Put your money where your mouth is

Money is the root of all evil, it's said. Ethical investment promises to prove otherwise. Dan Welch examines which retail fund (unit trust) providers are stepping up to the challenge, and explores some alternatives.

What's in this report

This report looks at ethical and green retail funds. That is, funds that are invested in a range of company shares (equity), bonds and sometimes other assets, on the behalf of individual investors. There are over 90 green and ethical funds in the UK, with a record number launched in the last couple of years — and dozens of providers. In addition, we look at some alternative forms of ethical investment. Investors are strongly advised to consult an ethical independent financial advisor (IFA) before making financial decisions (see LINKS).

Ethical Retail Funds

"When it comes to choosing where to save, most ethical consumers don't live up to their principles," according to Professor Alex Gardner. Gardner's report, 'How Green is Your Money?' published last year, suggested that despite rocketing awareness of ethical and green issues amongst consumers, most ethical consumers ignored their values when it came to banking and investment choices.(1)

That said, it is estimated that £7.2bn was invested in UK ethical retail funds in 2006.(2) Few individuals are wealthy enough for it to be financially worthwhile to trade directly in publicly quoted shares. Therefore, most individual investors who are prepared to take the risk of exposure to the stock market will be involved in retail funds, commonly known as 'unit trusts' in the UK. Retail funds are the commonest form, both of ethical and mainstream investments, for small investors. Individuals buy a stake in a fund, which pools investors' resources into a portfolio comprised usually of shares in a large range of companies (equity funds), or in corporate bonds (fixed term investments). Some funds involve other 'asset classes'. CF 7IM Ethical, for example, invests in shares, bonds, property and money markets. Investing in retail funds enables individuals to benefit from the money management of financial professionals, who 'spread the risk' across a wide range of industry sectors, as well as reducing the transaction costs of share dealing.

There are three main strategies of ethical, 'responsible' or 'socially responsible' investing (SRI):
Screened portfolio investment
Positive screening means investing in companies because the fund supports their sector (such as renewable energy), policies (such as fair trade) or products or services (such as social housing).

Negative screening means avoiding investing in companies because of their sector (such as the arms trade), policies (such as animal testing) or products and services (such as pornography).

Shareholder activism or 'engagement'
Engagement means using the funds' influence over companies to adopt higher standards of corporate responsibility (such as improving conditions in the supply chain) or change their behaviour (such as divesting from oppressive regimes). Many think that this approach, based on the fact that shareholders are owners of the company, is more effective to influence companies than simple screening processes. It may pose the dilemma, however, of investing in companies the policies of which one is opposed to. Ethical Consumer's report on Insurance looked in depth at engagement and the policies of some of the companies reviewed here.

Direct 'social economy' or environmental investments
Direct investments offer the most effective way for individuals to affect change, though they sometimes come with either low returns or high risk. We look at this area in 'Alternative Investments'.

Retail funds may employ one or all of the strategies of portfolio screening and engagement, although only 18% of funds practice screening alone.(3) Investors select funds that best balance their ethical interests with their financial needs (funds may be focused on long term capital accumulation, on providing income, or both, and are often pitched at different levels of risk). This report does not provide information on these issues, investors should consult an independent financial advisor (see LINKS).

How ethical are ethical investments?

The mainstreaming of ethical investment is perhaps best demonstrated by the launch last year of an ethical fund by Marks & Spencer Money, managed jointly by HSBC and Jupiter, with a 50/50 profit split between HSBC and M&S (ethiscore from March 2007 = 1.5). The new M&S Money Ethical fund seeks to invest in UK companies that make a "positive contribution to the community or environment", and to avoid investing in companies that have a "poor environmental record".(7)

According to the New Economics Foundation, with many more people interested in ethical investment, there is an increasing shift away from 'dark green' environmental concerns, to more 'light green' and social objectives.(8) Positive investment appeals to the 'light green' investor and weaker negative criteria allow for more diversified, and thus less risky portfolios. But is 'light green' ethics-lite?

A majority of 'ethical' funds still concentrate their investments in the top 350 FTSE companies. As such, they are arguably limited in their direct social and environmental impact. The new M&S Ethical fund immediately courted controversy when the press picked up on the fact that one of its biggest holdings was BP.

