Ethical investing explained
Oil spills and wars, droughts and melting ice caps, drunks marauding in town centres... the list of reasons to consider investing your money ethically grows ever longer.
However, interest in so-called ethical investment does not seem to be growing: only £16 million was invested in ethical funds in the first quarter of 2010, according to the Investment Management Association.
This is just a third of the level of 2009 and one of the lowest quarters on record. And that comes in a buoyant period for fund sales: retail sales overall were up by a third over the two periods.
Yet the sector has been performing respectably. Certainly, some funds have a dismal record - the Virgin Climate Change fund has not had a good start, while Sovereign, Scottish Widows and Prudential ethical funds have lost money over five years.
But leaders, such as First State's Emerging Markets Sustainabiliity Fund and Asia Pacific Sustainability Fund, Rathbone's Ethical Bond or Henderson's Industries of the Future and Global Care duo are among the first quartile of their relevant non-ethical sectors.
Tim Dieppe, director of SRI (socially responsible investment) funds at Henderson, thinks the industry could do more to promote its funds for their performance as well as their ethical criteria.
His funds are mainly promoted for their ethical overtones, but Dieppe says: "I love to be able to say to my colleagues that my funds are in the top quartile in the global growth sector."
Promoting them simply as global growth funds could widen the range of buyers they appeal to.
That may be more appropriate for some types of ethical funds than for others, and not just because in too many cases the performance would not warrant it.
Rather, it is because this is a very diverse area: there is not even a general agreement on what it should be called - green, ethical, socially responsible investing (SRI), sustainable or investing for the future - and the funds all pursue different themes.
This means you have to choose carefully to ensure the fund you buy meets your own ethical criteria.
Ethical fund development
Ethical investment started out by offering a way to avoid particular industries such as defence or tobacco, but it has since moved some way from simple negative screening.
Now funds - at least for new launches - that are badged green or sustainable are more popular. These funds are looking for companies that are seeking solutions to climate change, water shortages and so on.
Amanda Davidson, an ethical investment specialist at financial advisers Baigrie Davies, says she has noticed a shift among her clients towards this kind of sustainable investment.
"If all their money is invested ethically they are more attracted to sustainable investment opportunities."
These kinds of companies should be doing well, given the way the world is changing.
Governments across the world are setting targets for reducing emissions and increasing the use of renewable energy; the economic crisis has underlined the need for more responsible financial services; and the rapid growth in population, combined with urbanisation in countries like China and India, is putting pressure on global resources, while an ageing population is doing the same for social and healthcare services.
And there is huge investment going into these areas. Charlie Thomas, who runs the Jupiter Green Investment Trust and Jupiter Ecology Fund, points to research by HSBC, which shows that $520 billion (£357 billion) has been allocated to spending on climate change measures alone; of which just 20% has so far been spent.
"If you look at the starting point you can see the amount that is needed. In the UK, for example, just 3% of electricity is generated from renewables, but we have a target set by the EU to achieve 15% by 2020.
That is a significant opportunity [for companies in this area]. There is a question mark over whether we will make it, but even if we just get to 12% that is a fourfold increase in the market," says Thomas.
However, given the uncertain state of our own finances, and those of many Western governments, there must be some doubt as to whether the level of investment in renewables is sustainable.
Already, Spain and Portugal have cut their investment in this area and there is doubt over the level of German investment.
But optimists point out that a large proportion of US president Barack Obama's $800 billion stimulus package was earmarked for climate change projects.
Ian Simm, chief executive of Impax Asset Management, one of the leading environmental fund managers, is confident that the spending cuts will not be too severe.
"The last recession in the early 1990s was characterised by the view that spending on the environment was a luxury society could not afford, therefore many projects were abandoned.
"This time around, the environment is at the heart of efforts to support the economy, especially in places like China and the US. 50% of the Korean stimulus package was for green and infrastructure projects."
Emerging markets are responsible for a growing proportion of the spending on environmental projects. Thomas says that a decade ago the environmental industry was very Europe-centric, whereas now it is global.
And Millar Mathieson, co-manager of First State's Asia Pacific Sustainability Fund and the Emerging Markets Sustainability Fund, says China is getting serious about climate change.
It is expected to set a target to generate 15% of its energy from clean sources by 2020, and it has also been closing down cement companies that fail to meet pollution targets.
As with many other new technologies, the number of companies involved in clean energy areas can be small and demand for them can be large, which leads inevitably to bubbles and busts.
