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New energy breathes life into ethical investment

FEATURE: Can you have profits from your principles? With environmental and climate change funds you can
June 10, 2009

In 1984, F&C'S Stewardship Growth fund was known in the City as the Brazil fund, because "you had to be nuts to invest in it". However, the UK's first ethical investment fund, has outlived many mainstream funds, this month notching up a significant twenty-five year track record.

This pioneering fund, which is managed by F&C, one of Europe's largest and oldest asset managers, kicked off the growth of a segment of the investment industry that, in the UK alone, is estimated to account for £6.8 billion in pooled funds as at the end of 2008 and approximately 300 products across Europe.

But like many of its ethical fund peers, F&C Stewardship Growth has suffered over the past year from its restrictive investment policy, unable to invest in traditional defensives such as tobacco and big pharmaceuticals. Plus, it made a bad decision to invest in banks in 2007. As a result performance is down 27.08 per cent over the year to date and the long term performance record looks dire - investors are nursing losses of -4.22 per cent over ten years.

'Told you so'

Is this evidence that you have to sacrifice profits for your principles? On the surface, the answer is yes, but it's always best to dig deeper. It's difficult to measure the performance of ethical funds because there isn't an ethical sector. So you have to see how they perform against their non-ethical peers. This isn't a bad measure as it brings home whether you are sacrificing profits or, more pertinently in 2008, magnifying losses for your principles. But plenty of conventional funds have performed just as badly as F&C Stewardship Growth.

You need to understand the underlying reasons for underperformance. As one specialist adviser points out, it all depends on the point in the economic cycle at which you are gathering evidence. The past year's performance figures don't make ethical funds look so great. However, in boom years, ethical funds may benefit from their focus on small growth stocks. Swings and roundabouts, then.

Mark Hoskin, a certified financial planner with ethical investment specialists Holden & Partners says: "Over one year it does look like ethical funds as a group have struggled more than their market leading conventional peers in outperforming the FTSE 100. However, performance has not been too far from the market over this period. And those in the conventional market who have misunderstood the finance crisis have suffered badly.

"It is true to say that ethical funds as a group cannot go into defensive stocks such as Tobacco, which over three years as a sector has significantly outperformed the FTSE 100. This has always been a strong hold of Neil Woodford at Invesco Perpetual and has had a very positive impact over the last 3 years."

Of course, performance relative to conventional funds does not matter to committed ethical investors - who will be prepared to sacrifice profits for their principles. However, perhaps they don't need to, as the ethical sphere is throwing up some genuine growth opportunities - particularly in the environmental arena.

Mr Hoskin says: "Ethical funds need to do more than simply screen out stocks to compete with their conventional peers. It is clear that there is flexibility within the ethical investment universe to give better than market performance despite some of the exclusions it runs. This has become easier in recent times because of both the cultural changes happening in society and the legislation brought in to try to avert an environmental crisis and also provide energy security."

It is this environmental agenda which all investors - not only ethical investors - need to consider when looking at equities over the next 10 years. Already, according to Mr Hoskin, so-called "climate change funds" are outperforming the markets. To give two examples Schroder Global Climate Change and Henderson Industries of the Future have fallen over 11 per cent less than the FTSE 100 in the last year. "We believe that this is in part because the companies that these funds invest in are better protected from the downturn by legislation that is forcing consumers to change their purchasing behaviour," he says.

Government subsidies

A number of "Green New Deals" - government reflationary packages designed to kickstart economies and boost action to counter climate change – have been laid out by ministers around the world. Charlie Thomas, fund manager of the Jupiter Ecology Fund explains: "There is a great deal of capital being pledged for green projects as part of the various stimulus packages aimed at reviving the global economy. It is estimated that some $400 billion of the funding pledged by G20 nations will support environmental solutions projects."

In February, US President Barack Obama signed into law a government stimulus package called the American Recovery and Reinvestment Act and said the energy provisions within this will pave the path for doubling the amount of renewable energy in the next three years. Energy is a major piece of the massive $787 billion package, totalling about $38 billion in government spending and about $20 billion in tax incentives over the next 10 years, according to estimates.

Richard Philbin, chief investment officer at Architas multi-manager, who has no ethical drum to bang, agrees that Barack Obama's policies will be very good for climate change investing over the next decade. "No doubt there are investment opportunities," he says. And not just in the US. "For example, there is an EU law that solar panels need to be installed on new build houses," he says.

Even China this week announced that it is planning a vast increase in its use of wind and solar over the next decade and believes it can match Europe by 2020, producing a fifth of its energy needs from renewable sources. Zhang Xiaoqiang, vice-chairman of China's national development and reform commission, told the Guardian newspaper that Beijing would easily surpass current 2020 targets for the use of wind and solar power and was now contemplating targets that were more than three times higher.

Fund recommendations

To benefit from these green policies and climate change legislation you have to choose your investments carefully. Mr Hoskin explains: "Intuitively it would be thought that ethical or green funds would have a significant holding in companies that were tackling climate change. Our analysis suggests that this is not the case."

Holden & Partners' research shows that the majority of holdings within ethical funds are of traditionally large companies with an overweighting in banks and telecommunications. Most ethical funds’ top ten holdings are surprisingly mainstream, with names like Vodafone and Royal Bank of Scotland occurring again and again. Some even hold BP, Shell and the bête noire of environmentalists: Total. Very few seem to be directly tackling climate change. But here are some that are:

Investments trusts

The first two environmental or climate change funds to be launched are still firm favourites among investors with good performance track records to boot. They are both investment trusts: Blackrock New Energy plc (formerly known as Merrill Lynch New Energy Technology) launched in early 2000 to generate long-term capital growth through global investment in companies that focus on alternative energy generation or energy technology. .