According to Brigid Benson from ethical independent financial advisers The Gaeia Partnership: "Including companies such as BP and Shell is a pragmatic compromise, as they are best in sector compared to other major oil companies such as Exxon and Total". (7)

But for many it will stretch the imagination to say BP is making a "positive contribution to the environment" as M&S Money claims. Greenpeace has called BP's recent decision to invest in 'unconventional' oil production in the Alberta tar sands as participating in "the greatest climate crime" in history. (11)

But Benson is right, investments by 'ethical' funds in oil companies are not unusual. AEGON Ethical Equity, to take just one example, has holdings in Tullow Oil. Tullow is an oil exploration company which had operations in Equatorial Guinea, a rampantly corrupt oppressive regime.(9) Similarly, Skandia's Ethical Fund had the Norwegian oil giant Statoil in its 2007 top ten holdings, as well as ethical consumer b�te noire Tesco.(10)

To the uninitiated the holdings of many ethical funds look little different to conventional investment portfolios. But this is not without reason. As Brigid Benson notes, "an ethical fund which avoided oil, banks and pharmaceutical companies would be very volatile and could under-perform the market."(7)

Investing in the banking sector is a further complication. Whatever screen funds may apply to their own direct investments they are unable to determine the lending policy of the banks in which they invest.

Jupiter's 'dark green' Ecology Fund, the first positively screened environmental fund in the UK, has been followed more recently by their 'light green' Environmental Income Fund. This seeks to invest in companies that are "responding positively to and profiting from the challenges of environmental sustainability or are making a positive commitment to social well being".(12) Nevertheless, one of the fund's top five investments in the period was Royal Bank of Scotland (RBS). In a damning report last year the NGO PLATFORM argued that RBS's "core business is causing enormous harm to the environment and society" through financing climate change (see Ethical Consumer, issue 107).(13)

Funds regularly publish their top holdings over a given period, so concerned investors can find out relatively easily what a fund invests in (see LINKS). And some offer detailed reporting. Henderson, for example, publishes 'carbon audits' of its funds.

Retail funds - good for your pocket?

There is a growing body of evidence that there is a correlation between businesses' performance in terms of social and environmental responsibility and financial performance.(21) It might follow then that funds that favour companies that perform well in social and environmental responsibility will perform better than average financially. And indeed in 2006 the average UK equity ethical fund gained 16.8%, compared to 10.7% for mainstream funds � equivalent to an extra �305 on a �5,000 investment.22 Our regular Moneyfacts table shows fund performance over time.

Last year Co-operative Investment's 'Sustainable Leaders Trust' was the first ethical investment fund to top the UK All Companies sector, beating 320 mainly mainstream equity funds. That was achieved whilst excluding the oil and gas sector, a strong performer over the period in question.

With the credit crunch, stock market turmoil and some of the UK's biggest property funds shutting the door on withdrawals, this may seem a strange time to consider investments. But there can be no better example than the credit crunch of the need for the level of transparency demanded by ethical investment funds. And there is evidence from the US that some ethical funds were insulated from the crisis because of their responsible shareholding policies. While most mainstream rating agencies ignored the coming storm, ethical investment research firm Innovest forecast the meltdown in the capital markets.(23)

Investing for change

According to the European Social Investment Forum, 87% of assets under management in the UK are subject to an engagement policy of some kind, representing investments worth over �480 billion. And yet institutional investors are overwhelmingly failing to back shareholder resolutions on social and environmental issues, according to a 2006 study by the Dutch Association of Investors for Sustainable Development (VDBO).

According to Piet Sprengers, former MD of VBDO: "When it concerns the direction of the management of a company or the rewarding of the management, these institutions are prepared to meet them head on. When it comes to sustainability, the institutions suddenly become a lot more charitable and are unwilling to offend the management."(18)

When share price is doing well, there may be little incentive for fund managers to rock the boat. As the recent FairPensions report points out; social, ethical and environmental issues tend to play out over the long term, even if their detrimental effect to companies, such as damage to reputation or accidents, can be sudden. Most fund managers, however, are incentivised on a very short-term basis. The first report on the implementation of the UN Principles for Responsible Investment (UN PRI) showed, perhaps unsurprisingly, that eighteen months on there had been very little progress towards integrating the principles of ethical investing into incentive structures.(19) Fund managers are unlikely to give priority to these issues unless they are deeply integrated into the company's investment analysis and decision making � rather than just espoused in corporate social responsibility PR.

