Now it can pay to go green

Investing ethically doesn't mean you won't make a healthy profit too, says Kate Hughes

Saturday, 23 February 2008

Shocking predictions of rising sea levels and distressing reports of human exploitation for the sake of profit are finally starting to change the way we live, play and invest.

Research carried out by the Investment Management Association shows that ethical funds under management reached £5.9bn in the last quarter of 2007, up 18 per cent on the year before. Meanwhile, the Co-op has found that interest in ethical investment also increased by 18 per cent in the past year.

In theory, ethical investment is a great way to further both your financial future and the health of the planet. The widely held assumption is that a fund manager only puts your money into companies that promote a change for good environmentally and socially, while providing you with competitive returns.

But this is a sector that is riddled with misunderstanding about just what constitutes an ethical fund. Despite good intentions, it is all too easy to put money into "responsible" investments that are anything but, including those that fly the conscientious flag despite having airlines, oil companies, and arms manufacturers on their books.

How green is green?

The first hurdle is in the name. Environmental or climate funds deal with our effect on the planet. Ecological and socially oriented funds, commonly known as socially responsible investments (SRI) deal with both human and environmental welfare.

"Environmental funds themselves break down into three approaches," says Peter De Graaf, of environmental research organisation Trucost. "Firstly, clean technologies funds will only invest in companies that produce technologies promoting a cleaner environment. The second is the more traditional approach, when funds exclude certain companies or sectors that challenge the environment, such as oil and gas companies.

"Finally, some environmental funds will include companies that are most efficient when conducting their business, using the least resources or producing the least emissions."

This often includes so- called "climate change" funds, which, despite the name, may not invest in ecologically friendly companies at all. Virgin Money's new climate change fund is one of the latest to get in on the action. It can invest in companies from all sectors, including the most polluting types of industries, "but will only invest in those which have a lighter than average environmental footprint for their sector".

This means a company could be included simply because it is not quite as bad as the others. Some of the companies included in the Virgin portfolio include French car manufacturer Renault and UK energy producer BG Group. And many climate change funds invest in companies that will gain from climate change – even if they are not necessarily helping the environment themselves.

There are also engagement funds and strategies, offered by managers such as Aberdeen and F&C for example, which buy into companies on the condition that the company will commit to improving its ethical credentials.

If you add social responsibility into the mix, the options available follow the same pattern, says Adam Ognall, deputy chief executive of the UK Social Investment Forum (UKSIF). "Just like green funds, investors have a choice of screening options when it comes to SRI funds.

"For example, some SRI funds will employ strategies that screen out all arms producers or companies testing on animals, for example, known as negative screening. But others will include car manufacturers who occasionally produce armoured personnel carriers, or companies that use animals, but only for medical experiments."

And then there are the companies that may have a great environmental record, but a bad humanitarian one, or vice versa.

Picking an ethical fund

Because there is such a variety of SRI funds available, investors need to decide how strict they are or what their shade of green is, and then find the fund that matches it, says Alex Davies, head of socially responsible investment (SRI) at Hargreaves Lansdown.

"The darker green the fund claims to be, the stricter its ethical rules," he says. A dark green fund could focus on alternative energy producers or organ-isations promoting social welfare. But a light green fund could include an oil producer or a company with a sideline in armaments.

Principles and performance

Ethical investments have long laboured under the reputation of sacrificing returns for morality, but it appears that is becoming a myth. Hargreaves Lansdown's latest league table of the top 150 funds includes three ethical contenders – Jupiter Ecology, Aegon's Ethical Equity and F&C's Stewardship Income fund.

"People imagine that the restrictions on ethical funds hinder their performance," adds My-Linh Ngo, of SRI Research for Henderson Global Investors. "But investors should remember that most funds are restricted in some way, be that geographic regions or the size of the companies, for example. SRI is simply operating within parameters that exist across the investment world."

As the UK and the EU become more focused on social and environmental responsibility, new legislation could boost the attractiveness of SRI, she adds. "SRI investing is about focusing on promoting more environmentally sustainable, and socially responsible practices. Environmental regulation is a key driver for many of the companies we invest in, and those companies are better positioned to benefit from this trend than traditional companies."

To find out more about ethical investing, the UK Social Investment Forum runs an information website at www.investability.org, and the Ethical Investment Association, (www.ethicalinvestment.org.uk), provides lists of ethical financial advisers in the UK.

For more in-depth research information, Trucost, (www.trucost.com) and the Ethical Investment Research Services (www.eiris.org) provide independent research into the social, environmental and ethical performance of companies. The UK's first National Ethical Investment Week (www.neiw.org ) runs from 18 – 24 May.

To find a list of ethical fund performance, visit www.trustnet.com or www.morningstar.co.uk.