Ethical funds measure up in different ways, says Nick Sudbury. Some simply screen out the bad, while others actively support the good. But does it make any difference to the performance? 

 

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Positive Discrimination

Standard Life Investments UK Ethical Fund

There are around 50 UK based funds that have an ethical bias to their investing – and with every passing year, their attraction for investors and especially pension funds seems to grow. Most of these funds, of course, apply traditional negative screening to weed out companies that are considered to have a harmful influence; but those with an SRI mandate will often adopt a different approach, deliberately targeting more ‘socially responsible’ businesses.

Some will argue that the SRI type of approach is not only worthwhile but can also result in better performance – although the evidence is sometimes patchy. When the first of these products was launched in the UK back in the 1980s, it was mischievously dubbed the Brazil fund because you would have to be nuts to invest in it. Thankfully things have moved on since then and some have delivered some decent returns.

The Standard Life Investments UK Ethical fund is one of the more outstanding success stories. Aiming to provide capital growth, it’s ranked 29^th out of the 270 funds in the UK All Companies sector over 5 years, with an impressive gain of 151.3%. What’s more, it has done equally well over shorter time periods.

Lesley Duncan, the manager, invests in companies whose business activities she regards as making a positive contribution to society, in terms of preserving the environment or improving the quality and safety of human life. She also aims to avoid those that fail to meet a strict set of ethical guidelines.

The underlying criteria are approved by the Standard Life Ethical Committee and may be amended from time to time if appropriate. The Committee’s meetings are chaired by the company’s chief operating officer, and they include both investors and the managers themselves. Normally the committee will sit four times a year, with the aim of ensuring that the company’s ethical policy is correctly applied.

According to the latest data, the £213 million fund is currently invested in 64 different UK shares. The top 10 represent 26.6% of the portfolio and include businesses such as ASOS, DS Smith, Whitbread and Barclays. Just over a third is invested in the blue chips of the FTSE 100, with a further 56.5% in the mid-caps. The remaining 10% is in the smaller end of the spectrum.

 

Rigorous Approach

Kames Ethical Cautious Managed

Kames Capital is celebrating its 25^th year of ethical investing, which makes it one of the longest serving groups in the sector, and it has three products targeted at this segment of the market.

Like all the others, the Cautious Managed fund uses a rigorous screening process to identify which companies it should avoid. For Kames, these include businesses that supply the military or that operate in the nuclear power industry, as well as those that damage the environment or are involved with gambling, tobacco or alcohol.

The fund aims to provide both income and capital growth by investing in UK equities, bonds and cash, with all the holdings having to meet its strict ethical criteria. These are designed to prevent it from buying shares in companies that harm people, society, animals or the environment.

It has built up an impressive track record, and it is ranked second out of the 144 funds operating in the IMA Mixed 20%-60% Shares sector over the last 5 years. Despite this the cumulative return since it was launched in March 2007 has been limited to just over 50% by the impact of the 2008 financial crisis.

Around 54% of the fund is invested in equities, almost all of which are listed in the UK. It’s a diversified portfolio of 86 separate holdings, with the top 10 accounting for just 13.7%. Most are mid-caps, because blue chips don’t tend to meet the ethical criteria – and, in order to control the extra risk that results, the manager keeps them down to less than 3% each. The fixed income allocation makes up a further 38% of the fund and comprises 123 holdings, the majority of which are sterling investment-grade bonds. There is also 8% in cash.

Using an ethical screen is likely to affect the short-term performance, relative to its more mainstream sector peer group. To accommodate this, the fund aims to be in the second quartile over rolling 12-month periods and in the top quartile over rolling 3 years. The managers have certainly achieved the latter – and they have also accomplished their other objective of beating the 50% FTSE All-Share/50% iBoxx sterling non-gilts benchmark. These sorts of returns suggest that it’s a decent option for ethical clients looking for a multi-asset exposure.

 

Accentuate the Positive

F&C Stewardship Growth

It would be logical to think that an ethical screening process would ensure that the fund’s returns differ significantly from a mainstream benchmark – but in fact, history suggests that many socially responsible investments tend to perform in line with the wider market.

One such strong performer is F&C Stewardship Growth, which is currently ranked just below the middle of the UK All companies sector over a five year period. During that period it has been up around 100% – very similar to the gain on its FTSE All-Share benchmark, with which it has a high correlation. And this despite the fact that the positive screening means that some of the country’s largest companies are off-limits.

Catherine Stanley, the manager, aims to achieve capital growth and increasing income by holding a portfolio of UK companies whose products and operations are considered to be of long-term benefit to the community. She works closely with F&C’s Governance and Sustainable Investments desk and an independent Committee of Reference to ensure that each holding meets the ethical code that underpins the fund’s mandate.

Wherever possible, Stanley and her team try to meet the company management before making an investment in their business. This enables them to gain a better insight into their operations and to open a constructive dialogue on a range of environmental, social and governance issues.

It’s perfectly possible for stocks to fail the ethical screen and then change some aspect of their business so as to become acceptable. This was the case last year with AstraZeneca, GlaxoSmithKline and BHP Billiton, the last two of which are now among the fund’s top 10 holdings. The other major weightings include the likes of HSBC, Vodafone, BG and Legal & General.

In many ways it is surprising that the fund is so closely correlated with its FTSE All-Share benchmark, but the fact that it is could be reassuring for clients who want an ethically screened exposure to the UK stock market. Those that also need a decent yield may prefer the F&C Stewardship Income fund, which is run on similar lines but is paying out 3.5% a year.

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Brighter Future

Jupiter Green Investment Trust

Clients who want to actively change things for the better might favour the more proactive approach taken by the Jupiter Green Investment Trust. The fund aims to generate long-term growth by investing in a global portfolio of companies with a significant emphasis on environmental solutions.

Manager Charlie Thomas concentrates on what he sees as the core economic drivers such as the growing investment in renewable energy and greener infrastructure. Thomas has a strong bias towards small and medium cap companies, which can be seen from the top 10 holdings that make up around 30% of the fund. These include the US-listed Wabtec, which makes technology-based products for the rail and freight industries; the engineering and environmental consultancy Ricardo; and Cranswick, a UK food producer with green credentials.

JGC has had a strong 12 months, with the share price rising around 27%, but the longer term return has not been as impressive. After some decent initial performance, the financial crisis of 2008 left it trading well below the June 2006 issue price – and as a result the cumulative return over its first 8 years is not much more than 40%. By comparison the MSCI World Small Cap benchmark is up in excess of 150%.

The environmental sector hit a low point in early 2013, but since then it has bounced back strongly. This has been mainly due to improvements in the supply and demand dynamics in important areas like renewable energy, as well as the new raft of environmental policies announced by China and the broader economic recovery in the West.

Around 34% of the JGC portfolio is invested in the US, with a further 26% in the UK, and with most of the rest being divided between Europe and Japan. There have been times when the shares have traded on a 20% discount to NAV, but the recent strong performance coupled with an active share buyback program has narrowed it to less than 2%. The management fee is 0.85% and there is also a performance related fee, with the combined total capped at 1.75%.

There is no doubt that the areas the fund invests in will attract a lot of attention in the coming years, but the onus is on the manager to find robust companies that can outperform the wider market. This is no easy task – although the recent performance suggests that with the right tailwind he is perfectly capable of delivering a satisfactory return.

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