Broad-minded path to ethical profit

In the world of funds, ethical does not mean narrow, says Sue Round, the head of investments at Ecclesiastical, whose funds attract attention with top-quartile performance. By Tomas Hirst.

Moral capitalism may be the latest mantra for politicians in Westminster, but ethical investing is far from a novel idea for some groups. Indeed, the concept was the founding principle behind the launch of Ecclesiastical Investment Management a century and a quarter ago.

Despite its laudable intentions, there have been hurdles for the group to overcome. Not least among these was the need to challenge investors’ perception that investing ethically simply meant narrowing opportunities to deliver returns.

“The broader public are much more familiar with the terminology, and it has moved much further away from a negative screening approach,” says Sue Round, the head of investments at Ecclesiastical. “It now encompasses ideas such as sustainability, corporate governance, environmental awareness – all of which are much more in the mainstream now.”

The group, which runs six retail funds in total, has four ethically-screened products in its Amity range. Round, who has been at the company since the funds were launched in 1988, remains at the helm of the £64.2m Ecclesiastical Amity UK fund. (Focus continues below)

Alongside her are Robin Hepworth, the manager of Amity International and the unscreened High Income fund, and Chris Hiorns, the co-manager of the Amity Sterling Bond fund with Hepworth, and manager of the Amity European fund.

“There’s a lot to be said for the simple fact that if your funds are performing you will attract attention,” Round says. “Retail investors have started to understand it more but I think there’s probably still some confusion within the retail space about what it actually is to invest ethically. For a fund provider, the clearer you can be in describing what your funds are about the better.”

In a survey commissioned by the group last October, more than three-quarters of respondents claimed never to have been offered an ethical choice by an IFA. Two-thirds of respondents said they would be more likely to invest ethically if they were given advice on products.

Certainly there seems to have been a pick-up in interest over the past few years. When Fund Strategy last profiled the group in 2008 it had assets under management of about £1 billion. This had almost doubled to £1.9 billion by August 2011.

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Hepworth, who joined the group in 1988, took on the management of the Higher Income fund in 1994 before being appointed manager of the International fund at its launch in 1999. Much of the group’s recent success can be attributed to the performance of these funds, with Higher Income top quartile over three years to February 10, returning 49.29% to investors, and the Amity International fund returning 49.31% over the same period. The products have grown from £42m and £30m respectively four years ago to £96.5m and £117.9m today.

Rob Morgan, an analyst at Hargreaves Lansdown, says these numbers have been key to the growth of the business. “What drives interest is first and foremost the performance of the funds,” he says. “Rob Hepworth’s performance has been instrumental in that.”

Indeed, the only offering that has struggled in recent market conditions is the Sterling Bond portfolio, which dropped into the bottom quartile over three years. Over one year, however, the fund is second quartile, having returned 6.13% against an IMA £ Strategic Bond sector average of 5.03%.

In terms of fixed income, however, Round says in the short term investors find that the risk is weighting towards the downside, particularly in sovereign debt markets: “I think bonds are overvalued,” she says. “Yes, there might be a bit more to be gained through the dash to safety, but with yields at historic lows, are investors really going to want negative real returns?”

With various forms of monetary easing still underway in many developed economies, there may yet be the possibility of further yield contraction, but there is now far less room for it. Furthermore, with inflation looking set to run ahead of government debt yields for some time to come in many developed economies, the case for investing to protect capital is being eroded.

In both equity and fixed income markets, concern has been particularly focused on the situation in the eurozone. Although stockmarkets rallied towards the end of last year on news that the European Central Bank was providing cheap credit to the region’s banks, uncertainties remain over how policymakers will resolve broader structural problems.

In the latest factsheet for the Amity UK fund, Round makes the point that central bank actions may have stabilised the markets temporarily, but “the size of the allotted funds signalled the extent of the malaise within the European banking system”.

Round says the situation on the Continent is “uncomfortable” as people are putting a great deal of faith in politicians to deliver a solution. Despite this, the managers at Ecclesiastical are not entirely negative over the short-term prospects for markets generally.

“Of all the asset classes, equities probably offer the best opportunity, but I don’t think that they are desperately cheap,” she says. “Looking at the valuation of long-term P/Es [price/earnings ratios], they are probably about fair value. So, again, it’s looking for those opportunities. We’ve seen some reasonably good news from the US recently, though they remained mixed.

