Ethical investment: despite a sweet spot for performance, funds still widely ignored

This week sees the ethical investment industry’s annual effort to raise its profile with its Good Money Week campaign. Previously labelled National Ethical Investment Week, the campaign is now into its ninth year. Yet despite its best efforts to raise the awareness, industry data suggests that ‘ethical’ or ‘responsible’ investment has yet to make a convincing breakthrough in achieving greater popularity with the public.

Jason Hollands, Managing Director at Tilney Bestinvest, comments: “Although the UK’s retail ethical investment funds industry has been around since 1984 when Friends Provident launched the ‘Stewardship Growth’ fund, its share of overall fund assets has flat lined for years. According to statistics from the Investment Association, funds with ‘ethical’ mandates total just £11.89 billion of assets more than 30-years on*. This represents only 1.1% of total industry fund assets, a level which it has remained at for the past decade. Tellingly this is only 25% higher than the £9.5 billion invested by retail investors in the Woodford Equity Income fund in the two years since launch, a fund which currently has 14.6% invested in tobacco companies.

“On first impressions it may seem surprising that over the past decade the amount of money invested in ethical funds remains so modest. After all, over this period there has been growing interest in areas such as ethical consumerism and sustainable tourism and there has also been renewed focus on improving standards of corporate governance in the wake of the credit crisis.

“In part this might be down to a lack of understanding about this aspect of the industry, which at times seems to struggle to define itself and project a clear image. Indeed since its inception in the mid-80s it has periodically rebadged itself as ‘ethical’, ‘socially responsible’, ‘social, environmental and ethical’, ‘responsible’ and ‘sustainable’ investment. And within the broad universe of such funds can be found many different approaches from traditional ethical funds that strictly screen out ‘sin’ stocks in areas such as tobacco, gaming and weapons manufacturing; those which focus on companies that adopt ‘best in breed’ practices on governance and transparency as well as funds narrowly focused on investors concerned about the environment.

“Policies are always specific to the fund in question as are the mechanisms for developing and adapting stances on issues which range from independent panels of experts, periodic surveys to gain investor opinions or adopting third-party research. This means investors need to really understand the detail of the criteria on a fund and how this might change over time to make sure the approach taken will be one consistent with the issues and stances that most matter to them. One such example is in the area of animal testing where sincerely held views can differ radically around the appropriateness of holding healthcare companies in such funds. That makes the process of comparing 'ethical' funds inherently a lot more complex than simply measuring past performance, volatility or costs and it may explain why some advisers are reticent to raise ethical investing as an option other than at the request of the client.

“Another factor that may deter potential investors is that t00 often the subject of ethical investment is debated primarily through the prism of ‘will it result in lower returns?’ In my view this fails to recognise that investors who care passionately about a particular issue, whose positions may be underpinned by their faith, are unlikely to be swayed to invest in areas that they may morally object to on the basis of potentially enhanced returns.

“The reality is that ethical funds, particularly those with strict criteria, are likely to experience periods when returns may diverge significantly from broader market indices that they simply cannot replicate. That can mean periods of potentially worse returns and much better returns.

“In particular, most ethical funds are likely to be underweight areas likely commodities where the environmental impacts are high or because extractive companies often operate in developing countries with poor governance and human rights records. But it is also the case that such funds often have greater exposure to medium sized and smaller companies, because some large multi-nationals with diverse operations inevitably get screened out on the basis that they might have some modest exposure to an activity that will fall foul of the criteria.

“Of course in recent years a combination of weakness in commodity prices and strong returns from mid-cap shares versus larger ones have played out very well for UK ethical funds in particular, most of which have strongly outperformed over the last five years. This has been a great period for ethical investors who have been able to profit and stand by their principles but I would still caution those who are actually ambivalent about taking an ethical approach from investing in funds with a highly constrained investment universe.

“But to end on a positive note, there is no doubt that overall corporate governance standards have improved and increasingly pension schemes, life funds and asset managers are doing a better job at the engaging with investee companies on matters of governance and transparency as they realise that companies that don't adequately manage their reputations or environmental impacts are simply risky businesses. So perhaps the real triumph of 'responsible investment' could be that it just becomes increasingly integrated into mainstream investing - though there will always be a niche market for those who don't simply want their wealth invested in companies engaged in certain types of activity whether that be producing fags, booze or building tanks.”

-ENDS-

*http://www.theinvestmentassociation.org/assets/files/press/2016/stats/stats0816-12.pdf

Important information

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. Past performance should not be considered a reliable indicator of future performance. This press release is not advice to invest or to use our services.

Funds may carry different levels of risk depending on the industry sector(s) in which they invest. Due to their nature, specialist funds can be subject to specific sector risks. Investors should ensure they read all relevant information in order to understand the nature of such investments and the specific risks involved. Please note that ethical funds may, by definition, have a limited investment universe; this may affect performance.