The Big Theme
What does the word 'ethical' mean to you? Everyone's answer is different and this can be confusing. Take the well-known comedian, Jimmy Carr. He's listed as an official supporter of Fair Trade, but in 2012 it emerged that he had been dodging tax by storing over £3million in offshore tax havens. So is he ethical, or not?
We could argue about this all day, but if you're an investor with strong ideas about ethical practices in business, then you might want to consider investing some or all of your money in an 'ethical' fund. We'll come to exactly what this means in a minute, but even if you've only got eyes for profits and aren't that concerned about ethics, some ethical funds look like good money-makers and we think you could use them to diversify your portfolio and reap healthy long-term rewards.
Ethical funds haven't traditionally been seen as strong performers. But Morningstar data compiled for Investors Chronicle suggests that many are starting to catch up in terms of performance in the past year. But over five years, non-ethical funds still performed better.
Average performance of ethical funds vs. non-ethical funds
|Morningstar sector||1-year cumulative return (%)||3-year cumulative return (%)||5-year cumulative return (%)|
|UK All Companies (ethical funds only)||22.35||39.47||61.01|
|Global Equity (ethical funds only)||24.31||23.12||42.77|
|UK All Companies (non-ethical funds only)||21.20||36.83||69.71|
|Global Equity (non-ethical funds only)||17.89||27.97||56.81|
So ethical funds could be good investments for the future, but unfortunately investing ethically isn't straightforward. If you want your funds to truly fit your ethics, it requires time and energy for extra-through research. So here we give you a head-start by running through what funds are on offer, what to watch out for, and how to pick the funds that are right for your ethical values.
Decide on investment criteria
The first thing you need to do is work out what you want to invest in and what you don't. There are two main approaches here. The first aims to exclude practices you don't like from your investments. Companies that use or profit from 'unethical' practices or products like fur, tobacco and alcohol and sub-standard working conditions and wages in factories are often excluded in ethical funds.
This exclusionary technique, known as 'negative screening', is a must for anyone determined not to put even a penny in the pockets of companies that breach their moral values. In many cases, ethics override returns in terms of importance, but Bruce Jenkyn-Jones, an ethical fund manager at Old Mutual, admits that negative screening limits your pool of investments. And it's well known that stifling diversity isn't the best way to get the best returns.
Jason Hollands, head of business development at Bestinvest, also warns that funds with negative screens often change their policies to cater to changing trends in ethics, meaning you need to keep your eye on the ball if you've invested. For example, F&C's Stewardship fund, which was the first ethical fund launched in the UK, refused to invest in banks at first, but in 2009 it was revealed it had added a handful of them to its ethical portfolio, causing outrage among a number of investors.
But not all ethical investors are bothered about excluding certain businesses from their portfolios. They would rather invest purely in funds that focus on ethical, sustainable and socially responsible businesses. Many of them focus on big corporations that are making significant efforts to be socially responsible but there is also a host of 'environmental' funds that operate in the same way by only investing in companies such as clean energy providers, conservation projects, and technologies that bring social benefits to society.
You've picked a fund. But does it do what it says on the tin?
One of the most fundamental problems with funds that claim to be ethical in some way is that it's hard to tell if they actually are. Last year a study by responsible investment think-tank ShareAction found that 45 per cent of UK ethical funds do not disclose all the companies they are invested in. The UK is some way behind many other European countries in terms of ethical fund transparency. Of the 80 UK domiciled ethical and socially responsible funds in the UK (according to Morningstar data), 89 per cent would be banned from labelling themselves ethical if they were sold in France and Belgium. In these countries, funds that call themselves ethical have to meet minimum transparency standards outlined by a pan-European think-tank called European Sustainable Investment Forum (EUROSIF), because the French and Belgian trade bodies that represent investment funds equivalent to the UK's Investment Management Association (IMA), make EUROSIF a pre-requisite for funds to be included in their ethical sectors.
Designed to make ethical funds user-friendly for private investors, the code requires ethical funds to provide concise and easy to read information all in one place and disclose all portfolio holdings on a half-yearly basis - practices the vast majority of UK ethical funds haven't managed yet.
François Passant, executive director at EUROSIF, said: "I'd love it if the IMA made this compulsory for their ethical members." A spokesperson from the IMA declined to comment on why it doesn't make its ethical members comply with EUROSIF transparency rules, but said: "It's up to ethical funds to decide how they operate."
|UK Funds adhering to the EUROSIF SRI Transparency code|
|Amity UK Fund|
|Amity European Fund|
|Amity International Fund|
|Amity Sterling Bond Fund|
|Stewardship Growth OEIC|
|Stewardship Income OEIC|
|Stewardship International OEIC|
|F&C Ethical Bond Fund|
|IM WHEB Sustainability Fund|
Source: EUROSIF as of May 2013
Is the management team up to scratch?
These are specialist funds so you need to make sure the teams behind the funds have the specific expertise required to run them. They should possess a good track record in the sector, at the very least. Don't just assume a fund will be well resourced if it's run by a major fund house, because the opposite could be true. Last year the IC reported there had been staffing reductions among the ethical arms of big fund houses. Henderson axed six out of seven of its staff working on its ethical funds, while Aviva closed its ethical business altogether. And F&C, an investment house highly regarded for its ethical approach to investing, also waved goodbye to its head of governance and sustainable investment, Karina Litvack, but she was not replaced.
