Why the sun is sinking for ethical investors

Funds that target recycling and sustainable energy companies are suffering heavier losses than their more traditional rivals, writes Harriet Meyer
Harriet Meyer
The Observer, Sunday 22 March 2009

Ethical investors who pick green investment funds in an effort to balance profits with protecting the environment are suffering heavier losses than their counterparts in ordinary funds. Hit by exposure to smaller companies pummelled by the stockmarkets and unable to rely on ballast from the recession-proof tobacco and drug giants, those prepared to put their money where their mouth is have come unstuck.
The typical green fund that might invest in a mix of "clean" industries, recycling operators and suppliers of sustainable energy such as solar and wind power, slumped by nearly a third over the 12 months to the end of February, according to figures from financial analyst Moneyfacts.co.uk. The 30% fall compares with an average decline of 25% for non-ethical funds.
Similarly, over the past three years to the close of last month, £1,000 in an ethical fund would have seen you lose an average £269 compared with a loss of £218 if you'd placed your cash in a non-ethical investment fund. Over the same period, the FTSE 100 fell by some 34%.
"The big downside to ethical funds is that they [often] exclude defensive stocks, such as pharmaceuticals, certain commodities and tobacco," says Darius McDermott of IFA Chelsea Financial Services, and these are some of the strongest performers.
When a country enters recession, the stockmarket sees mid-sized and small companies marked down the most because of their higher susceptibility to going under, says Lee Coates, director of the Ethical Investors Group (EIG).
"As renewable energy and green companies tend to be smaller and ethical funds tend to be made up of more of such companies than mainstream funds, so performance may suffer until these companies return to profitability."
But that's not all: a number of large, mainstream companies that had managed to tick all the boxes for good governance in the past have also imploded.
For example, former banking giant HBOS previously scored well with ethical investors - but that didn't stop it, or other banks, from taking huge risks on the money markets and ending up being bailed out by the taxpayer.
"A lot of ethical funds include banks in their portfolios, which has partly led to their poor performance," says Richard Eagling of Moneyfacts. "So people are digging deep into ethical funds to ensure they're only exposed to the companies they want."
Plenty of ethical investors will have also been hurt by their habit of sticking with their funds for longer than ordinary investors who are happier to switch to a better-performing rival fund.
A key characteristic of people who invest in ethical funds is that they are more "sticky", says Mark Robertson from the Ethical Investment Research Service (EIRIS), because they pick their investment in accordance with their principles so are less likely to run for cover due to volatility in the market.
However, with many resigned to the detrimental impact of recession on investments, dipping a tentative toe into a stockmarket in the doldrums can be a good move, says Gavin Haynes, investment director at independent financial adviser Whitechurch Securities. "It's time to start searching through the wreckage for value," he says.
And you may be keen to shun more traditional stocks in favour of those that have the potential to do well by doing good. There are numerous "ethical funds" that back good causes, with around 95 environmentally and ethically screened funds worth more than £8bn, according to EIRIS.
When it comes to picking a fund, it is up to you to first decide just how "green" you want to be and whether certain areas, such as animal testing and arms manufacture, are justifiable.
"You've got to match your individual beliefs with the funds," says Eagling. "You may be bothered about gambling companies, for example, but not so much about those that produce alcohol. You're considering what you're happy to invest in and then seeing what choice you've got."
Coates at EIG says his clients complete a questionnaire so he understands which conviction has driven their interest in ethical investment. "One extreme we've had, for example, is somebody who was a strict vegan and wanted to avoid all companies involved in meat transport, animal testing and battery farming, but they were happy to invest in alcohol, gambling and human rights abuse."
There remain stellar funds that show strong long-term performance. Funds that have proved popular among financial advisers include Jupiter Ecology, F&C Stewardship Income fund - the oldest ethical fund - and Aegon's Ethical Equity.
Eagling also recommends CIS Sustainable Leaders. "It consistently performs well, trying to find companies that are leaders in sustainable industries," he says. For people seeking a fund with a particularly stringent screening process in place, he suggests Aegon Ethical Equity.
The Jupiter fund, favoured by Ben Yearsley at IFA Hargreaves Lansdown, has risen by 28.6% over five years. "Once an investor has narrowed down the list of funds to those fitting their criteria, they should look at the manager and their track record for performance," he says.
In spite of recent poor performance, ethical funds should perform well over the long term, says McDermott, as they are looking at companies that are, in most cases, sustainable businesses that have growth prospects.
His view is shared by Janet Rawlings, project manager for a green business park, from Chepstow. She has invested about £55,000 across six of the most popular ethical funds: Jupiter Ecology, Aegon Ethical Equity, Aberdeen Ethical World Income, Standard Life Ethical, Aviva Sustainable Future and F&C Stewardship Income.
"I invested in these in the mid-1990s, and drip-fed money into them over a few years," she says. "I chose these funds as I strongly believe that we have to take responsibility for our actions, so I try to shop and save ethically."
While the value of her ethical investments has plummeted in recent years, she remains confident these funds will perform well over the long term. "They are not sinking any more than the rest of the market, and avoid investing in dodgy practices such as sub-prime mortgages, but lean towards technologies for the future such as renewable energy and companies with good ethical policies."
• EIRIS has developed an Ethical Funds Directory that can be downloaded from www.eiris.org