A lighter shade of green - what does ethical investment entail?

Ethical investment has increased six-fold in the UK over the past decade. But what exactly do these ethics entail? Erik Jaques reports on the varying shades of green on offer

From the Quakers shunning the slave trade and the apartheid-inspired institutional investment embargo against South Africa, to today's climate change investment tacticians, the concept of moving your money around with a conscience is nothing new.

What is different, however, is the credibility of what is variously, interchangeably and often confusingly termed ethical, sustainable or socially responsible investment.

According to independent research organisation Ethical Investment Research Services (EIRIS), £8.9B was invested into around 100 green and ethical retail funds in the UK as of 31 December 2007. This may not appear to be a huge proportion of the commercial market. But it is a gargantuan step forward from a decade ago when the figure stood at just £1.5B and there were only a few dozen funds in existence.

Even in the midst of an ostensibly endless credit crunch, ethical investment is thriving. "It may be cold comfort at the moment, but the credit crisis could be the catalyst for a switch to more sustainable market practices with benefits for both investors and society at large," says Donald MacDonald, chairman of the feted BT pension Scheme and chair of the influential United Nations-backed Principles for Responsible Investment (PRI) voluntary initiative. The PRI recently announced that the number of institutions signing up to the principles has grown by 65% in the past year.

"Just as more people are buying fair-trade and organic products, they are increasingly beginning to make the link between their money and their investments," observes EIRIS spokesperson Mark Robertson.

"This is borne out by the increasing amounts of money being invested ethically but also the new funds that are being launched over the past year really to meet that demand."

The inaugural National Ethical Investment Week (NEIW), held in May, was a prominent showcase for how far ethical investment has come since Friends Provident jumped the chasm and launched the UK's first ethically screened investment fund in 1985.

Speaking at the event's celebratory reception, pensions minister Mike O'Brien announced that it marked "the beginning of a serious national conversation on how investors can use their money to make our society better". He went on to cite research that claimed half of those who will be enrolled in the personal pensions accounts system - due to be implemented in 2012 - would be keen to do so on ethical terms.

"A growing number of investors are taking a close look at sustainability criteria, and many are doing so today for different reasons than the ethical investment community did five to ten years ago," says Alexander Barkawi, managing director of the index business at Sustainable Asset Management (SAM), whose research informs the Dow Jones Sustainability Indexes. "Many now believe that sustainability is in fact a performance indicator and therefore a crucial factor from a purely financial point of view. As a result, you also find an increasing investor base moving into this field, because they believe these issues are essential success drivers for well managed companies."

No longer the preserve of well-intentioned left-leaning altruists, ethical investment is growing teeth and, crucially, is starting to generate healthy returns. A report co-authored by global investment consultancy Mercer and the Asset Management Working Group of the United National Environment Program Finance Initiative (UNEP FI), last year concluded that figuring environmental, social and corporate governance (ESG) factors into investment decisions does not necessarily limit profit potential.

This, it seems, is a widely held belief. A survey by Co-Operative Insurance (CIS) recently found that eight out of ten people believed that ethical funds could perform at least as well as the mainstream market. Another by Norwich Union claims 90% of Britons want to live more ethically and 56% consider unethical living as much of a social taboo as drink driving.

The investors of the future care, too: the study My Generation: Social Spending Power, launched to coincide with NIEW, surveyed teenagers to gauge their attitudes on ethical investment. It found that 54% would spend and invest their money with companies that behave ethically, while 76% said they will make a real impact on social and environmental concerns in the future.

"I don't think anyone is that stupid to say 'it's good, but I'm going to lose money'. I don't know anybody that would invest if that's what they really believed," says William Oulton, head of the FTSE Group Responsible Investment Unit.

"You may as well give money to charity if that's your approach. I think there's a general view from most ethical or value-based investors that those choices they make in the longer term will do as well as or better than the market."

Ryan Smith of AEGON, one of the UK's most respected ethical investment funds, agrees that ethical investors tend to do so with longevity in mind. "One of the things we notice is that, when people invest in our ethical funds, they tend to do it for the long term; whereas, with quite a lot of other funds, you see the so-called hot money jump about. That appears to be less the case with people investing ethically. So the cash comes in and is more likely to stay in the fund, in our experience."

So how do you do it and what do you need to know to make it work for you? "The first question people ask is 'what is ethical?' Within the universe of ethical funds, there are quite a few approaches," says Robertson. It depends on what ethical means to you. People often come to us as an organisation and expect us to provide a prescribed list of investments and we can give them a list of ethical funds. But generally we'd encourage people to do a bit of thinking around the kind of issues that are important to them as investors or within their lives."

Is it wrong to invest in the alcohol industry if you yourself enjoy a pint down the pub and the potential investment option has some progressive policies? Do you regard nuclear power as a problem or a solution? Can you reconcile an ardent environmental stance with a genuine belief that BP is really going 'beyond petroleum'? It can be a
highly subjective practice and one often best pursued with some expert advice.
"Because there is such a range of ethical investment funds, there is a danger that investors can get confused as to what it is they are buying. So we think it is increasingly important that investment houses and socially responsible investors are clear what it is their product seeks to achieve," said George Latham, head of SRI at Henderson Global Investors, one of the gold sponsors of NEIW.

Traditional ethical investment routes may not even be the best option; what of the glut of thematic funds - predominantly climate change-related - that have cropped up in recent years?

"I recommend that anybody who is getting involved with ethical investment should go to a specialist advisor, whether it's a specialist fund manager or a specialist IFA," says John David, investment director of Rathbone Greenbank Investments.

Generally speaking, an ethical investment fund employs negative or positive screening and engagement to identify opportunities that are socially, morally or environmentally responsible - or a combination of these.

Negative screening precludes organisations engaged in unethical practice (usual suspects are arms dealers, pornographers, brazen polluters, etc) from getting a chunk of your hard-earned cash. Also known as dark-green funds, these tend to limit the scope for investment by excluding entire industries.

Positive screening (which is often more commonly described as socially responsible investment or light-green investment) seeks out companies that are actively pursuing or implementing progressive measures or projects. This practice can often lead to including some seemingly incongruous companies under the ethical banner.

A report by independent financial adviser Holden & Partners reveals, for example, that several ethically branded funds hold stocks in oil giants such as Premier Oil, Shell, Neste Oil and BP. Prospective investors concerned that they might inadvertently subvert their own principles should seek advice and scrutinise all the small print they can lay their hands on.

Engagement, meanwhile, sees ethical fund managers, in their capacity as shareholders, sit down with company management and urge them to change their ways in order to attract more investment.

"It's not an either/or between ethical investment and other types of investment," notes Penny Shepherd MBE, chief executive of the UK Social Investment Forum (UKSIF). This is a membership network for sustainable and responsible financial services and the organisers of National Ethical Investment Week. "It's about including ethical investment in the mix of your investments, so you can make your money work for society and the environment."

To play the game successfully, investors need to understand the risks to arrive at a clear, balanced definition of what they want to achieve. You'll also need to be lucky or, ideally, highly choosy about the fund manager to whom you entrust your money.
So is there such a thing as a 100% ethical investment? "You could leave your money under the sofa," suggests Smith. "With our [AEGON's] ethical fund, we just try to be as explicit as we can with the criteria we apply so people can understand the types of companies we invest in. And I think that's the best you can hope for."

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