Ethical funds – the issues, the performance and some picks from advisers

19th December 2012

Christmas is a time for giving, with thoughts sometimes turning to those less fortunate than ourselves – for investors, one option to feel you’re making a change for the better is to pick stocks and funds that comply with ethical standards as Harriet Meyer writes.

Around £11.3 billion is invested in the ethical investment sector, according to the Investment Management Association (IMA), and research conducted by YouGov shows investors are increasingly keen to make their money work for good.

Around 45 per cent of adults say they want at least some of their investments to take green and ethical considerations into account, with 15 per cent wanting all their investments to do so.

Yet when the ethical investment sector first emerged it was regarded with a degree of scepticism.

Patrick Connolly, certified financial planner at AWD Chase de Vere, says: “The UK’s first mainstream ethical fund was launched by Friends Provident in June 1984, and at the time it was rather unfairly labelled the ‘Brazil fund’ because you would have to be nuts to invest in it.”

Then, the focus of these funds was simple. It was to avoid stocks associated with ‘sin’ industries such as brewing, armaments, tobacco, and oil.

These days the majority of funds employ a more positive approach, rather than simply screening out stocks. So they will actively invest in companies with sound social practices in a range of sectors.

However, constructing an investment portfolio that replicates your ethical beliefs can prove challenging as funds adopt different approaches – so what one fund may consider an ethical stock, another may not. It’s vital to check under the bonnet to see what you’re getting, and if the manager’s approach ties in with your personal opinion.

You might, for example, believe that British Gas is more ethical than it used to be, while others might say that given it’s an energy provider it’s environmentally unsound and should be excluded from an ethical fund.

Brian Dennehy, managing director of , warns. “Dig beneath the surface and you’ll find that banks stocks are key holdings to most ethical funds.

“Other funds have BP as one of their top holdings – a company which was responsible for the Deepwater Horizon oil spill in 2010.”

Connolly adds: “While some funds won’t hold shares in oil companies because they are harmful to the environment, others will hold those that they consider ‘best of breed’ and think will cause less damage or look for greener solutions.”

Yet it could be tricky to find out exactly what you’re investing in. According to a report by Fair Pensions in December, around 45 per cent of funds do not publish their full holdings. The lines are also blurred when it comes to their screening processes, as although 84 per cent of funds refuse to invest in porn, only 11% screen out child labour.

However, there are various means of finding a list of companies generally deemed ‘ethical'. For example,The Ethisphere Institute , a New York City think tank, has a list of the World's Most Ethical Companies.

There is also FTSE4Good, an index listing 30 companies judged on their ethical, environmental, social and governance standards. FTSE works in association with EIRIS, the Ethical Investment Research Service, to research company corporate responsibility performance, to come up with this list. The index is reviewed in September and March every year by the FTSE4Good Policy Committee.

But if you’re investing in ethical funds in the hope they’ll further improve their practices, you could be disappointed. FairPensions’ research showed that some ethical funds fail to convince large companies to improve their practices, with many ignoring issues such as fossil fuel use and child labour, for example.

Christine Berry, head of policy and research at FairPensions, said: “Savers choosing ethical products want to know that their voice is being heard and their money managed in a way which reflects their values.

“Our findings suggest that the ethical investment industry should be doing a lot more to ensure it stays relevant to the issues that matter to its customers.”

There are other downsides that investors should be aware of. Gavin Haynes, investment director at Whitechurch Securities, says: “Performance of an ethical fund may be very different from the stock market as a whole.

“The tracking error of an ethical fund against a benchmark such as the FTSE All-Share Index is likely to be higher than average due to them not being able to invest in key sectors such as oil and tobacco.”

Ethical portfolios will also tend to be skewed toward mid and small cap companies, as they are less likely to indulge in unethical practices or damage to the environment.

Yet while investment restrictions may mean there will be periods of under-performance, there are a number of actively managed ethical funds that have achieved attractive returns.

Haynes favours Kames Ethical Cautious Managed fund. It has returned 15.4 per cent, 33.6 per cent, and 29 per cent over one, three and give years respectively, and has a total expense ratio (TER) of 1.34 per cent.

He says: “The equity part of the portfolio – currently a little over 50 per cent – is managed by Audrey Ryan who has produced strong returns with the UK Ethical fund.

“Kames also has a very strong fixed interest team and David Roberts has proven that he can produce competitive returns despite the reduced universe due to constraints. Given the strength of management, this is an excellent core holding for ethical investors.”

Meanwhile, Connolly recommends Aberdeen Ethical World, Jupiter Ecology, Kames Ethical Corporate Bond and Standard Life Ethical Corporate Bond funds.

But whether picking individual stocks or an open-ended fund, bear in mind that there is no such thing as a perfectly ethical company. Some degree of compromise will need to be employed by investors to pick those making positive contributions to environmental, social and other ethical issues while minimising negative soc
ially responsible factors.

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