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Understanding ethical investments

Understanding ethical investments

Despite the growth in recent years of areas such ethical consumerism and eco-tourism, data suggests ethical investment has failed to make a decisive break through into the mainstream. According to figures from the Investment Management Association (IMA), funds under management for ethical funds were £8.6 billion at the end of August 2013 and their share of total funds under management was just 1.2%, the same as this time last year.

Ethical investing is not just about returns

All too often discussion of ethical investing seems to revolve solely around the question of whether investing ethically will result in lower returns. However, this misses the point: some investors have a desire not to have their money invested in businesses such as tobacco or those companies that test their products on animals irrespective of the returns those areas may offer. Ethical investing exists to provide these savers with a choice.

Investments encompass a wide range of strategies

However, choosing investments is not straightforward because ethical investments encompass a wide range of strategies and involve an inherent degree of subjectivity. The range of funds on offer includes:

  • traditional ethically screened funds, which encompass a multitude of concerns and filter out sectors (tobacco, alcohol, arms, gambling and pornography) as well as individual stocks that are evaluated as unacceptable;
  • funds focused on identifying companies that are ‘best of breed’ for corporate responsibility across a range of industries (which in the case of the Premier Ethical fund extends to a 3% holding in pub operator Mitchell & Butlers)
  • funds that emphasise ‘engagement’ with companies on social, environmental and corporate governance issues
  • environmentally-friendly thematic funds and niche products focused on alternative energy stocks

While it is common to categorise funds under broad banners such as ‘light green’, ‘mid green’ and ‘dark green’ these are inadequate in conveying the important differences and nuances between funds. Potential investors need to decide what the key issues of concern to them are – in particular whether they want a broad-based ethical approach or a more narrow focus on the environment – and then select a fund with a set of policies that most closely matches their concerns.

We would argue however that beyond a few sectors such as tobacco and gambling most companies that ethical funds invest in do not neatly fit into a black and white definition of ethical or unethical but sit somewhere in between. Perhaps contrary to the expectations of some, ethical funds invariably hold large mainstream companies such as Vodafone, Royal Dutch Shell, HSBC, Lloyds Bank and GlaxoSmithKline.

Ethical fund performance

It is also important to be aware that ethical funds will perform differently from conventional funds, as they will generally have a lower weighting to commodities than the broader market as well as defensive sectors such as tobacco and drinks. This means they have a higher tracking error. Over the last five years we found the average ranking of UK equity ethical funds was 56th percentile but with a generally broad dispersion between the best performers, such as Standard Life UK Ethical, which returned 96% and the worst, Scottish Widows Ethical, which delivered a 25% return. This suggests that while it is undoubtedly a challenge to deliver outperformance with a more restricted universe, underperformance isn’t inevitable either. Manager selection is the key.

To find out which ethical and green funds we rate most highly, download our guide: Ethical and Green investing – navigating the maze.

The value of your investment can go down as well as up, and you can get back less than you originally invested.

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