The Ethical Dilemma

Green and ethical issues are never out of the headlines, yet employees have been slow to engage in SRI funds through pensions. Paul Farrow discovers this month\'s National Ethical Investment Week aims to change that

The clamour for all things green continues unabated. Alistair Darling has clamped down on Chelsea tractors in his Budget, M&S is now charging for carrier bags and Virgin has launched a climate change fund. The media frenzy around global warming has not escaped the financial services industry, which this month holds its inaugural Ethical Investment Week conference.

It is the first time that the financial services industry has worked together, under the umbrella of UK Social Investment Forum, in a programme to raise consumer awareness of green and ethical investments.

Backed by major fund managers, financial advisers and community organisations it aims to raise awareness of green and ethical investment choices.

James Dalby, fund propositions manager at Norwich Union says: “There are many myths surrounding green and ethical investing. One example is ‘ethical funds usually under-perform’. This is generally untrue – and National Ethical Investment Week, which will run from 18th to 24th May, will help to bust this and other common myths surrounding this growing area.”

Julia Dreblow, SRI marketing manager at Friends Provident says: “Although ethical investment has enjoyed fantastic success over recent years, many people are still not aware of the range of green and ethical choices now available. National Ethical Investment Week will raise the profile of ethical investment as an option for all investors. Fairtrade Fortnight has shown how this sort of week can really make a difference.”

Certainly the official figures back up Dalby’s and Dreblow’s remarks and illustrate that green investing is growing. According to figures from EIRIS, as at 31 December 2007 there was £8.9bn invested in Britain’s green and ethical funds. The Investment Management Association says that the quarter to the end of September 2007 saw an increase of nearly 600 per cent in net new investments in ethical funds compared with the same quarter the previous year.

But while the whole world is going green and consumers are beginning to consider investing ethically, when it comes to employees they do not seem to care too much about having an ethical pension.

The take up of ethical or socially responsible funds (SRI) in the DC arena is slow. The latest annual survey by the NAPF shows that ethically and SRI options are offered by just 40 per cent of DC schemes compared to 38 per cent in 2006 – and oddly 40 per cent in 2005. And all those that offer an ethical option have a default fund which is not an ethical fund.

Slow takeup is demonstrated by the fact that Fidelity decided to put its first ethical fund on its pension platform in 2005. It opted for F&C Stewardship at the time, and three years on it is still the only green fund Fidelity offers, even though there are now dozens of funds with decent track records in the marketplace.

Julian Webb, head of DC business development at Fidelity, says: “It was put on the platform because trustees, sponsors and advisers wanted it but we are not seeing huge cash flows and because they are not utilised as default funds – and that is where we know most of the money goes. Where it is being utilised – and I think where the immediate future lies – is for people who have a preference for ethical to invest in personal pensions and unit trusts.”

Friends Provident, the leading player, says it has not noticed any significant increases or drops in demand for ethical funds over the past 12 months, but currently has no plans to actively promote the funds. It adds that a small number of organisations (mainly charities) specifically request ethical funds and use them as the default fund but these are in the minority.

“As an example we currently have three schemes – two of which are charities, and one is a not-for-profit theatre. We find that in this situation a high percentage – around 85 per cent – of the employees within the scheme opt for the ethical fund,” says a spokeswoman. “We currently run a GPP for a FTSE100 accountancy firm. Around 130 of its members have selected ethical funds, just 5.5 per cent of the total membership.”

One of the problems with take-up, say experts, is the increasing numbers of funds on offer and that is confusing matters. When the first ethical funds appeared in the early 1980s what a green fund stood for was relatively straightforward. A manager would not typically invest in stocks if they were associated with industries such as tobacco, brewing, armaments, oil or pornography. The Stewardship fund was the classic example of such a green fund – one that excludes stocks that do meet certain strict criteria.

But now the vast majority of green funds focus on “socially responsible investment”, or SRI as it is known. Rather than screen out stocks, funds that follow the SRI route take a more positive approach, investing in companies that adopt good environmental and social practices, regardless of sector. It is difficult to decipher what funds stand for.

Naturally this more proactive approach means that companies that would not otherwise be included on some of the strictest funds can be included in so-called ethical portfolios. Oil companies, for instance, are typically excluded from green funds – many extract oil in countries such as Kazakhstan, where human rights issues have been raised. But a stock such as Cairn Energy could count because its fields are in Bangladesh and India, which pass its human rights criteria.

