Ethical investing: a beginner's guide

It’s no longer necessary to choose between profit and principles: you can now invest in ethical funds, take out a green mortgage or open a savings account according to socially responsible values.

And although ethical assets remain a small proportion of total funds under management, investors are more ethically aware than ever before: the amount of money invested in ethical funds is three times more than a decade ago.

Some argue there is a strong investment case for pulling out of fossil fuel producers, as climate change may force governments to clamp down.

‘Investing ethically can be extremely rewarding, both financially and for your conscience,’ says Marcus Vassiliou, sales and marketing manager of Eco Investments. ‘It can be a great feeling to know your money is being put to use, improving lives in developing countries, having a beneficial impact on the environment, and at the same time earning you a decent return.’

The basics

The Investment Association now lists more than 60 green and ethical funds available to UK investors. It labels an ethical fund as one that will generally exclude investment in companies that threaten the environment, health or human rights.

But the way in which ethical funds are structured varies from fund to fund. Some funds employ negative screening, which filters out any companies that invest in arms, tobacco, gambling and oil, for instance. Others use positive screening, which favours stocks within environmental, renewable energy, welfare and healthcare sectors. Critics say negative screening has minimal social or environmental impact.

Other ethical funds are of a specialist nature, such as those investing primarily in green energy or ecology, while others are ‘best-in-class’ funds that can invest across the board; they tend to focus on how the companies themselves are run.

As an example, some funds won’t hold shares in oil companies because they consider these to be harmful to the environment, while others will hold those oil companies they consider best-in-class, as they have good corporate governance. ‘Many ethical investors may have been surprised to see their fund holding BP at the time of the Gulf of Mexico oil spill,’ says Patrick Connolly, chartered financial planner at AWD Chase de Vere.

Meanwhile, ethical banks such as Triodos and the Co-operative Bank have sprung up, offering green financial products such as current accounts, savings accounts and mortgages, with the money invested in community and social projects.

Since the first ethical fund was launched in 1984 (from Friends Provident), there has been an explosion of ethical offerings, and investors now have a wide range to choose from. An exhaustive list is available through Eiris, the ethical investment research group. Its consumer site ( details a table of funds available to UK investors, with ticks to denote what the funds can and cannot invest in. Ecclesiastical, First State, Legal & General and F&C all offer decent socially responsible investment (SRI) funds.

‘Through the financial crisis, we’ve seen not only a core constituency of ethical investors, but also a new crop who want to invest with those values,’ says Neville White, senior socially responsible investment analyst at Ecclesiastical. ‘Ethical funds give investors a stronger, more holistic view of companies altogether,’ he adds. That’s because ethical managers will look for better transparency within the company, which leads them to engage more with the business.

And they can outperform their less wholesome counterparts too, as demonstrated by the performance of the Money Observer Sindex, made up of companies that fail to make the ethical grade. The Sindex is compiled of the companies in the FTSE 100 that are not part of the Footsie’s ethical index, FTSE4Good. It features such names as mining giant Anglo American, Investec and Rolls-Royce.

In the latest comparison of saints and sinners, in June 2013, the FTSE4Good constituents had outperformed the Sindex over one, three and five years, although the Sindex retained the lead over 10 years.

What to be aware of

Because of the way ethical funds screen out various companies, some of the big blue chips from the FTSE 100 will typically not be included, so the average fund will generally be biased towards small- and mid-cap companies.

Unfortunately, there is no universal description of what makes up an ethical fund, which can lead to confusion for the investor. Also, keep an eye on fund costs. Often ethical funds can be quite expensive, as the investments can be more complex.

As a starting point for consistent ethical performance, it’s worth taking a look at Money Observer’s Rated Funds list, which includes some ethical funds among the selections.

We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.

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