oil company with plans to invest significantly in renewables.
3. Sustainability Impact: Funds investing in assets making a specific and measurable positive environmental or social impact. The role of the fund manager is assessed on an ongoing basis, as it's expected to explain and measure how its activities contribute to that positive impact using clear, reportable metrics.
4. Sustainability Mixed Goals: Funds investing in a combination of the above approaches. At least 70% of assets must be in line with the respective objectives for each part, and no holdings must be in conflict. 

Eligible UK-domiciled funds have been able to apply for and use the new sustainable investment labels since 31st July 2024. Asset managers also need to produce sustainability-related documents for investors. However, the labels don’t currently apply to non-UK domiciled funds, also known as ‘offshore funds’ so most ETFs for instance are not covered by the rules.

To qualify as a sustainable fund, at least 70% of the assets of a fund must be invested according to its sustainability objective. The remaining assets must not conflict with the objective, but they don't have to meet it exactly. 

Information relating to the fund’s sustainability is published in documents available alongside other product literature such as the fund factsheet, KIID (Key Investor Information Document) and prospectus. 

The main source for retail investors is a brief consumer document covering the key sustainability-related features of the fund. This explains what the fund’s label means, outlines the sustainability objectives and investment approach, and describes how sustainability performance is measured. 

More detailed disclosures are available in other documents, including in the fund prospectus if applicable. Ongoing disclosures on how the fund is performing according to its sustainability objectives will also be reported regularly. 

Funds on the Charles Stanley Preferred List with sustainable labels

Investors looking for the best sustainable investment funds for their needs may wish to consider the labelled funds on our shortlist of preferred funds for new investment compiled by our research team: 

Baillie Gifford Positive Change – Sustainability Impact

This global fund aims to contribute toward a more sustainable and inclusive world with an investment process that embraces four ‘impact themes’: Social inclusion and education, environment and resource needs, healthcare and quality of life, and ‘base of the pyramid’ which addresses the basic needs of the global poorest. 

EdenTree Sustainable Global Equity – Sustainability Focus

EdenTree is a pioneer of responsible and sustainable investing, having launched one of the first ethical equity funds available in the UK in 1988. The team’s core philosophy is to invest in global companies that create products or solutions that enable a better, more sustainable future. Stocks must pass both negative and positive screens to be considered for inclusion. 

FP WHEB Sustainability Impact – Sustainability Impact 

A well-regarded specialist in this area, WHEB targets sustainable companies from around the world that are expected to contribute to a positive impact on the climate and ecosystems, as well as do social good. Often, this is through activities that deliver cleaner energy, reduced waste, better water management, medical needs, and improved resource efficiency. 

Schroder Global Alternative Energy – Sustainability Focus 

This specialist fund invests in companies making a positive contribution to the transition to lower carbon energy sources. This can be anywhere across the energy supply chain from renewable energy production, distribution and storage, through to transport and the supply of materials and technology. 

Schroder Global Sustainable Value Equity – Sustainability Focus

The fund invests in companies identified as having an overall positive impact on society as well as significant scale and importance. Businesses are chosen based on setting high standards within their industry or otherwise being on a journey of significant and timely improvement. It offers a differentiated portfolio from the typically more growth-oriented funds prevalent in the sustainable space.

What about other funds and ‘responsible’ products?

It’s important to recognise that many funds will not have a sustainable label. The requirements are quite precise, and not all broader ‘responsible’ or ‘ethical’ funds meet them, especially passive funds that aim to follow a given index rather than take an active approach.  

Negatively screening out equities or using ESG criteria to prioritise certain areas isn’t on its own enough to meet the requirements for a label. A fund must have specific sustainability objectives with measurable positive outcomes. Additionally, overseas domiciled funds cannot currently apply for a label. 

Wider responsible funds may not be suitable for investors looking primarily for investments specifically designed to promote positive environmental and social outcomes. However, such products will still have documents setting out their sustainability-related policies and objectives, so investors should check fund literature carefully to ensure a fund meets their requirements before making investment decisions. 

What about ethical funds?

A traditional ethical investment process differs from a sustainable one. It typically applies a process to filter out businesses involved in areas deemed harmful or unethical such as oil and gas, alcohol, tobacco, gambling, weapons or animal testing. This is often referred to as negative screening or ethical exclusion.

The process typically focuses more on excluding specific areas rather than prioritising companies that are making positive contributions or are improving over time. However, it is certainly possible to combine both philosophies and there can be overlap in the approaches taken by ethical and sustainable funds. 

An example from our Preferred List is Rathbone Ethical Bond Fund, which applies a broad range of both positive and negative ESG factors to the asset class as well as including charity and green bonds in the portfolio in areas such as social housing, sustainable transport and renewable power. 

Ethical investment funds may not qualify for a sustainability label if they only employ a filter process, but they can often meet the needs of those wishing to invest responsibly. When choosing the best ethical funds for you, make sure you read the fund literature carefully to ensure it fits with your own views.