Why are investors shunning ethical funds?

Investors who have aligned their principles with their portfolio choices over recent years have enjoyed firm gains against more conventional investment vehicles. So why do ethical funds continue to exist on the periphery of the market?

Good Money Week, formerly known as National Ethical Investment Week, ran from 18-24 October and once again put the sector in the spotlight.

Numbers from Moneyfacts and Lipper show over the past three years to 15 October the typical ethical/SRI fund has delivered a total return of 30 per cent versus 24 per cent from the average non-ethical portfolio.

Five-year numbers paint a similar picture, with the two styles giving respective returns of 40 per cent versus 34 per cent. Over the past 10 years, ethical funds fall back but only just, with an overall average of 78 per cent against an 83 per cent mean return from non-ethical vehicles.

But despite the respectable performance, ethical funds are failing to gain any serious traction among UK investors.

The UK’s retail ethical investment industry has been around since 1984 when the Friends Provident Stewardship fund, the UK’s first ethical unit trust, launched.

According to statistics from the Investment Association, in 2014 ethical funds witnessed their highest net retail sales since 2007 at £460m. But the IA’s data also shows that three decades after their inception, funds now total £10bn of assets.

Tilney Bestinvest managing director Jason Hollands points out this represents only 1.2 per cent of total industry assets, a level it has remained stubbornly anchored at for the last decade.

He says: “The lack of cut-through for ethical investment over many years is really quite surprising when you look at other industries, where it is clear sections of the public are willing to adjust their economic activity to reflect their values.

“This is all the more disappointing given the relatively favourable investment climate for many ethical funds in recent years.”

Given green and ethical funds are generally underweight the likes of oil and gas companies, many of which have seen their share prices tank in the face of tumbling commodity prices, the backdrop for the sector has arguably never been better. However, sustainable investment research specialists Eiris believe progress is being made on the back of growing consumer interest in issues such as climate change, poverty and human rights.

The group says there are now almost 100 green and ethical funds available to UK investors – whereas a decade ago there were just a couple of dozen.

It estimates the total money invested in the UK’s green and ethical retail funds, including investment trusts and some pension-related products, is now more than £15bn, up from about £6bn 10 years ago.

Notably, fund analyst groups are allotting more space to the sector. In the summer, FE Analytics rolled out its inaugural recommended ethical funds list, while this month portfolio research site FundCalibre added a dedicated Responsible Investing sector.

Hollands believes the ethical investment industry needs to get to grips with a number of misconceptions to reach its full potential. He says: “There’s a perception that ethical investing is aimed at a narrow section of the public who are ardent in their beliefs; is focused on niche areas, and is lightweight when it comes to delivering returns, none of which is necessarily true.”

A quick look at some of the top holdings of many leading ethical funds shows most invest in well known brands such as Vodafone, Lloyds Bank and Next.

But many advisers and fund selectors are backing ethical and green funds. Both Hollands and FundCalibre managing director Darius McDermott point to Standard Life UK Ethical, which has soared by 76 per cent over the past five years.

McDermott says: “This fund encapsulates the best ideas from the experienced team at Standard Life Investments, which manager Lesley Duncan uses alongside a ‘no compromises’ ethical screening.”

Axa Wealth head of investing Adrian Lowcock tips the Jupiter Ecology fund, which invests in firms offering solutions to environmental problems, including water shortages and pollution.

Managed by Charlie Thomas since 2003, over five years the fund has achieved a total return of 33 per cent. Lowcock says: “Thomas has delivered a very good long-term performance and is highly experienced in the sector.”

For his part Hargreaves Lansdown senior analyst Laith Khalaf backs Kames Ethical Equity, which boasts a five-year total return of 69 per cent. “The fund is managed by Audrey Ryan, who has a very good track record in this field. The outperformance has been boosted by its exposure to small and mid-caps but stock selection within that has also been strong.”

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