Many savers like the concept of taking an ethical stance to which sustainability and environmental elements are often added.
Companies are increasingly open about their responsibilities in these fields, aware that investors and advisers alike are keeping a close eye.
Ethical funds typically use negative screening to rule out firms operating in the alcohol, defence, gambling and tobacco industries, combined with positive criteria seeking companies either involved in environmentally-friendly areas or with good records of corporate accountability. Green funds generally invest solely where a positive contribution is made to the environment.
Financial planner Keith Jackson at Leeds-based Allied Financial Services says the choice of ethical investments is still quite restrictive and that whilst clients often say they would like to take that route, the returns to be obtained elsewhere “overrides their ethics and emotions”.
The UK’s first mainstream ethical fund was launched by Friends Provident in 1984. Now called F&C Responsible UK Equity Growth, it has returned 76.3 per cent in the last 10 years. By comparison, UK company funds have risen on average 75.5 per cent but global emerging market collectives by 98.3 per cent.
However, some non-ethical funds have far outpaced: Liontrust Special Situations is up 246.8 per cent and Old Mutual UK Mid-Cap by 222.8 per cent.
A comparison between the ethical benchmark (FTSE4Good UK) and the FTSE 250 is fair, says, Adrian Lowcock, investment director at Architas. Over five years the respective growth has been 66 per cent and 94 per cent.
Aside from collectives, Martin Payne at wealth manager Brewin Dolphin in Leeds says it is possible to construct a broadly balanced portfolio with exposure to UK and overseas equities and other assets such as bonds.
Whilst a fund may be classed as ‘ethical’, it may not necessarily follow the guidelines an individual investor requires. Some funds operate on a ‘best in class’ basis so that it is possible to find investments in oil and gas markets, mining or even the defence industry within an ethical fund.
There are distinct risks. Saving on an ethical basis is thematic, akin to technology. If this is to the exclusion of all else, such investments can effectively increase risk as exposure will be limited to certain sectors and stocks as well as raising volatility. If the ethical theme falls from favour, long periods of under-performance could occur.
Jonathan Baker, investment director at stockbroker Charles Stanley, says they tend not to use funds as they usually duplicate each other in their holdings, preferring instead to build a portfolio of specific shares. They screen for the criteria required by each client, some of whom like to follow the Church of England guidelines.
“Engagement is the newest technique, using shareholder influence to actively pressure companies to employ more ethical policies whilst trying to enhance shareholder value,” says Gareth Shaw at Saga Investment Services. They particularly like Standard Life UK Ethical, up 61.9 per cent in five years, for its strict screening policy. Animal testing, genetic engineering, intensive farming and firms creating environmental damage are excluded whilst those with pollution control, promoting equal opportunities and diversity in employment are sought.
Interest in ethical investing is rising, albeit from a low base, notes Darius McDermott of Chelsea Financial Services. He says investors are now looking for positive screening where companies behave responsibly towards their staff and environment.
McDermott says this has been highlighted by Bank of England Governor Mark Carney’s remarks on the potential costs of climate change and highlighting its impact for investment, Prince Charles adding his voice to the debate and AXA’s recent move to divest completely from tobacco stocks in all its portfolios, citing a conflict of interest as an insurance company.
He particularly likes EdenTree Amity UK, Kames Ethical Cautious Managed, Rathbone Ethical Bond and Stewart Investors Asia Pacific Sustainability.
The top performing funds over five years according to FE Analytics supplied by Chelsea Financial Services are:
Royal London Sustainable World Trust, up 90.4 per cent
Stewart Investors Asia Pacific Sustainability, up 85.2 per cent
F&C Responsible Global Equity, up 78.5 per cent
Henderson Global Care Growth, up 76.8 per cent
Old Mutual Ethical, up 75 per cent.
Among investment trusts, there have been such success stories as Impax Environmental Markets (up 77.1 per cent) and Jupiter Green (up 53.8 per cent), both over five years.
Jupiter Ecology is tipped by Lowcock and Payne. Launched in 1988, it is now £450m in size aiming to achieve long-term capital and income growth consistent with protecting the environment with a bias towards small and mid cap firms in developed markets with almost 80 per cent in US and Europe.
Payne also recommends The Renewables Infrastructure Group, a £560m investment company, which seeks operators who generate electricity from renewable energy sources, notably onshore wind farms and solar parks. Most are in the UK but some of the 8-9 per cent annual return derives from assets in France and Ireland. Taking the ethical stance, it is difficult to reduce risk by diversifying away from shares, says Elizabeth Hastings, chartered financial planner at Chase de Vere in Leeds. She says that there are some good quality ethical fixed interest funds but other areas such as property are hard to find. Her fund choices include Aberdeen Ethical World Equity, Standard Life UK Ethical and Rathbone Ethical Bond.
Pictet Global MegaTrend Selection does not have specific ethical requirements but Lowcock says it looks instead to invest in eight long-term areas, many of which are closely linked to dominant ethical themes. They include agriculture, clean energy and water.
“There are different shades of green so investors need to dig down into the nitty gritty of which each fund does to ensure it is in line with ethical preferences,” suggests Laith Khalaf, senior analyst at private client discount brokers Hargreaves Lansdown.
Many member-owned organisations apply an ethical criteria. Tony Burdin, chief executive at Sheffield Mutual Friendly Society, says they “seek to adopt an ethical approach to investing” which is long-standing. “We know from feedback that excluding certain industries on ethical grounds strikes a powerful cord with our members.”
Tim Whitehead, investment manager at broker Redmayne-Bentley, has been looking after portfolios for over a quarter century and has “witnessed a significant increase in appetite for both ethical mandates and a broader trend towards socially responsible investing”.
He says screening has not impaired performance. In funds he tips Threadneedle Social Bond, which includes corporate bonds issued by Leeds University and the BBC, and EdenTree (formerly Ecclesiastical). The latter is defensively positioned and has one of the lowest levels of volatility.