Ethics and quality versus quantity

Demand for ethical investing mushroomed – although it has been around for decades – and has become mainstream. But superior returns will not necessarily be the result of this strategy.

Investing ethically – or socially responsible investment (SRI) as it has become more commonly known – is not a new phenomenon. It has been around for as long as I have been in the investment management business. Back in the mid-1960s, when I became involved with looking after portfolios for private investors, a choice to exclude the shares of companies engaged in the tobacco, drinks or armaments industries was a regular feature when signing up new clients.

The debate over whether such an approach adds to or subtracts from performance has raged ever since. And as with any argument involving reams of statistics, you can make a case for either side.

Comparing funds run with an ethical mandate with each other is less easy, though. Of the 54 funds identified by
Lipper as run to SRI standards, 21 feature in the UK All Companies sector – a huge universe. The rest are spread between 10 other sectors.

And the variation in performance is as great as any you will find in the funds marketplace. While there are plenty of first quartile managers around, second, third and fourth
feature regularly too. No firm conclusions can be drawn over whether or not adopting an ethical bent will help or hinder you to make money. That said, at least there is no evidence that ethical investing will damage your wealth.

One area that does appear to be reasonably consistent, though, is the Sterling Corporate Bond sector. The best performing fund over one year is the Standard Life Investments UK Ethical Corporate Bond fund, with the F&C Ethical Bond fund ranking number two.

Both these funds lost money, but corporate bond investing has been particularly troublesome during the past year. And there are six funds to choose from in this sector, which is more than in most of the others.

There are managers who make more of an effort to provide a spread of availability of ethical funds. Aviva Inves-tors, for example, has no fewer than seven ethical funds in its range, covering Global Growth, Balanced Managed, Europe, Sterling Corporate Bond, Active Managed and, of course, UK All Companies. Similarly, F&C has a full range of funds, three of which are badged with its “Stewardship” label. But
looking at both these groups, performance varies from fund to fund.

Performance is unlikely to feature at the top of the priority list for investors who decide to adopt an ethical approach. And the range of choice available will be limited in some cases. Many sectors do not have an ethical option at all, while others have just one or two. Asia Pacific ex-Japan, for example, has just one fund – First State Asia Pacific Sustainability – which ranks number one over three years, and is first quartile for both one and three.

Of the 54 funds that have been around for a year, 14 rank in the first quartile – about as close to 25% of the universe as you are likely to achieve.

With little real indication that any one group has an edge over the others when it comes to investing ethically, it will be hard for advisers to know how best to steer those clients who wish to take a socially responsible attitude towards investing. But what is clear is that some groups take it seriously, and the choices are not so narrow as to make the choice of fund too onerous.

The business of socially responsible investing has become highly professional. Screening processes allow managers to make swift decisions on what can and cannot be included in a portfolio.

While some will argue any restrictions must limit the manager’s ability to perform, the evidence suggests otherwise. Over five years there are 40 funds with a record, and 10 are first quartile. It seems that the law of averages applies throughout.

So, for advisers with clients wishing to adopt an ethical stance, the choices are there and there is no reason to dissuade investors from following this route.

It is unlikely that anyone choosing to invest ethically will be doing so because they think they will achieve superior performance.

At least there seems no reason to believe that the results will necessarily be any different from those achievable through funds with a wider remit.

Ethical investment funds - top quartile performers