Do 'ethical' funds share your values? Read the small print

Screening out stocks is not enough to create an effective policy, says Nicola Donnelly of Wheb Asset Management

On 20 April, BP's Deepwater Horizon drilling rig exploded in the Gulf of Mexico, killing 11 men and sending millions of gallons of oil into the sea. These deaths were the start of a tragedy that led to oil-coated birds and turtles washing up along the Louisiana coastline. The clean-up has cost $2.35bn so far.

The day before the spill, BP's share price was 655p. At the end of July, it hit a 14-year low of 304p - a drop of £55bn in its capital value. Last year, BP accounted for about £1 for every £7 of dividend income paid out by companies in the FTSE 100. This year, it has suspended its dividend.

Charities have not been immune to this effect. Typically, BP shares can make up about 8 per cent of the total equity portfolio held by a charitable endowment. Many of these charities would not have decided to follow an ethical investment policy and would have known they probably held BP shares. However, others will have pursued an ethical policy, and been horrified to find that BP and other oil companies are in their portfolio.

Ethical fund managers often justify the inclusion of BP in their portfolios because its corporate social responsibility policy looked better than other oil companies', a tactic known as best-in-class investment. BP is astute at ticking the boxes that these 'lighter green' or 'ethical' funds look for, and many fund managers seem to have glossed over a previous incident at a Texas City refinery and an oil spill earlier this year in Alaska.

So, how do ethical investors know what they are signing up to and how can they avoid being exposed to companies such as BP?

First, if an investor has particular ethical concerns, such as to avoid oil, tobacco and armament companies, they should check that negative screens are in place.

Second, look at the top 10 holdings, and, if possible, the entire fund. If mainstream stocks such as Imperial Tobacco and BP are there, then ask yourself whether this fund really is any different to a mainstream one.

Third, focus on funds investing in companies that provide environmental and social solutions to issues such as water resource shortages or climate change.

These funds will not have been exposed to unethical companies because they do not see such companies as good investment propositions.

The companies that they invest in are exposed to growth rates that are not only high but also sustainable, because their businesses are focused on addressing urgent social and environmental challenges that, sadly, are not going away any time soon.

- Nicola Donnelly is a fund manager at Wheb Asset Management

- More Finance & IT at: third sector.co.uk/resources/goodpractice

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