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Ethical ethos

The awareness of ethical and/or socially responsible investments among both investors and advisers has been steadily increasing over the past decade.

As professional financial planners, it is important to respect the preferences and beliefs of our clients. For instance, many charitable institutions and/or institutional clients may feel strongly that their investment strategy should have full ethical screening or perhaps specific exclusions (tobacco and armaments are common in this respect).

That said, however, one has to judge such methodologies on their merits as an investment strategy. Clearly, the adviser is duty-bound to comment if an ethical stance is likely to result in inferior returns to the client (or, as has been sugges-ted, greater volatility).

The implications within an investment portfolio must be considered very carefully as part of the overall planning process.

Conceptually, investing in an ethical manner can mean different things to different people. Advancements in this sector have been considerable but there is still an element of caveat emptor in making sure that the investment strategy employed does what it says on the tin.

In 1983, the Ethical Investment Research Service was set up by ethical investment enthusiasts who wanted a common source of research on company activities. The trend of greater social awareness through investing crystallised in 1997 when 17 per cent of shareholders voted in favour of a resolution at Shell’s AGM concerning the company’s social and environmental policy. This created a movement in shareholder activism which even found an advocate in Paul Myners’ review of institutional inv-estment in 2001.

Perhaps from an investor perspective, one of the most welcome advances in the acknowledgement of ethical and socially responsible investment techniques was the launch of the FTSE4Good family of social indices.

This followed an earlier introduction in America of the Dow Jones sustainability indices. This development has brought greater awareness but socially responsible funds represent less than 1 per cent of the total retail market in the UK, albeit represented by almost 500,000 unitholders.

When Friends Provident launched the first UK ethical unit trust in 1984, City analysts predicted that the consumer SRI market in the UK would eventually reach a maximum size of 2m. Statistics (pre-stockmarket slump) show that the total value of consumer SRI funds soared to over 4bn in 2001.

Of course, to those who specialise in the ethical and socially respon-sible sector, one of the most contentious issues is the extent to which ethical screening or socially responsible policies are incorporated within the investment strategy of a particular fund.

The two main approaches used by investors are negative/positive screening and shareholder activism/ engagement. Screening typically refers to the inclusion or exclusion of certain stocks and shares. This is the methodology used by retail funds and charities which have strict criteria.

Shareholder activism can be more difficult to predict and there is no guarantee of a particular outcome (unlike negative and positive screening, where things can be inc-luded/excluded).

I have, however, noticed that more trustees both of charities and private funds are keen to see their fund managers promoting activism not only on ethical grounds but also, for example, executive remuneration.

To some, there is a trade-off bet-ween the delivery of acceptable returns to investors and the extent to which ethical criteria is adhered to.

The screening process is often referred to as shades of green and it is usual to find three shades, with the darker reflecting a more stringent inclusion and exclusion criteria.

Irrespective of which approach is chosen, investors must understand and accept that by pursuing an ethical policy, the tracking error or deviation from mainstream ind-ices (such as the FTSE All-Share) will be greater, taking into account the fact that some large constituents of these indices will be excluded from the permissible inv-estment remit such as the oil sector which represents over 12 per cent and is never the most ethically-friendly area.

Some proponents of ethical investments suggest that companies which pursue an ethical policy are able to deliver greater returns but many cost-based investments specifically offer lower rates of financial return to allow the delivery of a higher “social return”.

Many ethically biased unit trusts performed exceptionally well before the collapse of the stockmarket bubble at the start of the millennium. Their fall from grace was as spectacular as their rise as a result of holding predominantly smaller company shares.

Greater transparency and availability of research enabling fund managers to spread their net broader than merely the small company sector will undoubtedly help deliver more consistent and less volatile investment performance.

Unfortunately, as investment managers push the envelope in terms of what does and does not constitute a socially responsible investment, so one has to investigate very carefully exactly what the investor is buying.

My personal view is that while I am totally in agreement with any form of shareholder activism, it is important that clients understand the exact nature of the investment they are entering into and what that investment entails.

In a world which has witnessed terrorism, war and tragic natural disasters in recent times, the principle of ethical investment has many a sympathetic ear although, unless well advised and carefully thought through, investors may end up with more (or less) than they bargained for.



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