"Unless fund managers measure and report on the results of their engagement activities," according to FairPensions, "it will be difficult to shake off the common suspicion that [responsible investing] policies are merely PR exercises � the fund management industry's equivalent of 'greenwash'."(20)

Engagement approaches vary hugely across different funds, and with the notable exceptions of Co-operative Investments and Insight Investment, there is often limited transparency. Practice does not necessarily follow policy. The UN PRI survey found that actual performance of engagement activities varied enormously. Whilst the median number of letters investment managers had written to companies on environmental and social issues between February and May 2007 was 24.5, the most active had sent nearly 4000.

Engagement in practice

Co-operative Investments (CIS) is recognised as demonstrating best practice in terms of 'engagement'. As auditors KMPG note, few institutional investors are prepared to vote against the receipt of a company's annual report and accounts on grounds of poor disclosure on social and environmental issues. CIS are "the notable exception to this rule".(24)

In the period covered by its most recent Sustainability Report (2005-2006), investment in five companies was withdrawn due their failure to respond to engagement. In the case of the French Connection Group, divestment followed the company's refusal to implement a policy addressing the use of fur.

Controversially, CIS continues to engage with BAE. As Ian Jones, Head of Responsible Investing put it: "If we sell out in BAE there is nobody in BAE's orbit who is pricking its conscience on oppressive regimes".(25)

CIS also has a track record of campaigning for structural changes such as the helping to establish the Roundtable on Sustainable Palm Oil, which it encouraged 56 investee companies to join, and a forum bringing together major UK companies to develop and lobby for renewable energy.

Focus on climate change

The Institutional Investors Group on Climate Change is a forum for collaboration between institutional investors. It includes: CIS, F&C, Henderson, Insight Investments and Morley (managers of Norwich Union Sustainable Futures)

In September 2007, another initiative, ClimateWise was launched by the insurance industry. The ClimateWise principles commit companies to incorporate climate risk into their business strategy. Signatories will report each year on what actions they've taken to implement them. Reports will be independently audited. Signatories in this report: Aviva Plc & AXA (owners of Norwich Union), CIS, F&C/Friends Provident, HBOS (owners of Insight investments), Lloyds TSB.

FairPensions' recent survey of the largest 20 fund providers found few fund managers with specific policies around climate change, and noted that if such a high-profile issue was not integrated into investment strategy, it was likely that other ethical and environmental issues were also being ignored.

The 10% rule

Funds will often have a threshold or turnover limit on their negatively screened categories, commonly 10%. This will allow the fund to invest in a company that earns 10% or less of its revenue from, say, alcohol or tobacco, whilst barring investments in tobacco or alcohol producers. This hugely expands the fund's range of potential investments, for instance allowing investment in retailers that stock drink and cigarettes without this being their core business. However, it is not uncommon for the rule to apply to more controversial activities. Aberdeen's negatively screened funds, for example, have 'military' and 'weapons' as two of their screens. But companies earning less than 10% of their revenue from these activities would be admissible. (14)

Alternative Investments

Funds are by no means the only form of ethical investment. Alternative share offerings, community bonds or investment in co-operatives allow investors to directly fund environmental and social projects without many of the ethical dilemmas of retail funds.

Alternative investments offer the potential for individual investors to have a clear impact on social and environmental change. These types of investments are therefore usually excluded from fund portfolios and are not open to institutional investors � therefore they are reliant on individual investors.

Investing in companies

IFAs strongly advise against direct share ownership to all except wealthy individuals. However according to Penny Shepherd, Chief Executive of UKSIF, direct ethical investing doesn't have to mean neglible returns or high risk.

Recent 'unlisted' share offerings include the Ethical Property Company and Caf�direct. A feature of these shares or bonds is that they lack liquidity � that is they are not as easy to sell as normal stock market shares. They are traded infrequently through matching sellers to buyers through brokers such as Brewin Dolphin Securities (0161 214 5542). Renewable energy supplier Good Energy's recent share offering is listed on PLUS Markets (tel. 020 7553 2000).

