Would you risk investment returns on your hard-earned cash to make a small positive difference to the world of businesses? If not, you should steer clear of 'ethical' funds, advisers are warning.
What does ethical investing even mean? You may as well ask "how long is a piece of string?". Everyone's concept of 'ethical' is different; there are hundreds of ways to invest, making it difficult to decipher just how good these 'ethical' funds really are.
You might be surprised to learn that the majority of ethical funds invest in major banks, as well as oil companies. These are the businesses that have earned a distinctly 'immoral' reputation in recent years, having had devastating global-scale consequences as a result of their failings. But ethical fund managers say they are there to try to improve their management, rather than shun them altogether.
More predictably, ethical funds do tend to exclude stocks with exposure to other 'unethical' industries such as fur, tobacco and alcohol. This is great if you don't want to support these businesses, but potentially disastrous if you want to protect your returns, according to Jason Hollands, managing director of business development and communications at Bestinvest.
"During tough economic times, people still smoke and they still drink, meaning 'unethical' companies, despite damaging other people's health, are defensive assets that will actually protect your portfolio," he says. "Ethical companies such as wind turbine and solar energy producers look the most flimsy during a recession, which is not very reassuring for private investors."
In decades gone by, ethical investors were a sneered-at minority, frequently referred to as "tree-huggers", according to Hugh Cuthbert, manager of the SVM All Europe SRI fund. They are still a marginal group with a limited pool of funds, but they have come a long way since those days. They also come armed with (some) stories of promising returns, and a powerful message that, in the long run, moral and sustainable businesses will thrive and become the outperformers.
But ethical investing is not as simple as investing in 'good' or 'bad' companies. There are a myriad of strategies, each of which will give you a slightly different skew. The approach ringing the most alarm bells is called 'negative screening', whereby 'bad' companies or entire sectors are banned from the fund's portfolio. Everyone we spoke to said this exclusionary method could strangle your returns and send your investment risk through the roof by killing diversification. So if there's anything to avoid like the plague, it's funds deploying this strategy.
Under this approach, robustly performing fashion houses such as Burberry may be excluded altogether because they have a tiny exposure to the fur industry when one or two of their jackets have a fur trim, for example.
Negative screening is badmouthed even by ethical investment experts themselves. One such 'green' critic is David Harris, manager of the FTSE4Good index and vice-chairman of the UK Sustainable Investment Forum (UKSIF), who appears to have some better ideas. He says 'positive screening', whereby funds mangers pick the companies they believe are the most ethical, is a better approach.
He also believes investing with ethics in mind can reap rewards in the form of returns, claiming all but one of the environmental FTSE indices has outperformed equivalent 'non-ethical' indices.
Patrick Connolly, certified financial planner at AWD Chase De Vere, is not convinced. "Ethical tracker funds are just so light touch," he says. And he's also startled by the high fees that come with them. The Co-operative charges 1.5 per cent a year on its FTSE4Good Tracker fund, while Legal & General charges 1.15 per cent for its ethical trust fund. Both look expensive compared with other, equivalent non-ethical tracker funds, which carry fees as low as 0.2 per cent. It's no surprise then, that Mr. Connolly refuses to recommend anything ethical to his clients unless they specifically ask for it.
So the off-the record advice from most of the advisers we spoke to goes as follows: If you care about a cause enough that you would stake your money on it, positively screened ethical funds are worth a look. But if you want to keep your nest egg safe, giving to charity or buying ethical products - such as fair-trade coffee - will put your money to just as good use, without the risk.
