Want to know if a fund is ethical? Start off by ignoring its name

Behind the virtuous labels there’s a Wild West world – and some invest in drink and gambling firms

IF YOU’RE a fund management business looking to attract new investors, there’s one guaranteed route to success. Put any of the words responsible, sustainable, ethical, green or positive into the name of an investment fund and then sit back as investors buy into it.

Sustainable, ethical or ESG investing is currently one of the hottest themes in town as investors – especially the young and women – look to make money with a conscience, with an eye very much on preservation of the environment (E), society (S) and good corporate governance (G).

According to wealth manager Interactive Investor, some two per cent of investments owned by investors on its platform now fall under the socially responsible umbrella. Although a tiny percentage, it is more than double what it was three years ago.

Among wealth platforms, Interactive has led the way on sustainable investing, launching in late 2019 the first best buy list of ethical funds. Over the last year, sustainable fund Baillie Gifford Positive Change has been the third most bought fund by its investors, only out-bought by Fundsmith Equity and Baillie Gifford American.

Rival AJ Bell also reports growing demand, especially among the young who it says are ‘more attuned’ to responsible investing. Its latest research indicates that more than half of its self-invested personal pension investors plan this year to invest more of their funds in companies that have a positive impact on the environment.

Yet research by wealth manager SCM Direct, conducted exclusively for The Mail on Sunday, suggests that some investors are not necessarily ending up with a fund that is as sustainable or responsible as its label suggests.

Many of these funds, SCM Direct says, are no more socially responsible in the companies they invest in than mainstream investment funds.

In other words, socially responsible investors would be just as well served by investing in many funds that do not have a sustainable label.

Furthermore, SCM Direct questions the reliability of some of the favourable sustainability ratings given to individual listed companies that are operating in industries normally off limits for ethical investors – for example, gambling and the manufacture of alcohol.

This can result in companies ending up in ethical fund portfolios that investors would be very uncomfortable with.

ALAN Miller, author of the research, says: ‘SCM Direct is a strong believer in the reallocation of investors’ money towards sustainable investments and companies that can contribute to a better future. But at the moment, it’s an investment area that resembles the Wild West in terms of lack of transparency, inconsistencies and ineffective rules.’

He adds: ‘As a result, it makes it impossible for ethical investors to know with certainty that their money is being invested in a socially responsible way.’ SCM Direct’s research is based on analysis of the current ‘sustainability’ scores of 194 investment funds from the Investment Association’s ‘UK all companies’ sector.

Between them, these funds manage assets of £99billion and invest primarily in UK companies – many of them FTSE 100 listed.

The scores, compiled by ESG data scrutineer Sustainalytics, are built around how ESG-friendly individual funds are. ESG stands for environmental, social and corporate governance and is the bedrock around which socially responsible or ethical investing is built.

Sustainalytics rates companies held by the funds on each of these three criteria and then comes up with an overall sustainability score for the fund. None of this information is available on individual fund provider websites. But it can be found on the website of fund scrutineer Morningstar if investors know where to look before making a decision to buy an individual fund. The lower the score (out of 100) the more appropriate the fund is for an investor seeking to invest responsibly.

Of the 194 funds analysed, 16 are labelled as ethical, responsible or sustainable. In theory, they should come up with the best sustainability scores. But they don’t.

As the table above shows, only two of the 16 – Aegon Ethical Equity and the popular Royal London Sustainable Leaders – appear in the top ten sustainability scores within the 194 funds analysed, based on Sustainalytics’ data. But even these two are beaten by mainstream funds such as Lindsell Train UK Equity and Franklin UK Mid Cap, in terms of sustainability.

Some of the 16 score poorly, most notably Liontrust Sustainable Future UK Growth, Jupiter Responsible, Castlefield Best Sustainable UK Opportunities and Premier Miton Ethical. Out of the 194 funds analysed, they were ranked 83rd, 88th, 110th and 128th.

Miller says one of the problems is that ESG covers a broad range of issues – from the impact of a company’s business on the environment, how an employer treats employees, supplier ethics, through to the diversity of its boardroom.

This can result in companies getting favourable ESG ratings even though many ethical investors would baulk at holding them in their portfolios. For example, drinks companies Diageo and Heineken are respectively judged low risk and medium risk by Sustainalytics.

This explains why Lindsell Train UK Equity’s 15 per cent exposure to these two companies does not damage the funds’ overall sustainability score. ‘Baffling,’ says Miller. The wealth manager believes the way forward is for sustainable funds to disclose all their holdings to investors, in an accessible and up-to-date format. This, says Miller, would then allow a potential investor to make an informed decision on whether to buy a fund or not. ‘Investors need to be protected,’ he says.

This is not the first time Miller has raised concerns about socially responsible investments. Eighteen months ago, he produced a report on the ‘Misclassification and Misselling of Ethical Funds’, stating there was evidence of a ‘greenwashing epidemic’ – funds dressed up to be more ethical than they really are. Then, in August last year, he told Wealth that companies were ‘jumping on the ethical bandwagon offering portfolio services and funds that do not fit the bill’.