Can you really make a profit in ethical funds?

Do you refuse to shop in budget clothing stores for fear of where and how the merchandise was made, or are you vigilant about recycling?

Both are commendable habits, but there are other areas of your life where you may want to consider the implications of your actions – investing, for example.

Ethical investment, also known as socially responsible investment (SRI), is a growing sector. According to Experts in Responsible Investment Solutions (EIRIS), as of December 2009 there were 95 UK-domiciled ethical funds to choose from, with a total of £9 billion under management.

The number of funds in the sector has been rising consistently since 2007, apart from a small blip in 2008 due to the knock-on effect of the financial crisis. But despite this trend, ethical funds still only represent just over 1% of UK-domiciled funds under management.

So will ethical ever be mainstream? Darius McDermott, managing director of Chelsea Financial Services, is far from convinced. "I always hear ethical investments are getting greater and greater, but I've yet to see any real evidence for it," he says.

One problem is the sheer difficulty of defining SRI. As Richard Marwood, investment manager at AXA Investment Management, says: "There's no one definition: no two clients have the same ethical stance and no two funds have the same ethical criteria."

According to the Investment Management Association, ethical funds are ones that aim to avoid companies involved in activities believed to be harmful, such as tobacco production or child labour.

In recent years, this remit has expanded to include funds actively investing in companies promoting ethical policies. These range from engagement in environmental development to corporate governance practices and community-relations schemes.

Until recently, the 'green scale' was popularly used to illustrate the ethical credentials of a fund or company. 'Dark green' companies were seen as more ethical and 'light green' as less so.

But this scale focused SRI too firmly on environmental issues alone when it is in fact far more wide-ranging. So it has been replaced by 'positive and negative' screening.

Negative screening is a way of weeding out companies that are involved in unethical activities – for example, any company directly involved in gambling operations or the production of tobacco, alcohol or violent materials.

Positive screening, on the other hand, focuses on companies with a good ethical track record. In recent years, most ethical investment providers have gradually moved towards a combination of positive and negative screening with a 'best-in-class' approach.

So what should the ethical investor look for? Ketan Patel, SRI analyst at investment management firm Ecclesiastical, feels it's important to look for businesses that are making a conscious effort to become more sustainable.

As an example he points to supermarkets Tesco and Morrisons, which are starting to make serious efforts to cut their energy use.

It's often thought that to appease your conscience you have to compromise on returns. Adrian Lowcock, senior investment adviser at Bestinvest, admits this can sometimes be the case.

"The sector is a little more sticky, there's a less diverse range of asset classes and ethical funds may experience more volatility," he warns. But ethical doesn't have to mean low returns.

According to Lowcock, one top-performing ethical fund, Aegon Ethical Equity, has almost kept up with a top-performing non-screened fund Invesco Perpetual Income. Over five years, Aegon's fund has returned 34.33% compared with 46.81% from Invesco Perpetual's.

McDermott says performance can be put down to a particular stage in the investment cycle. "If the sectors these funds are not allowed to be in underperform they tend to do well, but if the market is dominated by stocks they can't hold there's not much they can do about it."

For instance, during the financial crisis, when many mainstream funds positioned themselves defensively – in commodities and financials – many ethical funds had to find other ways to ride the storm.

Mark Mansley, investment director at Rathbone Greenbank Investments, says ethical funds do their best to hedge against such eventualities: "We allow for the cycle as much as we can. There are some factors that help and some that don't, but it's not a systematic problem."

Mark Robertson, spokesperson from EIRIS, agrees with this analysis: "A lot of funds operate under constraints; it comes down to the skills and experience of the fund manager."

For example, if commodities are booming, ethical funds may have to work that bit harder to achieve returns, but a good fund manager should be able to sniff out other growth areas to limit the effect on their performance.

If you're looking to invest ethically there are a few things you should consider before taking the plunge. Lowcock suggests approaching SRI with a degree of flexibility. You may have strong ideas about what you will and won't invest in, but practicalities can change your perspective.

"You need to set your criteria and then find a fund that matches these as closely as possible," he says.

It can be hard to tick all the boxes, so you might have to compromise. Penny Shepherd MBE, chief executive of the Sustainable Investment and Finance Association, says if you want to build ethical investments into your portfolio you should speak to an IFA with experience in the field.

"The Ethical Investment Association is an association of financial advisers who are committed to providing quality advice," she says. This can make all the difference when it comes to choosing your ethical portfolio because many advisers choose not to learn a lot about the sector.

Of course, the outstanding performance of some ethical funds cannot be ignored.

For example, Ecclesiastical's Amity International fund, managed by Robin Hepworth, was the global growth winner in Moneywise's 2009 fund awards, and has outperformed not only its ethical counterparts but also all non-screened funds in the sector.

And as topics such as climate change receive increasing political momentum – as seen at the Copenhagen Summit last year – companies already looking at sustainability are likely to have a head start. So now's the time to make sure your investments do too.


If you think you can handle the fall-out come judgement day, it could be financially more beneficial to invest in non-ethical companies over ethical companies.

In July last year, our sister publication Money Observer looked at the performance of 28 companies traditionally excluded from ethical investment portfolios and compared them to 72 members of the FTSE 100 index, which are also included in the FTSE4Good index.

The team's research found that over 10, five and three years, as well as the first six months of 2009, 'sinners' outperformed 'saints' by a considerable margin.

Over 10 years, anyone investing £100 in the Money Observer 'Sindex' would now have more than £258; the same stake in the saints would have shrunk to £61.

Two big names featured on the Sindex were British American Tobacco and Rolls-Royce (for its defence operations). They also chose two from the FTSE4Good index: Workspace and Vodafone.

Over five years from March 2005, shares in BAT have gained 112% and over the three-year period they have gained 61%. Rolls-Royce has also performed well, gaining 84% over five and three years. However, while Workspace is up 99% over three years, it's down 91% over five.

Vodafone is up 0.5% over three and down 2% over five years.


Darius McDermott, managing director of Chelsea Financial Services, recommends: Aegon

Ethical Corporate Bond
Fund managers: Philip Milburn & Iain Buckle

There are only two ethical bond funds available, and this one outperforms the other. It is run by a top-performing bond team that also runs a number of successful non-screened bond products.

Ecclesiastical Amity International
Fund manager: Robin Hepworth

Number one in the global growth sector over three years, this fund has returned 34.9% to investors, and over five years, 81.8%. Not only has it stayed ahead of its green rivals but has also beaten the mainstream non-screened funds.

It offers the opportunity to invest in socially responsible screened investments on a global basis, allowing exposure to some of the more rapidly growing regions and greater diversification.

Adrian Lowcock, senior investment adviser at Bestinvest, recommends: Aberdeen

Ethical World
Fund manager: Aberdeen global equity team

With three analysts dedicated to researching and running ethical portfolios, and the support of the wider global Aberdeen team, this fund is well positioned for investors looking to get broad exposure to ethical sectors. It has a bias away from healthcare, oil and gas, and materials, but has global equity exposure.

Standard Life UK Ethical
Fund manager: Lesley Duncan

This fund looks to identify growth companies through earnings and cashflow growth, and uses independent filters to meet ethical criteria. It has a mid and small-cap bias and a concentrated portfolio of 50 stocks.

Jupiter Ecology
Fund manager: Charlie Thomas

The manager looks to identify funds with positive growth, supported by trends in environmental and social policies and regulation. It maintains a narrow 'dark green' (very ethical) mandate and has a UK bias.

Your Comments

Darius McDermott says there are only 2 ethical bond funds available. Not so, there are at least 5 - Aegon, F&C, SLI, Aviva and Ecclessiastical.