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What does investing ethically mean?

Rob Morgan
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There are some constraints involved in investing ethically but a number of fund options are available. (Source: Shutterstock)

Ethical or socially responsible investing encourages corporate behaviour that promotes environmental stewardship, consumer protection and human rights. In addition, it usually means actively avoiding businesses involved in such areas as alcohol, tobacco, gambling, weapons or animal testing.

The main approaches funds use to ethical investing are:

Negative screening – avoiding companies engaged in what are perceived to be harmful activities, such as tobacco, gambling or manufacturing weapons. This might be considered a 'dark green' or strict ethical approach.

Positive screening – Rather than avoiding certain areas, the manager will assess each sector, looking for the 'best-in-class' companies to use and favouring those that contribute most positively to society or the environment.

Engagement – actively engaging with firms in order to promote socially responsible business practice.

How do ethical funds differ from standard funds?

Although ethical funds vary a great deal, they all have a process that to some degree reduces the size of the universe of available investments. It often means some large companies and sectors being absent from a portfolio, which can either work for or against them in terms of performance over a given period.

With a smaller pool of companies from which to choose, ethical funds can also be less diversified and more volatile, meaning they experience greater ups and downs. Many industries excluded by ethical funds, such as tobacco, beverages (alcohol) and some healthcare companies, are often considered more defensive. In addition, larger firms are often screened out meaning fund managers must seek an alternative among smaller companies, which can be riskier.

While investors may be interested in the concept of investing ethically, it may involve some compromise. The objectives for most investors are maximising returns and managing risk, but both of these are more difficult to achieve if investing ethically. We generally prefer an unconstrained approach because this gives fund managers the flexibility to invest wherever they see the best opportunities.

Fund options

Once an investor has accepted the in-built biases involved in an ethical approach, picking funds for a portfolio follows the same process, just with a more limited range of options. While we don’t currently have any funds on the Charles Stanley Direct Foundation Fundlist classed as ethical, the funds below have been identified by our research team as being potential options ethically-minded investors:

Kames Capital Ethical Equity

For investors seeking ‘dark green’ ethical exposure to UK equities, the Kames Ethical Equity fund might be worthy of consideration. Manager, Audrey Ryan, takes a flexible and pragmatic approach, aiming to alter her portfolio to suit the market environment. However, the strict ethical screen does steer her to a more growth-orientated approach than the average UK equity fund, and results in a bias to smaller and medium-sized companies, which can be higher risk.

Stewart Investors Worldwide Sustainability

The emphasis of this global equity fund is on positive, rather than negative, ethical screening. The managers invest in the shares of companies expected to have a positive impact on society, the environment and health. This ‘light green’ process is part of the fabric of the investment approach rather than simply being a ‘filter’, and although it means they are unlikely to invest in certain companies (for example those involved in tobacco, alcohol and weapons) they are not specifically excluded. The Stewart Investors global equity approach focuses on high-quality companies with good long-term growth prospects and sound balance sheets.

Kames Capital Ethical Corporate Bond

Ethically-minded fixed income investors have a limited choice. However, under the tenure of Iain Buckle and Euan McNeil this fund has performed well in the corporate bond sector, which mainly represents funds not constrained by an ethical approach. This is impressive given that the fund’s stringent ‘dark green’ approach reduces the investable universe of bonds to just 40% of the total market. With Kames’ well-resourced team and commitment to ethical investing this might be for ethically-minded bond investors to consider further.

Greencoat UK Wind Trust

This investment trust could offer something a bit different for investors looking for income and diversification. Through owning a portfolio of UK wind farms the Trust aims to pay a high dividend yield that grows with inflation and offers the potential for some capital growth through the reinvestment of surplus income.

Although the Trust only invests in operational wind farms (thus taking no construction risk) there are a number of other potential pitfalls including legislative change, the potential for power prices to fall and any rise in bond yields that sees deterioration in sentiment towards areas paying a largely pre-determined level of income. Yet the sector could be an attractive source of long-term income linked to both inflation and the power price.

Ensure you understand the approach

Please note that as well as ensuring a fund meets your needs in terms of its objectives and level of risk, if you wish to invest ethically you should understand the approach towards screening. A stricter ‘dark green’ approach that excludes certain industries entirely will suit some investors. Others will be willing to accept a ‘light green’ approach, which focuses on companies operating in a socially responsible way or striving to improve their industry and reduce environmental impact.

This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in collectives should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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