George Latham, chief investment officer at WHEB, a socially responsible investment house, says to prevent fund managers making buying and selling decisions for profits - rather than ethics - all ethical funds should have a separate and independent governing body deciding how the process works. So if a fund you're eyeing up has one, it can only be a good sign.
Seven ways to identify a genuinely 'good' fund:
■ Do you identify with the manager's views?
■ Do you agree with the fund strategy?
■ Does the fund have a separate governing body setting out the ethical process?
■ Is the team running the fund well resourced and are they experts in their field?
■ Has the fund performed well enough to make it a worthwhile place to put your money?
■ Are the fees fair?
■ Is the fund transparent about what it does?
BEST ETHICAL AND ENVIRONMENTAL FUNDS
For UK equity exposure, we like the F&C Stewardship Growth Fund (ISIN: GB0030833981) This fund is part of the F&C stable, a fund house with a 25-year track record in running ethically-screened funds. It won a place in our Top 100 Funds this year and is one of the nine UK funds that complies with EUROSIF's transparency guidelines (note four out of nine of them are F&C funds). Investment is concentrated in UK companies with products and operations considered to be of long-term benefit to the community both at home and abroad, with the aim of achieving long-term capital growth and increasing income, and emphasis on capital growth. As it's consistently trailed the FTSE All-Share index over one, three and five years, this is a fund for those who do not regard financial gain as the sole criterion for investment, but look to wider issues and want a genuinely ethical fund.
Those hoping for a juicier performance should look at Standard Life UK Ethical (ISIN: GB0004331012), which has consistently been the top-performing ethical fund benchmarked against the FTSE All-Share, according to Morningstar data. It's seconded by Ecclesiastical Amity UK (ISIN: GB0009371310) which has produced strong returns over a one, three and five-year periods and also complies with EUROSIF's transparency code, which means you should know what you're getting.
If you'd rather have some ethical bonds for your portfolio, Royal London Ethical Bond (ISIN: GB00B4WSJK27) is a member of the IC Top 100 Funds. This fund invests predominantly in investment-grade UK corporate bonds that meet pre-defined ethical criteria. The policy of the fund considers all of the following ethical issues: alcohol, armaments, gambling, pornography, tobacco, human rights, animal testing and the environment. While most ethical funds struggle to beat their non-ethical peers, despite some negative screening, this fund's performance record was good enough to win the Best Bond Fund at the IC Fund Awards 2013, beating its non-ethical peers. Alternatively, F&C Ethical Bond fund (ISIN: GB00B23YHT07) is compliant with the EUROSIF's transparency code and provides an excellent level of information about its processes and holdings.
And if your concerns are focused principally around green issues, rather than broader ethical issues, Jupiter Ecology (ISIN: GB00B4KLC262) is one of the longest running environmental funds and Bestinvest's top choice in the sector. The fund invests in global equities, with around 40 per cent of the portfolio in the US - which means it could be a good portfolio diversifier. It's investment policy is to invest worldwide in companies which demonstrate a positive commitment to the long-term protection of the environment. The manager, Charlie Thomas, has an excellent track record in green investing and the fund has beaten the sector average over one, five and 10-year periods, and slightly underperformed over three years. He believes the renewable energy sector will bring opportunities for investors over the long term, quoting research from Bloomberg that suggests 70 per cent of new power generation will be sourced from renewable energy between now and 2030.
|Fund||Ongoing charge||1-year total return %||3-year total return %||5-year total return %|
Ecclesiastical Amity UK A
|F&C Ethical Bond 1||1.05||1.39||14.75||39.45|
|F&C Stewardship Growth 1 Inc||1.61||20.19||34.91||59.87|
|Royal London Ethical Bond A||0.94||3.41||20.30||49.79|
|Standard Life UK Ethical R Acc||1.60||27.82||54.92||92.26|
Source: Morningstar. Performance data to 4 October 2013.
Environmental investment trusts
There are no specifically ethical investment trusts, but there is a small 'environmental' sector.
Jupiter Green Investment Trust (JGC) aims to generate long-term capital growth through a diverse portfolio of companies providing environmental solutions. Unfortunately, this investment trust is tiny at £38m total assets, meaning some analysts think it could be at risk of being wound up.
Meanwhile, BlackRock New Energy (BRNE) aims to generate long-term capital growth for its shareholders by investing globally in companies which have a significant focus on alternative energy or energy technology. The trust is trading at 42.25p, a discount of 7 per cent to its underlying net asset value. However, this trust also is small at £104m total assets.
We think Impax Environmental Markets Trust (IEM) has the most appeal to 'green' investors. A member of our Top 100 Funds, the trust invests in innovative companies within the energy-efficiency, alternative energy, water and waste sectors. The portfolio of 76 investments has a strong bias towards small caps, so it's a high risk fund. However, its market capitalisation is greater than the other trusts at £319m. Plus, at 139.75p, the trust is trading at an 11 per cent discount to its underlying net asset value, meaning investors may be picking up a bargain.
There is just one ethical tracker fund in the form of CIS UK FTSE4Good Tracker Trustm (ISIN: GB00B05Q3G94). However, its charges of 1.5 per cent are simply too high for a passive investment and have contributed to it underperforming its index over longer time periods.
View the IC fund tips.
Visit our funds and ETFs page for fund profiles, interviews with fund managers and the latest fund news.
View our top 100 funds list.