Ethical Investments

What exactly is ethical investment?

Put simply, ethical investment seeks to invest in companies which make a positive contribution to the world and seeks to avoid companies which harm the world, its people or its wildlife. It is difficult for an individual investor to judge whether a particular company is ethical or not. Therefore, most ethical investments are held through a managed investment fund such as a unit trust or life insurance or pension fund.

There are funds which merely exclude investment in specific activities or industries such as tobacco, gambling, alcohol and armaments. Others take a more pro-active stance, actively looking to invest in companies involved in environmentally sound, socially progressive businesses.

A third way, which evolved in the late 1990s, goes further. It is based on the belief that ethical or socially responsible investment should go beyond the 'avoidance' or 'supporting' approaches described above. Often called an 'engagement' or 'influencing' approach, here the investment fund will not apply any screening criteria to its investment choices. Instead, the fund manager undertakes to create a dialogue with a certain number of companies in the portfolio on a specific number of social and environmental issues. The aim is to encourage them to adopt the best business practices. Those companies which are already demonstrating a good performance in this area, are encouraged to continue to set the highest standards.

Funds under management in ethical investment schemes are still only a small percentage of total investment funds. However, the city is starting to pay serious attention to ethical investment criteria. It was not always so. When ethical investment began in the UK in the1980s, some City wags talked about 'Brazil Funds'. They were not referring to any involvement in South America. They reckoned ethical investment was for nuts!

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Why should I be interested in it?

If you care about your environment and about the problems of the world, you could be interested in ethical investment. There are two main reasons why you would consider investing in ethical investment funds. First, you may feel it appropriate that your investment decisions should mirror your own personal views and behaviour. Ethical investment helps you to invest according to your principles.

Second, by investing 'ethically' you can gently influence companies to improve their ethical record. Like it or not, money makes the world go round. If companies found that unethical behaviour caused investors to withdraw their money, it would make them think twice.

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How long has it been around?

The roots of modern ethical investment may be traced to the 1920s. The Methodist Church in North America decided to invest in the stock market, having previously viewed it as a form of gambling. However, they wished to exclude certain types of companies, specifically those involved in alcohol or gambling. The Quakers soon followed, but they were especially keen to avoid weapons manufacture.

Public demand for ethical investment vehicles took off in America with the launch of the Pax Fund in 1971 as a reaction against the Vietnam war. Discontent caused by the Vietnam War had led some investors to question how their money was being used. Many were particularly angry with the manufacturers of Agent Orange, the defoliant sprayed on Vietnamese jungles, which caused deformations in the babies of people who came into contact with it.

The history of ethical investment in the UK goes back to the late 1960s/early 1970s when a number of groups were exploring the possibilities for this type of investment fund. One of the individuals involved was Charles Jacob, then an investment manager with the Methodist Church. He prepared a proposal for the first ethical unit trust in 1973. At that time it failed to obtain approval from the Department of Trade, but a few years later permission in principle was granted.

In 1983, Friends' Provident which had been founded in 1832 to provide life assurance for members of the Society of Friends, more commonly known as Quakers offered to manage an ethical fund with the investment criteria determined by a separate committee. This led to the launch of the Stewardship Unit Trust, Stewardship Life Fund and Stewardship Individual Pension Fund in June 1984. Charles Jacob was appointed as a founder member of the Stewardship Committee of Reference.

Since the launch of Stewardship, other financial institutions have entered the market, and there are now more than 80 different ethical and socially responsible funds to choose from.

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What are the investment criteria?

Some funds adopt an engagement approach which 'overlays' the fund and does not affect investment decisions in any way. The only criteria for inclusion or exclusion are geographical and financial. Beyond that, the investment management group uses its power as a shareholder to encourage companies to adopt best business practices. However, most UK ethical funds are not engagement funds and are based on a combination of positive and negative investment criteria. Some emphasise the former, while others concentrate on the latter, and some try to strike a balance between the two.

For example, Friends' Provident's Stewardship fund is the oldest-established ethical investment fund in the UK. It seeks to invest in companies which, it believes, make a positive contribution to society, and avoid those which harm the world or its people. Some 'harmful' activities are regarded so seriously that Stewardship will not invest in such a company under any circumstances, such as arms manufacture. In other cases, harmful behaviour may be counterbalanced by exceptional performance on the positive side of the equation. These marginal cases are scrutinized closely and reviewed more frequently than those which are more clear cut. The Stewardship fund uses both positive and negative criteria to decide whether a company is a suitable investment, other funds have their own set of criteria.

To identify companies which make a positive contribution to society, Stewardship focuses on their record in the following areas:

• Supplying the basic necessities of life
• Providing high quality products and services which are of long term benefit to the community
• Conservation of energy or natural resources
• Environmental improvements and pollution control
• Good relations with customers and suppliers
• Good employment practices
• Training and education
• Strong community involvement
• A good equal opportunities record
• Openness about company activities

In identifying activities which harm the world or its inhabitants, Stewardship prefers to avoid the following areas:

• Environmental damage and pollution
• Unnecessary exploitation of animals
• Trade with or operations in oppressive regimes
• Exploitation of Third World countries
• Manufacture and sale of weapons
• Nuclear power
• Tobacco or alcohol production
• Gambling
• Pornography
• Offensive or misleading advertising

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Who decides which companies meet the criteria?

