How ethical investing can pay off, and unethical even more...

You can combine profit and principle

Does Socially Responsible Investing (SRI) mean having to trade profits for principles? Not necessarily, says Steven Frazer in Shares. There are now around 40 dedicated ethical funds according to TrustNet, half of which have outperformed the UK All Companies sector, and the FTSE4Good Global index has outperformed the FTSE 100 by about 11% since its launch in 2001. Shares recommends a starting portfolio of the following seven firms that combine profit and principle.

Clipper Windpower (Aim: CWP, 390p) is an "eco-friendly energy play". It makes wind turbines that are "designed to maximise efficiency, be long lasting and run at low cost". Although it is not yet profitable, there is growing interest among the big energy suppliers in wind power in the American Midwest in particular with contracted development projects rising from 301MW to 461MW. Clipper expects to have 100-110 wind turbines operational by the end of this year and 155 by the end of 2007.

Scottish & Southern Energy (SSE, 1,118p) also looks promising as a result of its enthusiasm for renewable energy not to mention its 4% yield.

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The other five companies are orthopaedics expert Smith & Nephew (SN, 519p); hydrogen fuel cell pioneer ITM Power (Aim: ITM, 211p); biotech NeuTec Pharma (Aim: NTP, 520p); ethanol fuel producer Renova Energy (Aim: RVA, 221p); and consumer debt specialist Debtmatters (Aim: DEBT, 325p).

but you'd be better off with the sinners

Geoff Ho, also in Shares, takes a different view. Adjusting for the fact that the FTSE 100 index is a UK index and the FTSE4Good Global index is not, closer scrutiny of the numbers shows that "regardless of whatever period you look at, ethical investments always underperform the market".

So, while it may be possible to combine the two if you have a good fund manager, on average, there is a penalty to be paid. From its launch on 31 July 2001 to end-December 2005, the FTSE4Good UK 50 returned just 1.22%, compared with 3.2% for the FTSE 100 and almost 7% for the All Share index.

That shouldn't come as a surprise, says Investors Chronicle. After all, many "unethical" companies are "terrific" businesses. Often, they are in low-tech industries. In some cases, they may even have changed their behaviour yet continue to "trade in the shadow of a previously poor reputation".

A case in point is Drax (DRX, 796p). During the 1980s, Drax (along with the rest of the country's coal-burning power stations) got the blame for acid rain in Scandinavia at a time when the UK was known as "the dirty man of Europe". Since then, it has spent millions of pounds curbing emissions and now claims to be not only the largest, but also the cleanest power station in the country.

Yet it is excluded from many ethical portfolios, while financial-services companies that are "regularly lambasted by church groups and charities" for charging the poor up to 185% in interest a year for loans are not. What's more, unlike these ethical' loan-sharks, Drax reported a doubling in profits in 2005 over 2004, with most of today's high wholesale electricity prices now locked in until at least 2007.

Other "unethical" investment targets identified by Investors Chronicle include Gallaher (GLH, 848p); BAE Systems (BA, 419p); Radstone Technology (RST, 291p); Rio Tinto (RIO, £30.60); British Energy (BGY, 701p); and 888 Group (888, 235p). Shares also likes BAE and British Energy. Its other tips are Dmatek (DTK, 120p); British American Tobacco (BATS, £13.83); Sportingbet (Aim: SBT, 427p); SSL International (SSL, 319p); and Blavod Extreme Spirits (Aim: BES, 19.88p).