Set up in 2002, Impax Environmental Markets plc aims to enable investors to benefit from rapid and sustained growth anticipated in the markets for cleaner or more efficient delivery of basic services of energy, water and waste. Profile of .

Open-ended funds

Mr Hoskin recommends Henderson Industries of the Future and Jupiter Ecology.

"These two funds are both ethical and climate change funds. They are both looking for investments in the new energy world."

The Henderson Industries of the Future Fund was launched in 1995 and applies a diverse 10 themed approach, based on sustainability trends and challenges. The premise behind the fund's investment strategy is that a new industrial revolution is underway. Powerful trends are creating investment opportunities in companies providing solutions to the world’s sustainability challenges. The environmental and social themes resulting from these trends are what Henderson defines as the ‘Industries of the Future’.

Jupiter Ecology, which is celebrating its 20th anniversary, has an active focus on six green investment themes: clean energy; water management; green transport; waste management; sustainable living; and environmental services.

Exchange-traded funds

There are plenty of clean energy ETFs that offer a low cost way to play the climate change theme. For example, in March we tipped thewhich has an inexpensive total expense ratio of 0.65 per cent. This ETF offers exposure to shares of around 30 of the world's largest publicly traded companies involved in clean energy production or the manufacture of equipment and technology for the clean energy industry.

Venture Capital Trusts

Holden & Partners is recommending the Triodos Renewables Fund and the Ventus VCT plc and Ventus 2 VCT plc.

Triodos Bank has provided debt finance for over 220 renewable energy projects across Europe in the last 25 years. The Triodos Renewables Fund which was launched in 1995 is their first foray into offering their customer base in the UK an opportunity on the equity side of the renewable energy fence. The fund owns and operates four wind farms as well as a hydro-electric scheme.

It currently has 16MW of wind projects in the pipeline over the next six months at attractive values, with a further 107MW at various stages of development, giving investors good cause for optimism. But a key advantage is that the regulatory framework also looks secure with subsidies accounting for around 60 per cent of their earnings set to stay in place until 2037.

However, Holden & Partners argue that two main factors make this fund less attractive than the Ventus plcs. The first is tax relief, and the second is one of liquidity and pricing.

Ventus provides project finance for renewable energy projects, mainly wind farms, but now also hydro-electric, biomass and landfill gas schemes. The Ventus offering operates within a Venture Capital Trust and as such investors enjoy 30 per cent up front tax relief, together with the promise of tax free dividends into the future.

The management team, Climate Change Capital, have proved their business model in setting up and running small scale energy projects - the three previous Ventus venture capital offerings have presented impressive returns compared to their venture capital competitors.

Mr Hoskins says: "For our clients the main problem is income. This is why Ventus is attractive - it will provide a tax free income of 8 per cent if it does as well as before. Plus energy prices should move in advance of inflation.

"In a sense it's project finance - not a traditional ethical fund or a VCT. It is infrastructure - there is a construction risk but you sign up to a long term power agreement with government guarantees."

The Ventus plc and Ventus 2 plc C-share offering closes on 30th June. For further information visit www.ventusvct.com.

Top 20 UK open ended ethical/ecology funds over 1 year

Fund1 yr %Rank in sectorQrtl in sectorSector avg.3 yrs5 yrsIMA sector
Rathbone Ethical Bond Acc-12.73674-6.49-17.87-9.32£ Corporate Bond
Henderson Glbl Care Grth Rtl-17.31411-20.77-4.4428.08Global Growth
Henderson Glbl Care Mgd Rtl-17.34763-16.76-10.121.65Balanced Managed
Henderson Industries Future A-17.49421-20.77-3.2827.87Global Growth
Aviva Inv SF Managed SC1 Inc-17.56793-16.76-6.8919.39Balanced Managed
Halifax Ethical C Inc-18.86632-20.77-5.2122.5Global Growth
F&C Stewardship Intl SC1 Inc-19.81822-20.77-10.4318.38Global Growth
CS Fellowship R-21.83942-23.9-15.9114.03UK All Companies
Aberdeen Ethical World A Inc-21.951153-20.77-438.27Global Growth
Insight Inv Evergreen A-22.211203-20.77-10.8714.38Global Growth
Jupiter Ecology-22.391223-20.77-3.5353.63Global Growth
St James's Pl Ethical Inc-22.421233-20.77-4.5241.86Global Growth
CIS Sustainable Leaders-22.711252-23.9-8.5734.72UK All Companies
Ecclesiastical Amity UK A Inc-23.461603-23.9-20.767.64UK All Companies
Aberdeen Responsible UK Eq A Acc-23.551643-23.9-19.8N/AUK All Companies
Aviva Inv SF Global Grth SC1-23.621374-20.77-10.4114.35Global Growth
Real Life A Acc-23.951753-23.9-21.395.05UK All Companies
F&C UK Ethical 2 Inc-24.811973-23.9-16.1312.43UK All Companies
Aviva Inv SF Abslt Grth SC1-25.45944-19.95-13.3118.99Active Managed
Old Mutual Ethical A Acc-25.622183-23.9-32.721.53UK All Companies

Source: Morningstar 08/06/09

Notes: Table shows funds with 3 year track records only. Figures show % change on an initial £100 lump sum on a bid to bid basis at basic rate tax.