A guide to ethical funds

Ethical funds are also known as green funds or socially responsible investment (SRI) funds, and are categorised as funds where the investment choices are shaped by criteria linked to social, environmental and other ethical issues. This is usually done through one or more of three approaches: screening, best in class and engagement.

Screening involves the exclusion of certain companies due to their involvement in ‘negative’ activities such as high levels of pollution, animal testing or dealing in arms. Companies can also be ‘screened in’ for making positive environmental and social contributions. These can include organic agriculture, providing recycling and waste services, or involvement with renewable energy.

Best in class is used to create preferences in selecting companies which share a number of other equal factors. Social, environmental and ethical criteria are applied to ensure the best companies of their type are selected for the ethical fund. An example might be a fund which enables investment in the oil and gas industry, but which offers investment in those companies with the best environmental and human rights records.

Engagement is different to the previous two methods, as it is not a method of exclusion, inclusion or preference. Instead, either the fund manager or the investor themselves offers active encouragement to the companies included in the fund to use social and environmental best practices. This is usually achieved through participating in votes at annual general meetings, or attending senior management meetings.

As mentioned earlier, many ethical funds opt for a combination of two or more of these methods to maximise their social and environmental impact. There are some trends, however: retail funds usually utilise all three methods in some way, whilst larger ethical pension funds are more likely to focus entirely on engagement.

Despite the positive outward impression ethical funds give off, they have come under some sharp criticism in recent years. Problems with some funds have included secrecy surrounding holdings, stock selection using outdated methods, and failure to publish ethical criteria. A few have even been found to be purchasing ‘sin stocks’, which includes the buying of companies such as pub chains and gambling businesses.

These issues have led to a number of market experts suggesting that some funds calling themselves ethical or green are simply engaging in emotive marketing. This, coupled with ethical funds gaining a reputation for sluggishness in terms of their performance, means that any investment in such a fund should be thoroughly researched and discussed with an independent financial adviser, before any money is invested.