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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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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. Because they don’t make money. Just looks at the fund managers who invest in Tobacco – some of the most successful in the industry – Train and Barnett to mention just two.

    Look at selected defence stocks – Raytheon for example over the past 5 yrs has done extraordinarily well. Not surprisingly as the world’s largest supplier of guided missiles.

    Not investing in these areas won’t stop them or stop others investing in them, so you may as well joint the party. If you have a conscience make money and give to charity.

  2. The comparison at the top of the article is a false one. The average ethical investment fund holds smaller companies than the average non-ethical portfolio. So its higher returns are not by itself a success but merely the least you would expect. Higher risk should mean higher reward.

    To get an accurate comparison you need to compare ethical funds with small / mid cap indices with a similar risk profile.

    “Given green and ethical funds are generally underweight the likes of oil and gas companies, many of which have seen their share prices tank… the backdrop for the sector has arguably never been better.” Yes, if you are the sort of herd-following sheep who thought that the backdrop for the technology sector had never been better in March 2000. Not if commodity prices recover in the short to medium term and if oil and gas companies are currently undervalued, in which case there could not possibly be a WORSE time to invest in ethical funds.

    This shoddy data and twisting of the facts is the kind of underhand tactic that leads me to instinctively distrust anything with the “ethical” label. It is usually an excuse to sell shoddy products at eye-watering prices, with little evidence that the business does any more good than its “unethical” rivals. Look at the Co-op.

  3. As many investors will know Ethical investments generally have a small and medium sized company bias and therefore tend to be riskier. However with the added risk comes higher rewards so Ethical funds tend to outperform. In the past year it has also been an advantage not to be holding many if any mining and oil stocks which Ethical funds normally avoid.

    While I would hesitate to say that Ethical investment has come of age another feature I am noticing is that Ethical funds by default also tend to avoid those sectors which government are increasingly focusing their attentions on such as Banking, Utilities, Alcohol and Tobacco. This aspect appears to have been driving the performance of Ethical investments over and above the features mentioned above. This may also be more sustainable and the primary reason we are including more ethical investments in our mainstream portfolios.

    If you ask investors if they want to invest Ethically many would normally say yes as they wouldn’t want to invest “unethically” would they? However if you ask them if they just want to maximise potential returns with the commensurate lowest level of risk necessary most say yes to that also. For clients seeking an ethical stance I run “light green” portfolios as there are assets that I would like to invest in such as Gilts that are anything but ethical; albeit Gilts can prove a useful tool in portfolio construction. In addition it is difficult to completely avoid all unethical activity. For example many people would consider M&S to be an ethical company but it does generate some of its profits from the sale of alcohol.

    I once did an MBA thesis in the area of Ethical Investment and one of my conclusions was that as people get wealthier they are more prepared to forego potential returns to invest ethically and it may simply be the case that following the credit crunch and age of austerity, coupled with a low yield environment people are not yet prepared to forego returns or take on perceived additional risk so therefore give ethical funds a wide berth.

  4. Is this simply an advert for ethical funds? I attended a TED conference in Glasgow recently where the head of Aviva Investments complained to the audience that there was a lack of interest from the general public as institutional investors and the public failed to question the group on how ethical there investment strategies are. I think this strange as surely fund managers are expected to make ethical decisions without the need of retrospective questioning from investors.

    I

  5. Because all other funds are not unethical and the self-righteous approach of many in the ‘industry’ is misguided as it aims to sell something which cannot be delivered. It is better to encourage investors to use and spend their money wisely and for their causes (giving tax efficiently too) rather than suggesting that investing in certain shares or not) is doing some ‘good’ when it is invariably doing none at all, simply holding pieces of paper acquired from someone else. It is effectively a deselective investment policy, not a doing good one.

  6. @David Thomas: Your point about M&S raises another reason why ethical investment is bunk – few people agree on what ethical actually means. I fail to see how selling alcohol to grown adults is unethical. True, some of them may use it to ruin their lives if they drink too much of it, but by that yardstick it is unethical to sell cleaning fluid.

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