Ethical investments can be costly and complicated
As investment in socially conscious funds accelerates, Harry Brennan finds those who jump on board risk being left behind
Ethical investing is becoming an increasingly popular option for savers who want their money to be put towards environmentally and socially conscious companies that can provide decent returns at the same time. However, over the past decade, the performance of ethical funds has been woeful, falling well short of conventional equivalents, meaning anyone with cash invested could have missed out on hundreds of thousands of pounds in potential gains.
Investors have piled around £11.7bn into the 450 ethical funds available to buy in Britain this year, according to Morningstar, the investment research group. But, at least on the basis of past performance, the investment case is as yet unproven.
If you had invested £100,000 in the past decade’s top-performing ethical fund 10 years ago, rather than the top-performing conventional fund, you would be £302,650 worse off, according to research from Fund Expert, the investment analysis tool. Furthermore, if you look at a specific area such as the UK All Companies Sector, the top “green” fund, Standard Life Investments UK Ethical, grew by 162pc over the 10-year period, dwarfed by the performance of the strongest conventional fund, Slater Growth, which grew by 392pc, a difference of £230,040.
The Standard Life fund was the only ethical fund to make it into the top 20pc of the best-performing funds in its sector.
Fund Expert said: “Ticking an ethical box comes at considerable cost” and anyone pursuing a “green” investment strategy runs the risk of excluding a large number of vastly more profitable investment opportunities.
Experts have said that ethical funds have underperformed in the past because they have excluded companies that do not fit with the funds’ criteria, limiting the investments available.
Hortense Bioy of Morningstar said: “Strict exclusionary screens can prevent managers from investing in reliable, high-quality stocks, and this can affect performance.” For example, she said, a number of ethical funds exclude tobacco companies, but stocks like British American Tobacco have performed exceptionally well over the long term.
She added that while past performance on the whole has been poor when compared with other funds available, contemporary ethical funds now perform on a par with conventional peers. She said the industry had moved on from “pure exclusions to a more integrated approach that looks to reduce risk and enhance returns” by engaging with firms and making a positive impact from within.
For example, an ethical asset manager with a stake in a copper mine that emits a lot of sulphur dioxide may seek to work with the company to reduce those emissions.
However, some say this has blurred the line between ethical and other funds.
Dan Farrow of SNB Wealth Management, a financial adviser, said all fund managers had a mandate to hold the companies they are invested in to account.
He also said the “engagement approach” meant funds could invest in virtually any company they wanted, no matter how unethical, on the grounds they were steering the business in a new direction. “Sustainability is the corporate buzzword at the moment, so finding a company that waxes lyrical as to how sustainable the business operations are is not hard,” he said.
He added that ethically minded investors often failed to distinguish between funds that market themselves as “sustainable” and those that claimed to be “ethical”. He said “sustainable” simply referred to a good business that could weather future storms, whereas “ethical” was something entirely different.
“If we had clients who were adamant that they wanted to invest ethically, it would put us in a difficult position. It would mean we would have to offer them overpriced, underperforming strategies,” he said.
Some 49pc of savers believed social values were as important as returns when it came to investing, according
to savings and investment provider Foresters Friendly Society, and 27pc would accept lower returns as long as their investments were ethical.
This is just as well, according to Mr Farrow, who said ethical investing was akin to a client not wanting to maximise their returns. “If we didn’t try to make more money, then we would not be doing our job,” he said. “Even the Church of England shuns ‘ethical’ investing. Why? Because its investment managers have been given a mandate to make as much money as they can, and they won’t be able to do this by taking the ethical route.”
The Church of England is committed to “responsible investing” and refuses to invest directly in categories such as tobacco. However, it recently faced claims of hypocrisy as it continued to invest substantially in Amazon, despite the Archbishop of Canterbury accusing the firm of having “leeched off the taxpayer”. At the end of 2017, the Church’s national investing bodies agreed to an engagement strategy with fossil fuel firms, with disinvestment as “a last resort”.
Rob Morgan of Charles Stanley Direct, an investment firm, said it was unfair to judge ethical investing as a whole, based on its historic performance.
“Even five years ago, your choice was much more limited but the fund providers are responding to demand. We are now starting to see new and interesting choices on the market. We should start to see better performance as competition hots up.” However, Mr Morgan conceded that there was still a danger that savers could be duped by some fund groups claiming to be ethical without making special efforts.
“It is certainly a danger. Any fund manager can point to a company that it has ‘engaged’ with,” he said. “Investors need to look very closely at what they are buying, and examine what the fund’s underlying holdings are.”
He added that investors should look for a fund manager they could see had ethical considerations at the heart of its work, rather than simply as a lazy afterthought that attempted to tap into the increasing demand for greener investment choices.
The Church Commissioners invest in Amazon, despite Justin Welby’s critique