Can you invest responsibly and still make money?
Billions of pounds have been ploughed into green and socially responsible funds since they were first launched three decades ago, but the jury remains out on whether they are capable of delivering sustainable returns.
Figures compiled by EIRIS, the sustainable investment research specialist, reveal that the amount of money invested in such products hit more than £15 billion in 2015, up from around £6 billion 10 years ago.
Stephen Hine, deputy chief executive at EIRIS, cites several factors behind the increase: “With continued consumer interest in global issues like climate change, human rights and equality, it is not surprising that consumers are keen to explore responsible finance.”
His comments are backed up by YouGov research for the UK Sustainable Investment and Finance Association (UKSIF) that reveals 54% of British investors want their investments to have a positive impact, beyond just making money.
Simon Howard, UKSIF’s chief executive, says the public clearly wants the finance sector to make its money count, and argues that the rising demand for sustainable investment presents a real challenge for the industry.
“So far, it has responded well with a diverse range of sustainable options from energy efficiency to sustainable investment funds and community crowdfunding – but more needs to be done,” he says.
But while a number of responsible funds have made decent returns over various time periods, others have suffered significant losses that, rather depressingly, suggest there can be a heavy price to pay for letting your beliefs guide investment decisions.
Statistics compiled for Moneywise by Morningstar illustrate the point and emphasise the need to examine these funds on a case-by-case basis in order to understand what you’re buying and in which environments they are likely to perform.
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Ethical funds can be volatile
Over the past year, the best performers that follow an environmental or an ESG (environmental, social and governance) approach have achieved double-digit returns – while the worst have lost a similar amount, according to data to 30 November 2015.
This is probably a key reason why ethical investing has never really enjoyed its long-expected explosion in growth, despite occasional periods of interest from investors, according to Patrick Connolly, a certified financial planner at Chase de Vere.
“Many investors are interested in the concept of investing ethically,” he says. “However, the overriding objectives for most investors are maximising returns and managing risk, and both of these are more difficult to achieve if investing ethically.”
This slightly jaundiced attitude towards such portfolios can be traced back to the launch of the first mainstream ethical fund by Friends Provident in 1984. “It was rather unfairly labelled as the ‘Brazil fund’ because you would have to be nuts to invest in it,” recalls Connolly.
While socially responsible funds are increasingly mainstream nowadays, many financial advisers and fund managers still view them with a degree of suspicion, pointing out that there are a number of problems with investing with a socially responsible focus.
“It is difficult to construct an investment portfolio that will replicate the ethical beliefs of an individual investor,” says Connolly. “This is because ethical funds adopt different approaches, so what one fund may consider an ethical stock, another might not.”
He also suggests diversification is a major problem for ethical investors, which is why such funds can be volatile. “Investors must also accept they are likely to have to make some compromises, either to their returns, volatility or ethical beliefs,” he adds.
According to Justin Modray, founder of Candid Financial Advice, the returns generated by ethical funds are largely driven by the performance of companies that these portfolios embrace or avoid.
“While the FTSE 100 has been hit quite badly through a weighting in energy and mining stocks, the performance of ethical funds looks relatively good by virtue of the fact that they will have avoided those sectors,” he explains.
The majority, for example, will avoid investing in sectors such as energy, mining, oil producers and tobacco stocks, as well as often having a bias towards smaller and medium-sized companies.
“If the oil price goes through the floor, which it has done over the last couple of years, then ethical funds will look relatively good versus conventional funds simply by default – but
if it bounces back, they may end up lagging behind them,” he says.
Funds involved in this area also take vastly different approaches. Some managers use negative screening to avoid companies engaged in what they perceive to be harmful activities, such as tobacco, gambling or manufacturing weapons. Others adopt a positive screening approach, whereby they actively include companies in their portfolios that are capable – and willing – to contribute positively to society or the environment.
Restrictions sow doubt
James de Bunsen, an experienced fund manager within Henderson’s multi-asset team, has invested in renewable energy and in funds that put their money into companies that take environmentally friendly approaches, but still remains hesitant about this area.
“I can’t see why I’d want to invest in something that was restricted in that way,” he explains. “It clearly suits some people’s investment goals but it means the fund manager is missing out on some investments which although not evil, just don’t meet the screens.”