Ethical bank Triodos is currently sponsoring venture capital investment in the Real Food Pub Company - raising funds to develop food-orientated pubs focused on locally produced, organic and seasonal produce. Minimum investment is �5000.

Screened direct investments

Bespoke ethical portfolios, for clients with sufficient funds, are available from the following UKSIF members:
Cazenove 020 7155 5600
Schroders 020 7658 4645
Rathbone Greenbank Investments 0117 930 3000

Co-operatives, IPS and CDFIs

The UK doesn't have a legal definition of co-ops, so they come in a variety of forms, most commonly as Industrial and Provident Societies (IPS) or as companies, either not-for profit (limited by guarantee) or with shares.

Co-operatives sometimes offer reasonable rates of return on investments. The Phone Co-op, for example, currently offers members 5.5% gross annual interest.

Since the late 1990s, community development finance institutions (CDFIs), commonly structured as IPSs, have been developed to channel loans to small businesses and social enterprises in deprived areas. Shared Interest, established in 1990, is an IPS which allows investors to contribute to the development of fair trade and 'just finance initiatives'. While these commonly offer investors returns below the market rate they are an important alternative to simple donations, allowing capital to be re-invested in new projects.

Bonds

Interest paying bonds are issued for fix terms. Triodos Bank has been at the forefront of developing bonds as innovative methods of financing social and environmental projects.

CityLife is a "Community Investment Company" that issues bonds to raise money for regeneration projects. The bonds offer no interest but guarantee a return of capital invested after five years.

NatWest (owned by RBS � company ethiscore 2) Community Savings Bond provides affordable finance for community projects. ABN AMRO (owned by a consortium led by RBS) issues bonds on behalf of the not-for profit Housing Finance Corporation, which lends to UK housing associations.

Microfinance

Microfinance involves lending small amounts to small businesses, co-ops or artisans often in the Majority World. www.kiva.org allows individuals to lend directly to projects in the Majority World. Loans are managed by 'field-partner' micro-finance organisations. Loans are made in $25 increments through the website, allowing individuals to select the actual business they want to lend to. No interest is paid, but repayment terms are typically only 6-12 months, after which loans can either be redeemed or re-lent. A gift-certificate option offers an innovative alternative to charity give-a-goat schemes. Kiva attracted so many lenders before Christmas it was forced to restrict the amount lendable to $25 so as not to disappoint keen lenders. Kiva is currently raising over $500,000 a week.

Best Buy - Triodos Renewables

Triodos Renewables Plc invests in renewable energy projects, specialising in community-backed wind farms and small-scale hydro-electric projects. There are two ways to invest. Existing shares are traded through Brewin Dolphin. There will be a new share issue this spring. To register interest call 0500 008720 or email reneweablesfund@triodos.co.uk.

Triodos Renewable Energy Bond offers 4.5% AER/gross for a fixed two year period. Minimum investment is �2,500, maximum �10,000. This is a realistic financial alternative to retail funds for the small investor, combining limited risk with a high environmental impact.

A very short history of ethical funds in the UK

Charles Jacob, an investment manager with the Methodist Central Finance Board, proposed the first ethical fund in the UK in 1973. This led to an ecumenical investment network, the Church Investors Group, which helped develop ideas on ethical investment.

In the 1980s, the call to boycott businesses supporting apartheid in South Africa pushed the development of the ethical investment movement in the UK. In 1983 Ethical Investment Research Services (EIRIS) was launched as a collaborative research venture by a group of churches and charities who needed information to put their own principles into practice. And in 1984 Friends Provident launched the first ethical fund, the first of its Stewardship funds, now managed by its investment arm F&C. These early efforts primarily took the form of negatively screened funds. In 1988 the Mercury fund (now the Jupiter Ecology Fund) was launched with positive environmental screening, reflecting a growing interest in environmental issues and sustainable development. In 1991 the UK Social Investment Forum (UKSIF) was founded, bringing together institutional investors, retail fund managers, unions, NGOs and others - including Ethical Consumer - with an interest in ethical finance. In 2008, UKSIF launches the first National Ethical Investment Week, which will run from 18-24 May [see LINKS]. Nearly six times as much is going into ethical funds compared with a year ago.(4)

