The basics of ethical investing are quite straightforward. After all we don’t find it complicated to purchase items that have not been tested on animals. We soon stopped purchasing so many diesel cars once the facts were out. We would purchase many more electric cars if they weren’t quite so expensive. We are fastidious at sorting our rubbish into recyclable or not.
Shareholders sometimes group together to campaign against certain issues, such as excessive director remuneration. This could be considered as the engagement approach to ethical investment issues. When you invest in ethical funds you are, in effect, also voicing your concerns by using your money to influence the behaviour of companies.
Oath for any enterprise
‘I will manage my enterprise with loyalty and care, and I will not advance my personal interests at the expense of my enterprise or society … I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation … I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.’
Oath devised by MBA students at Harvard University
The background to ethical investing
‘The modern roots of socially responsible investment can be traced back to the 1920s when the Methodist Church wished to start investing in the stockmarket while avoiding companies involved in alcohol and gambling. The Quakers soon followed, avoiding weapons manufacture.’ (Penny Shepherd – Executive Director, UK Social Investment Forum).
2008 saw the first National Ethical Investment Week (NEIW) which brought together advisers, charities and Churches, financial organisations, faith groups, NGOS and community groups to spread the word about green and ethical investing. This was later renamed Good Money Week and will be held on 11 – 17 October 2020.
The concept of an ethical fund open to investment from the public dates back to the early 1970s and so is possibly a new concept or not a new concept depending on your age! As with many advances in the investment world, the first American ethically screened mutual fund predated the launch of ethical unit trusts in the UK by more than a decade.
In 1971, the Pax World Fund was set up in response to the demand for investment in companies which did not benefit from the Vietnam War. In the 1980s, it was then opposition to South African apartheid which fuelled the ethical investment movement both here and in the US.
Friends Provident was the first investment group in the UK to launch an ethical fund – the Stewardship Fund – in 1984. Friends Provident was founded in 1832 as a mutual Friendly Society for Quakers (ie the Religious Society of Friends) but in 2001 it demutualised becoming a publicly listed company no longer linked to the Quakers, and now trades as Friends Life.
In 2006 the Stewardship Fund became the first ethical fund to reach the £1 billion mark. A growing number of other investment groups are making a serious contribution to the range of choice for investors.
Ethical investment received a boost in 1998, when Pensions Minister John Denham announced that he was ‘minded to require trustees to disclose to what extent, if any, they have taken account of social responsibility considerations in their investment strategy‘. His proposals become law in 2000 and now all occupational pension funds have to consider formally whether or not to develop policies on social, ethical and environmental issues.
You can now have the option of an ethical fund when considering a wide range of investment decisions.
‘Ethical’, ‘green’, ‘environmental’ and ‘socially responsible’ funds tend to be referred to under the generic name of ethical funds. There are, however, differences which can be very important for particular investors and we will begin by outlining those differences. Having done this, we will, in the rest of these notes simply refer to ethical funds and mean that to include all of the types of funds.
Ethical and socially responsible funds
Funds that call themselves ‘ethical’ or ‘socially responsible’ tend to apply negative criteria when deciding which stocks and shares to invest in. This could be considered as the avoidance (ie negative screening) approach. They may, for example, avoid investment in companies which are involved in the production of alcohol, tobacco, pornography, or in the supply of armaments, or operate in countries with oppressive regimes. They may also avoid companies which exploit animals or are involved in nuclear power.
The degree to which the criteria are enforced varies considerably from fund to fund. For example, some funds will buy shares in companies which sell alcohol but do not produce it.
Funds that call themselves ‘green’, as their name suggests, concentrate largely on what has become known as ‘green consumerism’. For example, in many green funds you will find stocks such as Marks & Spencer and Tesco because they sell ‘friendly’ detergent and organically grown vegetables.
In the main, the green funds are passive, investing in companies which they believe are not damaging the environment ‘too much’. This could be considered as the support (ie positive screening) approach.
Funds that call themselves ‘environmental’ do not apply ethical criteria as such – although they would not usually invest in major polluters, for example.