Then there are so-called best-in-breed funds. This approach sees some managers buying into sectors that may be viewed as not socially responsible, such as oil companies, but only select companies that are less damaging or actively searching for greener solutions.
It’s a complicated area but the whole selection process is being helped by services such as Fund Calibre, the free independent ratings service run by Albermarle Street Partners and Chelsea Financial Services, which has recently started covering socially responsible funds.
According to Darius McDermott, Chelsea’s managing director, this signifies the way such portfolios have entered the mainstream in recent years – and the extent to which these issues are now being discussed by politicians.
“There are some really good funds in this area so if you’re interested in investing ethically, then it’s certainly worth a look to see what’s available,” he says. “We are trying to help investors find the best of breed funds in this category.”
He pointed out that socially responsible investing covers a multitude of areas, including sustainable, socially conscious, environmentally responsible or ethical businesses. Funds in this category may invest in any asset class and their level of “responsibility” will vary.
“Some funds will use negative screens and avoid certain investments, some will have positive screens and encourage good practice, while others will use a combination of both,” explained McDermott. “You also have those that will look instead to invest back into the region or asset class for the benefit of local people and business development.”
Ethical funds in detail
At the launch of its responsible portfolio focus, Fund Calibre rated four such products: EdenTree Amity UK, Rathbone Ethical Bond, Standard Life Investments UK Ethical and First State Asia Pacific Sustainability. Others are due to be added soon.
The Standard Life Investments UK Ethical fund, for example, has strict negative criteria so any company that causes environmental damage, tests products on animals, is involved in genetic engineering, pornography or alcohol production won’t be considered.
It takes a similarly hard stance on those involved in gambling, processing of nuclear power, tobacco production, selling fur products or marketing breast milk substitutes. However, it also takes into account a number of positive screens.
For example, it will look favourably on companies that make a positive contribution to the environment, promote sound employment practices, donate to charities that are strongly involved in the community, and have clear policies on bribery and corruption.
Its 10 largest holdings, which together account for 25% of assets under management, include Vodafone, BT, Prudential, Crest Nicholson, Howden and Bellway, according to the fund’s fact sheet.
“With a yield of nearly 3%, this fund offers something different from other ethical funds,” says McDermott. “Standard Life’s considerable research team, plus a consistent and conscientious manager in Lesley Duncan, should combine to make a strong return for clients.”
Such funds, he suggests, are worth considering. “We believe that these funds will play an increasingly important role,” he says. “It is therefore important that potential investors understand the different nuances of the funds so that they can pick the best fund to match their own views.”
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The fact that issues such as climate change are headline news only goes to strengthen his argument. For example, it was only a short time ago that a deal was agreed at the United Nations Climate Change Conference in Paris to limit the rise in global temperatures.
Mike Fox, head of sustainable funds at Royal London Asset Management, believes there will be ramifications for all corporates with penalties for poor environmental practices getting more punitive as governments seek to implement the Paris agreement.
“Investors may have to pay a premium for those companies showing leadership in environmental management as they are likely to be more profitable,” he said. “They should look out for innovative companies providing products with lower-carbon intensity.”
These, he believes, could be stars of the future. “They may well become as important as those created in the early stages of the internet,” he says. “Watch out for the next Google and Amazon, but this time in the areas of energy efficiency, clean energy or energy storage.”
Top five areas that ethical investors want to support:
- Healthcare and access to medicine - 43%
- Renewable energy - 40%
- Energy efficiency - 37%
- Sustainable forestry - 36%
- Sustainable agriculture and fishing - 34%
Top five issues that ethical investors want to avoid:
- Pornography - 61%
- Tobacco - 59%
- Labour/workforce exploitation - 56%
- Gambling - 55%
- Animal testing - 54%
Source: Castlefield.com, October 2015.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Socially responsible investing
An investment strategy that seeks to maximise both financial return and social good. In general, socially responsible investors favour corporate practices that promote environmental stewardship, consumer protection, human rights, and diversity. Some (but not all) avoid businesses involved in alcohol, tobacco, gambling, weapons, and the military. Ethical investment reduces the number of shares, securities or funds available to the investor and it tends to increase the volatility of a portfolio and therefore the risk profile. Also, because of the time-consuming ethical screening, ethical funds charge slightly higher fees.