Do ethical funds harm your wealth?

Investing only in ethical companies naturally appeals to many people, says Adam Jourdan. But are you sacrificing the best returns?

The notion of ethical or socially responsible' investing has been around for some time. It involves screening stocks for a range of factors, from how companies treat their staff, to their environmental impact. The idea of investing in companies that do good' or at least do no harm' naturally appeals to many people.

But what does it mean for your returns? The answer is, not a lot. "Modern portfolio theory says that [your returns] should hurt, because anything that makes an investment universe less diversified results in a lower expected return for a given level of risk," says David Kathman of research group Morningstar.

Yet, in practice, experts have failed to show any significant difference over the long term. Separate studies in 1993, 2000, 2002 and 2005 all concluded that there was "no significant difference in the risk-adjusted returns of socially screened versus unscreened mutual funds".

In the latest study, from 2011, published in Journal of Investing, authors Lloyd Kurtz and Dan DiBartolomeo looked at the performance of the KLD 400 Social Index against the S&P 500 between 1992 and 2010. The performance of the KLD Index which excludes many energy and industrial stocks for environmental reasons, and is usually heavier than the broader market in technology stocks, which tend to score well on environmental, diversity, and employee-relations measures was "essentially indistinguishable" from the S&P 500 index, after accounting for sector weightings and its slight growth bias.

It's perhaps not surprising. Managers of socially responsible funds at least have to exercise some stock-picking skills, rather than simply finding ways to hug an index. But what the research really shows is that socially responsible funds are just like any others: and that means that, on average, by investing in any given fund you're almost certainly overpaying for the privilege of underperforming the broader market. Overall, we'd rather stick with cheap trackers or investment trusts following our favourite markets (such as Japan), then top up with individual stocks (where you can exercise your ethical judgement as you see fit).

If buying a socially responsible fund does still appeal, do your research. The label covers a wide range of funds, from those based on religious beliefs to green' funds. Ethics being what they are, you may well find that what some investors consider acceptable (buying an oil firm that's trying hard to be greener') strikes you as an unacceptable cop-out.

Recommended

Why the market is wrong about private equity
Investment trusts

Why the market is wrong about private equity

When it comes to listed private-equity trusts, investors are overly sceptical, with many funds trading at heavy discounts to their net asset values. B…
9 Aug 2022
Asia: long-term opportunities amid short-term noise
Advertisement Feature

Asia: long-term opportunities amid short-term noise

In a tough first half of the year for financial markets, Asia has struggled more than most. But that weakness may represent an opportunity for invest…
26 Jul 2022
Analysis: it’s been a terrible six months for investment trusts
Investment trusts

Analysis: it’s been a terrible six months for investment trusts

The first half of the year has not been kind to investment trusts because of their skew towards growth stocks and the global downturn, says Max King. …
25 Jul 2022
The ten investment trusts with the highest dividend yields
Investment trusts

The ten investment trusts with the highest dividend yields

Investment trusts are one of the best ways to participate in the stockmarket, and the way they are structured means they can maintain their dividends …
22 Jul 2022

Most Popular

Are UK house prices finally heading for a crash?
House prices

Are UK house prices finally heading for a crash?

The latest house price figures show a fall of 0.1% in July. With interest rates rising, inflation hitting double figures and a recession on the cards,…
5 Aug 2022
A low-risk way to beat inflation
Share tips

A low-risk way to beat inflation

Demand for care-home places is strong and the sector should be able to raise prices ahead of costs, says Max King.
8 Aug 2022
Where to find inflation-resistant stocks
Investment strategy

Where to find inflation-resistant stocks

Terry Smith’s latest update contains some valuable pointers for investors looking to protect against inflation.
8 Aug 2022