Only 4% of investments integrating ethical criteria in the UK are carried out by individuals or retail funds on their behalf (roughly 50/50) � the vast majority are carried out by institutions, such as charities, pension funds and insurance companies.(5) The market for individual investors, however, provides a strong signal to institutional investors to engage with ethical investment, not only through the niche ethical retail fund market, but throughout their investments. Today 78% of the assets of the largest UK pension funds incorporate some ethical investing principles.(6)

In a signal that the investment world was beginning to take ethics seriously, in April 2006 institutional investors from 16 countries signed up to the UN Principles for Responsible Investment. And European investments that include some ethical criteria were worth $1 trillion in 2006, up a third since 2003 and representing 10-15% of total assets under management.(5)

LINKS

Ethical independent financial advisors:

IFAs who specialise in matching investors to the right fund. See websites below for directories. Pioneers in the field include:

The Ethical Investment Co-operative tel. 01748 822402

The Ethical Investors Group distributes at least 50% of its own net profit to charities and good causes each year. Provides an Ethical Fund Directory that rates each fund in the areas of Environment, Animals and Social criteria. tel. 01451 850777.

The GAEIA Partnership tel. 0161 434 4681

National Ethical Investment Week takes place 18th - 24th May 2008. The website has a directory of ethical IFAs that can be searched by postcode.

Ethical Investment Research Services has a directory featuring detailed information on each fund

UKSIF's website for individual investors, includes a directory of funds and UKSIF IFA members.

The Ethical Investment Association has a directory of ethical IFAs in the UK and produces guides for investors

UK Social Investment Forum 020 7749 9950

European Social Investment Forum's SRI Funds Service is a free information tool to combine fund performance measures with selection criteria -

www.trustnet.com provides fact sheets on most unit trusts and OEICs, including largest holdings.

Alternative Investment

Trade Association for Community Development Finance Institutions 020 7430 0222

CityLife 01223 488400

Shared Interest 0191 233 9100

Co-operatives UK, the central membership organisation for UK co-ops 0161 246 2900

KIVA: innovative microfinance website

Disclaimer

This report should not be taken as financial advice or a financial endorsement of any company. Whilst every effort has been made to ensure information is correct Ethical Consumer cannot guarantee accuracy and investors should consult an IFA before taking any financial decision based on the information herein.

References

1 www.triodos.co.uk/uk/whats_new/latest_news/press_releases/green_eyed_monsters viewed 01/08 2 'Ethical Consumerism Report 2007', Co-operative Bank 3 'Going Green? how financial services are failing ethical consumers' New Economics Foundation (NEF) 2007 p24 4 www.investmentuk.org viewed 01/08 5 European SRI Study 2006, EUROSIF 6 'Your money, your choice' EIA & UKSIF 2005 7 The Telegraph 17/03/07 8 NEF op cit p14 9 Corporate Watch newsletter:issue 24, 2005 10 Skandia Invesment Managment, Ethical Fund factsheet 09/07 11 The Guardian 7/12/07 12 Jupiter Environmental Income Fund Manager's Annual Short Report 30/09/07 13 'The Oil and Gas Bank' PLATFORM 2007 14 'Aberdeen's Socially Responsible Investment (SRI) Capability' Pdf, www.aberdeen-asset.com viewed 01/08 15 'Fund Manager Transparency and Engagement on Environmental, Social and Governance Issues'FairPensions 15/10/07. 16 ibid p.7 17 ibid p.2 18 'Investors seen failing to vote for green resolutions' www.wbcsd.org 19 www.environmental-finance.com/2007/0709sep/pri.html viewed 01/08 20 op cit p.50 21 For example: Orlitzky, M, Schmidt, F & Rynes, S 2003, 'Corporate social and financial performance: A meta analysis', Organization Studies, vol 24, no. 3, pp 403-11. and "A study into the influence of Environmental Governance and Financial Performance" Innovest Strategic Value Advisors 11/04 22 The Guardian 6/01/07 23 www.socialfunds.com/news/article.cgi/article2366.html viewed 01/08 24 Co-operative Group Sustainability Report 2006 25 The Guardian, 31/10/06 26 'Influencing Power' SustainAbility\WWF 2007 27 Corporate Responsibility Report 2006 p.10