How to invest with a clean conscience

If the squabble between David Cameron and Gordon Brown over who can raise green taxes the highest is anything to go by, green issues look set to influence the political landscape for some time to come. But as a survey last week from Co-operative Financial Services showed, green issues are increasingly important in the investment world too. According to Co-operative Financial Services, 67% of those planning to use their Isa allowance this year said they would consider investing in a scheme with benefits for the environment. The amount invested in ethical funds' is now £6.5bn, a fivefold increase on the same figure in 1997, according to London-based Ethical Investment Research Services (see Eiris.org). But what exactly is an "ethical fund" and do you have to sacrifice performance for principles?

What are ethical funds?

Ethical funds are just like normal funds the difference is that they follow certain guidelines about which firms they will and will not invest in. But just as we all have different ethical boundaries, so too do the funds. The first and oldest type are known as dark green funds'. They take what is called a negative approach to investing, deliberately excluding certain industries or sectors. Unsurprisingly, those firms avoided tend to be ones that make most of their money from the tobacco, gambling, pornography or arms manufacturing industries, and also those firms with significant dealings in countries with poor human rights records, for example which often rules out mining and oil companies.

Light green' funds take a positive approach, investing in firms that are actively helping the environment, such as windfarms, solar power or waste management. A more common approach among a newer batch of funds is to engage' with companies, pressurising and lobbying them to make positive changes. The more cynical might be tempted to dismiss this approach as being a product of more mainstream fund managers who know an investment bandwagon when they see one: it means they can invest in essentially the same stocks they've always invested in, as long as they make some effort to suggest they're lobbying the firm to change. In any case, finding a fund to suit your specific requirements shouldn't be too difficult several websites, such as the Ethical Investors Group (Ethicalinvestors.co.uk) provide comprehensive databases of funds that you can sort by various criteria, including animal welfare and environmental concerns. So much for the ethics, what about performance?

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Do ethical funds work?

Some argue that ethical funds run the risk of making investing an afterthought the business of finding good-value companies takes second place to buying firms that are cutting carbon emissions, for example. Ben Yearsley of IFA Hargreaves Lansdown tells Bloomberg, "You are leaving out parts of the market that might provide the best returns. The more ethical you are, the more you'll lose out." But although ethical funds are clearly missing out on big profits in sectors such as oil and tobacco, there's no evidence that they underperform their non-ethical peers by a significant amount. In fact, over the past three years, the average ethical fund has returned 63.6%, while non-ethicals have returned 59.8%, says Patrick Connolly of J&P Towry Law in The Daily Telegraph.

Of the 324 trusts in the UK All Companies sector, the best-performing fund is an ethical one, the CIS Sustainable Leaders Trust. It gained 26% in the 12 months to 5 March, compared with 8.7% for the FTSE All-Share Index, according to Standard & Poor's. A core element of the trust is "companies that can offer products or services that help others improve their environmental performance", says manager Mike Fox in The Guardian. The group is "seeing increasing levels of demand". Holdings include Spice, which advises firms on how to cut carbon emissions and energy usage, and Enterprise, which fixes leaking pipes at water works.

How to pick an ethical fund

Experienced investors could, of course, use a self-select Isa and make their own green stock choices those with the money to spare can even pay to have their portfolio vetted for suitability by Eiris if they wish. Otherwise, a good method of finding your way through the ethical maze is to look at a fund's top ten holdings. "If you disapprove of the selections, don't invest", says Peter Temple in The Daily Reckoning.

Ian Wishart, director at Edinburgh-based Hurley Financial Services, tells The Scotsman he likes F&C's Stewardship Income fund. It focuses mainly on UK mid-cap and small cap stocks and is up 20.2% over the past year and 94.3% over five years. IFA Julian Parrott of Ethical Futures Parrott tells The Herald that he likes Jupiter Ecology and Aegon UK Ethical, both of which "are dark green' strongly researched, responding to positive criteria, and with a consistent track record".

Of course, you could always take Bill Gates's approach. The world's richest man, and arguably the most generous the $35bn Bill & Melinda Gates Foundation finances philanthropic grants of more than $1.5bn a year isn't a great believer in ethical investing. In a recent FT piece, one member of the foundation said that "it did not want to be distracted by devoting time to the issues" involved in extensive stock screening. So perhaps the best idea is to focus on ensuring that your investments make money, first and foremost you can then spend your profits as ethically as you see fit.