Ethical investing has been described as more of an art than a science. Indeed a fundamental problem with ethical investment is that it is largely a self-awarded title and what may be ethically sound for one person may not be so for another.

Most ethical funds managers use external consultants such as EIRIS, the independent Ethical Investment Research Services - www.eiris.org. EIRIS was originally set up in 1983 with the help of churches and charities which had investments and needed a research organisation to help them put their principles into practice.

In addition to external research groups many fund managers, such as the Friends Provident Stewardship range of funds, also have an in-house research team as well as a panel which set criteria and establish or monitor the approved list of companies.

In fact, the "ethical/environmental" tag may be on the way out. Such funds in the USA prefer to use the term "socially responsible investing" or SRI. This attempts to take a positive approach to investing rather than a negative one which rules companies out. SRI wants to encourage better business practices. Thus where an ethical fund might not invest at all in a given industry sector, a fund run on SRI lines would invest in the company which is making the best effort to improve its environmental policies. SRI fund managers also indulge in what they call "constructive dialogue", talking with managements on a continual basis to encourage better practices.

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Where do ethical funds invest?

Companies which find their way into ethical investment portfolios will have been screened to see if they match the fund's investment criteria on business practices and environmental impact. Most ethical trusts and funds have a bias towards smaller and medium sized companies. This is because most of the very large companies, due to their history and diverse range of activities, tend to fail the screening criteria.

Ethical fund managers often know a great deal more about the companies they invest in than ordinary fund managers. The ethical screening process requires ethical managers to ask more questions to identify investment opportunities.

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What's the difference between light green and dark green?

Ethical investments are often referred to by their shade of 'green'. Light green funds will generally be prepared to invest in the oil industry, pharmaceutical companies and banks, but will shun arms companies, tobacco conglomerates and research companies engaged in testing on animals. Dark green funds adopt much stricter ethical criteria and will exclude any companies that fail to meet their required standards.

Light green funds tend to be less concerned with avoiding investments, using a positive 'best of sector' approach to portfolio selection to invest in the top 200 UK companies and similar sized ones in Europe and North America. Dark green funds inevitably exclude a large proportion of leading companies from their potential portfolio - and therefore a significant proportion of the stock market.

Regardless of the shade of green and the boundaries are not colour fast; you could argue the inclusion of light/medium and medium/dark categories what about the performance and investor popularity of ethical funds? Cynics always maintain that performance is compromised by the restrictions imposed by the selection process.

How well does it perform?

Ethical trusts and funds have been available in the UK since 1984, and over this period have often matched or beaten their non-ethical counterparts. However, as with most share-based investments, the price of units and any income from them may go down as well as up.

The main reason that there is concern about ethical funds under-performing their non-ethical counterparts is usually the absence of large companies, which often drive the growth in popular benchmarks FTSE 100 or FTSE All Share indices.

Nevertheless, over the medium to long term there's evidence that an ethical investment policy need not damage your investment returns. In a report published back in November 2002, WestLB Panmure commented, "Although the observation period is not long enough to be able to draw final conclusions, a simple performance comparison already shows that the frequently voiced hypothesis of a systematic return disadvantage of ethical/SRI is clearly not supported by the present data."

In July 2001, the FTSE4Good Index series was launched to measure the performance of companies that meet globally recognised corporate responsibility standards, and to facilitate investment in those companies.

Analysis of the performance of the FTSE4Good Global index over the past five years when compared directly with the FTSE100 index of the UK's most highly capitalised shares shows the two indices moving in tandem but also highlights outperformance by the ethical index since the first half of 2003. However bear in mind that this might not continue in the future.

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What types of investment are available?

According to EIRIS there are around 80 ethical funds to choose from Source: Money Marketing 07/09/2006.You may invest in a variety of unit trusts and open-ended investment companies, through life assurance funds to pension funds that rely on ethical investment criteria.

There are also ethical individual savings accounts ISAs, regular savings plans, investment trusts, investment bonds - even ethical mortgages for those wanting to borrow and, of course, not forgetting ethical credit cards made from biodegradable plastic!

The UK Social Investment Forum keeps track of a wide variety of ethical financial instruments.

How can I find out more?

There is no doubt that ethical investing is becoming more popular. More and more fund managers are climbing on the bandwagon - either because they believe it is right or because they realise its going to be an important sector of their business and don't want to miss out.

The majority of ethical investment business is conducted through independent financial advisers IFAs, and that should be your starting point. Contact your IFA and ask about ethical investment. Your financial adviser can find out all you need to know and recommend the right product for your needs.

Do you need unbiased independent financial advice? Why not give us a call?

2009-02-17 00:00:00 © Moneyextra.com