“And despite talk of a hard landing in China, I think it would be a mistake to underestimate the country.”

Even on Europe there might still be grounds for optimism. Hiorns says he “continues to believe that there is long value in the European equity markets and the potential for a recovery in valuations once a more lasting solution to the European sovereign debt crisis emerges”.

The top-performing fund in the range is the unscreened Ecclesiastical UK Equity Growth fund, managed by Andrew Jackson. The fund, which can invest across the cap spectrum, ranks 60th of 271 funds in the IMA UK All Companies sector and is top quartile over both one and three years.


Running successful unscreened products, however, may give rise to the question of whether ethical screens do involve a degree of compromise. Round readily admits that the filter prevents the funds from investing in mining companies, for example, which make up a sizeable proportion of the FTSE 100.

“There is a risk that [screened funds] will be more reliant on the mid-cap space than other funds in their sectors, and that will have periods of underperformance,” says Morgan. “Ultimately there will be areas that they will miss out on, such as miners, so investors do have to compromise to an extent.”

Although the products may well fail to capture cyclical rallies in raw materials markets, the ethical investment theme has evolved some way from simply keeping clear of tobacco and arms companies. The screening tools themselves are more nuanced and have shifted away from simply identifying companies that cannot be invested in.

“The purist stance has probably been diluted by the best-in-class approach,” Round says. “You can look at some mainstream competitor portfolios and see little difference. So yes, the negative screening is still relevant, but the idea that you’re doing something positive is important to make it appealing to investors.”

”The negative screening is still relevant, but the idea that you’re doing something positive is important to make it appealing to investors”

Turning back to the talking heads at Westminster, many within the financial services industry have been bracing themselves for a regulatory onslaught in the wake of the banking crisis. Thus far there has been little in the way of firm action and the latest move by the Coalition government to introduce additional powers for shareholders could be seen as a step towards promoting greater self-regulation.

Last month Vince Cable, the Business Secretary, in an effort to appease public concern over executive pay, outlined proposals for shareholders to get a binding vote on board remuneration packages. The policy met with a lukewarm response from both union leaders and some Conservative backbenchers. Nevertheless, those in the investment world who have long campaigned for greater shareholder engagement might be expected to applaud the measures – and indeed benefit from them.

Morgan says Ecclesiastical has already established “a pedigree in the shareholder engagement area”. The group routinely votes on corporate governance or ethical issues involving companies held in the funds, sometimes collaborating with similarly-minded organisations to exert maximum influence.

It may come as something of a surprise, therefore, that while Round is supportive of shareholders taking an active role in corporate governance issues, she remains unconvinced by the government’s proposals.

“There’s a lot of noise about shareholder activism at the moment,” she says. “I do think that the asset management industry itself is just about coming to the idea that they should vote. Getting a consensus [from shareholders] can be difficult, though.”


Part of this difficulty is that companies with active shareholder bases may be perceived as more vulnerable than those without. It also raises questions over whether executive pay is a key factor in controlling systemic risk in the financial sector, or whether the proposals are being used as a political ploy to avoid criticism over the lack of broader regulatory reform.

“I’m not sure that a legislative approach is the right one,” Round says. “I would prefer a model where if a certain percentage of shareholders voted against a proposal then a company would have to enter into a dialogue with them. It’s not the best model if you’re having to wait until a binding vote to register your discontent.”

Irrespective of legislative pressure, it is clear that in order to protect their investment shareholders ought to be playing a larger role in the oversight of companies. For asset management groups holding significant numbers of stocks, this could be an additional burden on resources to those who do not have the infrastructure already in place.

While on that basis Ecclesiastical seems well placed, there are concerns over whether the group has sufficient scale to compete with some of its more mainstream retail competitors.

“The main drawback for us is that [Ecclesiastical] are still relatively small and rely on a few individuals,” says Morgan.

Scale is not something that is achieved overnight, and if the past few years are a gauge then the future of the group looks bright. As long as its funds continue to produce compelling results and maintain their ethical credentials, there appear to be few barriers to growth ahead.

Ecclesiastical Investment Management was founded in 1887 to provide insurance for church property and was one of the founders of ethical investment in Britain. The group offers six retail funds. As at August 2011, it had more than £1.9 billion under management.