The relative performance of ethical funds
I believe it is important for investors in ethical funds to realise that nearly all such funds are heavily invested into smaller companies. This is because the screening process has tended to drive ethical funds away from many large capitalisation stocks. Please note, however, that when we speak of ‘smaller companies’ these are usually defined as those with a capitalisation of less than £50 million!
As a consequence some green funds are now adopting a neutral approach, that is, they are allowing investment in companies that are neither positively harmful, nor positively beneficial. What has been referred to as a ‘light green’ approach.
If you are thinking of making an investment into one or more ethical funds it is important that you appreciate the impact that investing predominantly in smaller companies could have on the short term performance of your investment.
It is also the case that because of this emphasis on smaller companies the funds are predominantly suitable for growth investments rather than producing income.
Smaller companies have tended to underperform the market during times of recession. During falling (bear) markets investors naturally tend towards investing in larger household name companies for security. In such times, you may pay a heavy price, in terms of lower returns, for your socially responsible stance. On the other hand smaller companies have tended to do better coming out of a recession than larger companies.
During rising (bull) markets investors tend to let their natural conservatism slip away from them and invest in smaller companies which seem to be growing faster than their larger counterparts.
There is increasing evidence that over the longer term of ten years or more smaller companies as a group tend to perform as well as, if not better than, larger companies.
The general view, therefore, is that investing in ethical funds over the long term should present no noticeable cost to you. In the short to medium term, that is less than ten years, however, you should be prepared to pay a price in terms of lower overall growth in your investment, even if, in the event, that lower growth does not in reality materialise.
When choosing an ethical fund is important to be aware of the subjectivity which investors bring to any particular fund. The investment managers may interpret the basic criteria of the fund in a different way to that of you, the investor.
Take, for example, a supermarket chain that is being considered for inclusion in a share portfolio. The group offers ozone friendly deodorant sprays, recycled toilet paper, washing powder in bags, organic vegetables and charges for every carrier bag unless customers bring their own. It sells cigarettes, however, and apples from an African country with a known oppressive regime, plus a range of wines and alcoholic beverages. Can this stock be included in an ethical fund? Some funds will certainly consider investing in such a stock and some will not.
From your point of view it will depend on whether you are inclined towards environmental issues and enjoy the occasional glass of wine, or whether tobacco is anathema to you.
Can an ordinary investor make a difference?
People are gradually becoming aware that even a small change of lifestyle can, over the years, have a dramatic effect upon the world in which we live.
Once people are made aware of the fact that they can make an ethical, green or environmentally friendly choice when purchasing their pension or savings plan then there is no doubt that many more investors will wish to do so.
As a first step when taking out a new investment product you may wish to designate that a percentage of your investment be allocated to an ethical fund.
Whilst you may feel that this will restrict you as to the choice of life or pension office to be used, there is a growing number of household name product providers offering an ethical fund choice. The really big improvement for ethical investors, however, is the availability of fund platforms.
Ethical savings and investment are not just limited to those with a lump sum to invest. A number of product providers now offer regular savings plans and investments with an ethical fund option.
- An investment into an ethical fund such as a unit trust, OEIC, ISA, or other collective investment scheme, is intended as a long-term investment.
- Past performance is no guarantee of future returns.
- The capital is NOT GUARANTEED and your capital will reduce in value if you take income payments which exceed the growth or if there is negative growth.
- The value of the ethical investment is determined by the value of the units, the price of which can fall as well as rise. The overall value of the investment is therefore not guaranteed and you might get back less than you originally invested, especially in the early years.
- Some ethical funds include overseas investments which value may be affected by currency fluctuations.
- These notes do not replace the full product specification that accompanies each investment recommendation. Each ethical fund has its own objectives and risk factors. These are detailed in the Key Features document. Before you decide to invest in any ethical fund you must read this document.
Links to more information
- Ethical investing
- Ethical Research Organisations etc
- Money Advice Service notes on Ethical Savings and Investing
- If you need personal financial advice on Ethical Investing then I am happy to introduce you to Flying Colours Life who have access to independent financial advisers throughout the UK
This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.
Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.
If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.