Investing with the angels

Nearly £9bn is invested in the UK's green and ethical funds. But finding the fund to fit your charity's mission can be tricky. Mathew Little reports.

It once provoked gales of laughter in corporate boardrooms and fund management houses, but ethical investment is now on the verge of becoming the new orthodoxy. The latest figures show that nearly £9bn is invested in the UK's green and ethical funds, compared with less than £1.5bn in 1997. According to some analysts, however, ethical and socially responsible investment is a victim of its own success. In conquering the mainstream, it has become a pale shadow of what it was once meant to be.

A report published in February by financial consultancy Holden & Partners argued that when SRI and ethical funds emerged in the 80s, they promised to invest in companies that protected the environment. But their modern-day counterparts actually invest in very mainstream companies, such as Vodafone and the Royal Bank of Scotland. Oil companies such as Shell, BP and Total also often feature in the top 10 holdings of many funds that claim to be based on environmental principles. "Investors in SRI funds who were hoping to be buying into the low-carbon economy might find that they are exposing themselves largely to multinationals that are more part of the problem than part of the solution," the report says.

Buying into the corporate line

"We think that a lot of ethical funds are resting on their laurels," says Mark Hoskin, a partner at Holden & Partners. "They are buying into the corporations' corporate responsibility line and every company under the sun, even mining companies, has a great corporate responsibility line."

Does the fact that many ethical funds could be more truthfully designated as 'non-unethical', at best, pose a problem for charities? For many, maybe not. A large proportion of charities that approach ethical investment still do so from the perspective of wishing merely to exclude stocks that conflict directly with their charitable objectives. The remainder of the portfolio can be invested according to conventional principles.

"If a charity wants to invest ethically, it will be influenced by the issues that are most important to it," says Sam Collin, charity adviser at Charity SRI, a project that aims to raise understanding of ethical investment among charities.

"That will vary because the sector is so diverse. An animal charity might want to ensure that it does not invest in companies that test cosmetics on animals, but that might be only a small proportion of what it can invest in. So it will be investing in a lot of mainstream companies."

But that limited approach will not suit everyone. A growing number of charities, encouraged by the Charity Commission's acceptance that SRI funds produce financial returns as good as those generated by conventional funds, now try to invest according to broad ethical or sustainability principles. Even if a charity wants to focus on one issue, that doesn't mean its investment choices will be simple.

An animal welfare charity, for example, might decide that its mission demands that it excludes not only companies that engage in cosmetics testing on animals, but also testing for medical research purposes. It might want to screen out firms that are involved in intensive farming, which would rule out supermarket stocks. Construction companies that damage natural habitats might also be blacklisted. The International Fund for Animal Welfare's criteria on ethical investment excludes so many sectors that it cannot find a compatible ethical fund to invest in.

Going it alone

A charity that wants to invest ethically can go it alone, if it is large enough and has potential investments valued at more than £500,000. It can ask a fund manager to invest its funds in a segregated portfolio that fits its ethical criteria. This was the approach taken by the RSPB. "We employed Merrill Lynch, now Black Rock, as our investment managers," says Alan Sharpe, director of finance and IT at the charity.

"We did all the work with ethical investment advisers Eiris. We told them the companies we would like to exclude and they picked the stocks. It's very time-consuming and it's not something that many charities would have the skills to do in-house."

For most charities, the only realistic option is to invest in a pooled ethical fund. Ethical and SRI funds vary - some will invest in a large number of mainstream companies on a 'best-in-class' basis, whereas a minority will choose companies that make a positive difference to problems such as climate change, selecting renewable energy or organic agriculture stocks.

Deciding which of the plethora of funds that call themselves 'ethical' best aligns with a charity's ethical demands is no easy task. If it can afford it, a charity can hire an investment adviser to research the market and produce a list of suitable funds. Hoskin recommends this route. "Charities are coming to this blind," he says. "No charity I know knows anything about investing ethically. Charities pay for lawyers, so why aren't they paying for investment advisers?"

There are, however, free resources for charities that want to investigate the ethical market themselves. Charity SRI, for example, hosts a database of ethical funds designed for charities. It gives details of the ethical issues they consider and their policies. "It's quite easy to search for funds according to ethical criteria, because you can tick which issues you are most concerned about and it tells you which firms cover those," says Collin.

She says the database can be used to shortlist appropriate funds, but she advises charities to investigate the underlying holdings of funds they are interested in to see what companies they invest in, and to examine their financial returns.

Whatever pooled ethical funds charities choose to invest in, they will never achieve a perfect alignment with their ethical requirements, says Hoskin. Pooled funds, by their nature, require compromise. "You buy into a fund's philosophy and you will never completely match, no matter what its criteria," he says. "You will take a view and say 'it's close enough'. That's all you can do."

That, and the need to maximise investment returns, could mean investments in many mainstream companies. Investment manager F&C manages a portfolio of socially responsible funds on behalf of the Charities Aid Foundation. The funds exclude 55 per cent of the FTSE, shunning tobacco, arms, gambling, alcohol, pharmaceuticals and most oil companies. But they do invest in other firms whose ethics have been questioned.

"We quizzed F&C about Tesco," says Gill Nunn, director of charity financial services at CAF. "My personal view is that I'm not so sure I would invest in Tesco. But their view is that Tesco's core business is a basic necessity sold quite cheaply. They are currently acceptable - but if things change, the holding will be sold."

The RSPB decided to abandon its segregated ethical portfolio in 2005 because it needed greater diversification. The charity appointed financial advisers Cambridge Associates to research the pooled ethical fund market and recommend appropriate vehicles, both in terms of ethical criteria and financial performance. The RSPB then invested in several funds, which it reviews annually.

Sharpe accepts that the pooled fund approach involves compromise. "It's a trade-off," he says. "In theory, we could have a portfolio that was perfectly aligned with what we want. But in practice, we just haven't got the firepower to construct such a portfolio, so we came down on the side of saying that the most practical approach is to use a pooled fund and accept that we'll find one that is closely aligned to our interests, but not perfectly aligned."

Sharpe says the decision to use pooled funds rather than shoulder the burden in-house has also led to better choices over ethical investment. "What we are doing now, taken overall, represents a better fit with our principles because we've got managers who are spending their time analysing companies and coming to much better informed decisions. We've lost some of the flexibility, but we have gained better-informed decision-making."

WHAT DOES ETHICAL INVESTMENT MEAN?

Ethical or socially responsible investment means that the values or concerns of investors are taken into account in selecting which companies to invest in. The desire to maximise financial returns is not the only motivation, though proponents of ethical investment claim that ethical funds perform financially at least as well as conventional funds.

Since the first ethical fund was launched in the UK in 1984, ethical investment has taken a variety of forms. One of the most common kinds is negative or ethical screening, whereby companies involved in activities such as arms production, tobacco or animal testing are excluded from portfolios. Many funds labelled 'socially responsible' are based on best-in-class screening, which selects the best performing company in a given sector from a social or environmental point of view. In theory, this approach could include the 'best-in-class' tobacco company. Other funds may adopt a positive screening approach, selecting companies that promote solutions to social and environmental problems, such as renewable energy. Charities can also take an activist or engagement approach, investing in companies that might not be very ethical at all to try to improve their behaviour through dialogue with management or voting at company AGMs.

Mission or programme-related investment involves charities investing in enterprises in order to further their aims directly. This is not officially classed as investment by the Charity Commission because there is no duty to obtain the best possible financial return.

Sources: Holden & Partners, Charity SRI.

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