That has certainly characterised the alternative energy industry, where solar and wind power companies have seen dramatic rises and falls.
Some fund managers think they still look too expensive. "I would love to have a large proportion of the fund in wind or solar energy, but I can't find the management quality I look for in that area," says Mathieson.
Henderson's Dieppe is gradually increasing his exposure to renewables as prices have started to look more reasonable, but clean energy makes up just 7% of the fund.
He thinks the diversity of industries his fund can invest in - its 10 themes include health, efficiency, water management and social housing - means it can move easily between companies if a sector looks overvalued.
"A lot of other funds that are focused on clean technology cannot do that, so they have a much higher exposure," he says.
Moreover, he highlights research by HSBC which shows that around 40% - or $1.2 trillion - of the stimulus packages proposed by countries that are members of the G20 will be going into projects that fit with the fund's themes.
Impax's Simm points out that, globally, there are 1,400 companies operating in his environmental arena to choose from, and that they are among the strongest performers.
Over the past five years companies in the FTSE Environmental Opportunities All-Share index have risen by 109%, which is more than twice the increase in the MSCI World index.
He also points out that the earnings forecasts for environmental companies predict growth of at least 15%, which is far greater than is likely to be seen in the market as a whole.
While sustainability-type funds have been at the top of the performance tables over the past three years, some of the more traditional ethical funds have been having a much more difficult time.
The F&C Stewardship Growth Fund and Stewardship Income Fund are both languishing at the bottom of the one, three and five-year tables, but Stewardship Income is in second place over 10 years with a performance that would also put it firmly into the top quartile for all income funds.
F&C fund manager Catherine Stanley makes no bones about the poor performance, but attributes it to the fact Stewardship Income cannot invest in the kind of companies, such as mining and tobacco, that have been doing particularly well recently.
British American Tobacco's profits, for example, have doubled in five years.
She is also prevented from buying most of the banks, which recovered strongly over the past year. In contrast, a sizeable proportion of the fund is invested in utilities, which have not performed well.
"The indirect effect of not owning any miners, pharmaceuticals, tobacco, beverages or oil and gas firms, and few banks, means that I am overweight every other sector," says Stanley.
"I have to buy something. Because there has been great interest in companies that are benefiting from the cyclical recovery, the interest in the others has been falling."
Change on the horizon
However, there are some signs that things could be changing. The sharp fall in global markets since the Greek crisis means she has had a better relative performance recently and is fairly optimistic about the future.
Stanley thinks investors risk getting confused when funds are badged as sustainable. "It is not clear what sustainable means from an investor point of view.
Is it just energy and climate change? If so that does not work in the UK market - there are limited investment opportunities."
Certainly, anyone interested in investing specifically in clean energy and environmental areas would have to consider an international fund and F&C Stewardship International does have a better record over three and five years, although it lags the UK funds over 10 years.
But investing overseas, and particularly in emerging markets, does mean that the risks increase. Davidson recommends Jupiter Ecology and First State Asia Pacific Sustainability for those who are prepared to take a bit more risk.
It is also worth remembering that ethical investors do not have to confine themselves to equities. There are a number of bond funds to choose from, including funds from Ecclesiastical Amity and Rathbone, while CIS's Sustainable Diversified is a multi-asset fund.
Additionally, some banks, including the Co-operative and the Ecology Building Society, offer savings accounts that are backed by sustainable projects.
The cost of investing in ethical funds varies widely. An analysis by Moneyfacts found that Neptune's Green Planet fund has a total expense ratio (TER) of 2.4%, although its screening is not particularly rigorous.
That is more than double the 1% of the L&G Ethical Tracker; however, the latter's performance will only be as good, or bad, as the index. F&C Stewardship International's TER is 1.3, while Jupiter's Ecology and Environmental Income are 1.7%.
There are a few investment trusts in this area, which generally have lower charges. The favourites among these are Impax Environmental and Jupiter Green.
Clearly sacrificing profits for principles is no longer as widespread a notion in this arena but you need to be clear about your own principles before investing.
This article was originally published in Money Observer - Moneywise's sister publication - in July 2010
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.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
A stockmarket security (a form of derivative) issued by companies on their own ordinary shares to raise capital. A warrant has a quoted price of its own that can be converted into a specific share at a predetermined price (called the conversion price) and future date. The value of the warrant is determined by the premium of the share price over the conversion price of the warrant. Warrants give the same economic exposure to an underlying security without actually owning it, and cost a fraction of the price of the underlying security.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
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.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.