The door could be opened to ethical common investment funds (CIFs) following a re-writing of the Charity Commission guidance document on investment.
The guidance, CC14, is being revised in the light of the changes brought in by the Trustee Act 2000, which came into force last year.
Executive legal commissioner Michael Carpenter said he believed ethical funds were "the next area for development
in CIFs, which are pooled investment funds authorised by the commission and aimed mainly at smaller charities in the sector.
"Fairly soon we will be issuing revised guidance on charity investment and within that we will be addressing and perhaps re-stating the position on ethical investment,
The changes could not only lead to ethical CIFs, which the Commission has so far been reluctant to authorise, but could also generate increasing investment by charities in the ethical fund market.
Carpenter said that, over time, many people in charities had come to believe that they were not allowed to invest on ethical lines because of the landmark Bishop of Oxford case in which the court ruled that charity trustees' primary duty was to get the best return on their assets.
Ethical funds have been questioned because they often exclude large sections of the stock market, which increases the volatility of the funds, although a new generation of socially responsible investment (SRI) funds concentrate more on positive engagement with companies rather than excluding sectors.
Carpenter said the law was not as restrictive as many people believed and that the Trustee Act's emphasis on diversification of investments meant that ethical funds could be a key part of a diversified investment strategy.
The Commission has already authorised CIFs in hedge funds and property in the past year, as part of a strategy to increase the range of investments CIF investors can consider. Most CIFs are still focused on UK equities or bonds.
But Carpenter stressed that in order to limit risk charities should attempt to have a diversified investment policy.
"The danger with an ethical CIF would be if charities thought they could put all their money into it simply because it's a CIF,
he said, adding that it would have to be regarded as one component of a wider investment strategy.
John Rogerson, head of investment services at the Charities Aid Foundation (CAF), welcomed the prospect of new guidance.The commission has traditionally discouraged charities from investing along ethical lines, partly because its guidance has been based on an ethical model that is increasingly outdated, said Rogerson.
"Today there is much more emphasis on investing in companies that have a positive social impact, rather than the traditional model of excluding companies,
CAF launched its own socially responsible investment fund in 2000, focusing on "positive engagement
with companies rather than exclusions.
"I think a change of guidance would provide a fillip to the ethical market and would encourage ethically oriented funds to look more positively at the charity market,