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Green Shoots Pruned back

Ethical funds must prove that last year’s performance is sustainable over the long term, says Chris Salih
Ethical funds enjoyed their most successful year in 2007 as a boom in sales showed the sector was starting to go mainstream but the credit crunch has seen performance and sales take a hit.

According to Lipper Feri, ethical funds accounted for 15.2 per cent of net equity sales in the first eight months of 2007, up from 2.6 per cent in the whole of 2006.
Early in 2007, the CIS sustainable leaders fund made a landmark breakthrough by topping the UK all companies sector over one year, the first time this was achieved by an ethical fund.
The latest figures from the Investment Management Association show that ethical funds under management were £5.2bn in the second quarter of 2008, down from £5.7bn in the same period last year. Retail sales slowed to a net inflow of £49.5m compared with £137.7m a year ago.
Can these funds weather the storm and prove their worth in the long run?
Chelsea Financial Services managing director Darius McDermott says: “Ethical funds do well when mid and small caps perform and struggle when large caps like oil are performing. This year has certainly been a bad year for them, as indicated by the drop-off in sales which is naturally linked to performance. As for whether awareness of ethical funds is on the rise, it may be but I have seen no evidence of it.”
The performance of most ethical funds is down over the past year. CIS sustainable leaders is still top quartile in the UK all companies sector, losing 4.88 per cent, but the Sovereign ethical fund is down by 22.29 per cent.
Hargreaves Lansdown head of socially responsible investment Alex Davies says it is unfair to compare the funds as they operate in different fashions.
He says: “Investors tend to pigeonhole all these funds together but each fund’s mandate differs. There are no rules about what ethical funds can hold. Each provider decides its own criteria.
“I think there is an assumption that ethical funds will not hold any mining or oil companies but a lot of providers set criteria which allow them to hold stocks in any sector. It is the activities of the individual businesses that determine whether or not the manager can invest.”
Davies says the one thing they have in common is a bias to mid and small caps which means they can be hit hard when large caps outperform.
He says: “Small caps are down by 24 per cent and mid caps are down by 12 per cent over the last 12 months. Large caps are only down by 4.8 per cent, which is a huge difference. However, during the latest rally in the last month, mid caps have been the top performers, returning 12.4 per cent compared with the FTSE 100 returning 7.35 per cent. Small caps are up by 8.9 per cent.”
Oil and mining companies have been the big successes in the large-cap sector this year but Morley sustainable futures fund manager Mike Appleby says there is no reason why ethical funds cannot compete.
Appleby says: “First, the financial sector has been hit hard, with the MSCI World index off 26 per cent this year. This is an area we have not been involved in. You also have to look at the effects of high oil prices. On the one hand, they are good for oil companies but on the other, they are bad for the likes of airlines which have to buy oil. We would invest in renewables, which may prove more attractive in the longer term.”
Jupiter ecology fund manager Charlie Thomas says: “We continue to see difficult market trends, with financial stocks remaining in a delicate position, uncertainty in earnings’ forecasts from analysts across many sectors and big liquidity issues in the market. Further market volatility appears inevitable.
“Fortunately, despite these issues, the long-term case for green investment continues to strengthen. High fuel prices are motivating political agendas to focus on energy efficiency and renewable energy sources, bolstering our investment thesis. We continue to invest in our six green themes which we believe will benefit from the rising oil price, political regulation and changing corporate and consumer behaviour.”
T Bailey fund manager Jason Britton is not a fan of ethical investment as he says there are more hurdles to be able to compete.
He says: “You can see in the long run that an ethical fund will struggle against an unconstrained fund and managers have to produce the best long-term returns for their clients. You could argue that they are less volatile than traditional offerings and we have used Ted Scott’s F&C Stewardship income fund but competing in the mainstream will be difficult long term.”
Informed Choice director Martin Bamford says the long-term argument for ethical funds remains strong and the short-term effect of the high oil price will not deter him from placing investor money in these funds.
He says: “The long-term story is better than it ever has been. We have more demand for socially responsible funds than ever as the developed and emerging worlds become more ethically aware. We would still usually invest in them through client-driven demand and would have no problems making an ethical fund a core portion of an investor’s portfolio if they were young, as these funds have the ability to compete with mainstream funds over the long term.”

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