The so-called “engagement” approach is one area that some managers reckon will appeal to investors who are concerned about compromising on performance by excluding rafts of companies. If companies measure up poorly, managers will go back and talk to the board and encourage them to do better. Whether fund managers have the clout is debatable – they would have to be major shareholders to shake-up an AGM, but the principle has some credence.

In short, the burgeoning ethical investment fund arena is becoming a minefield. It can be staggering to read the types of stocks held in funds – and many of them may not be what your ethics dictate. For example, climate change funds are the latest wheeze but Holden & Partner’s Guide to Climate Change Investment cast doubt on many of the funds credentials.

The firm analysed the top 10 holdings of every SRI fund available to private investors in the UK. Most had only insignificant holdings in clean-tech or environmental companies – while instead banks and telecoms companies dominated. Only one out of 58 funds analysed claimed to have more than 50 per cent of its portfolio in environmental stocks.

Virgin has admitted that many stocks in its new climate change fund will invest in companies that make a big contribution to greenhouse gases and this could include airlines. It argues that it is about investing in companies that have a lighter footprint than their peers in a sector.

Doubt has already been cast on whether many fund managers going down the SRI route have the resources actively to build a relationship and influence companies they invest in. It wasn’t so long ago that another report, from FairPensions, claimed that the majority of Britain’s biggest occupational pension schemes were keeping their members in the dark about the environmental and social impact of their investments.

It argued that the lack of transparency meant a supporter of Amnesty International may unwittingly be backing business ventures in states with oppressive regimes, or someone who regularly donates to Friends of the Earth could discover they have effectively been supporting an oil company’s climate change denial policy.

The plethora of fund choices is clouding the issue and putting trustees off from making a decision – or from wanting to get involved in the first place.

“The big problems are that there are so many different types of fund and trustees do not know which to go for. There are so many measures and exclusions that nobody knows what the definition for ethical is,” says Tim Currell, head of sustainable development at Hewitts. “It is why the FTSE4Good funds are quite a good option for trustees.”

One of the leading players in the ethical arena is Jupiter. It has a decent track record and the resources to match – and Emma Howard-Boyd, its head of SRI reckons that funds that take a negative screening approach could well be less consumer friendly than positive screened companies.

“If a company implements a climate change strategy for its business – a fund with a climate change remit and one which can be seen to be profiting from improving the environment is more likely to resonate with employees.”

It’s a point echoed by Webb. “I would have thought that funds that are positive would have a better chance of growing in popularity. Employees would have a better chance of understanding what the fund is about.” Webb adds that names such as ‘Stewardship’ may not stand out as being ethical funds to the uninitiated and perhaps that does not help with take-up.

Ethical investing is still an immature area and consultants could make a difference. Many upped the ante, have specialist teams and are recruiting experts to assess the different strategies to advise employers.

Currell says that each time a DC scheme is reviewed, ethical options are discussed – although they and not the employers prompt discussions. “We raise the issue but they do not feel ethical is high on their list and that they are not getting loads of queries from staff.”

Trustees and sponsors are still sceptical on performance despite the age-old myth that ethical investors have to compromise on performance being turned on its head. Performance from many groups has rivalled that of their non-ethical peers, with many frequently at the top of the performance tables, and all of a sudden green fund managers are not the hippies they were once perceived to be. Indeed, a report out last month showed that ethical funds perform just as well as non-ethical ones.

The report, compiled for Oxford University, finds that in UK equities ethical funds outperformed the market on average over the past one, three and five years, and broadly matched the market and non-ethical funds over 10 years.

In global equities, ethical funds outperformed over one, three, five and seven years, but lagged modestly behind over 10 years. They outperformed non-ethical funds over all of these periods apart from five years. The report points to ethical funds’ structural bias towards mid- and small-cap companies as a key factor in determining their performance.

‘Socially responsible investment (SRI) funds have sometimes laboured under the misconception that investors sacrifice returns if they invest in funds with an ethical or SRI policy,’ said Edward Jewson, chief executive of investment consultants Jewson Associates, which compiled the report. ‘But our research suggests this is not the case over the long term.

‘What we have found, however, is that returns from ethical funds in the UK are, to some extent, correlated with the performance of small- and mid-cap stocks, and so are likely to be more volatile.’

But again, while advisers and consultants know the score, the perception in the marketplace is still one of performance being compromised. “Greed is also a natural human trait, and a common response from clients when discussing the merits of ethical investments is that “I like the idea, but not if it means I will get a lower return”,” says Lee Smythe at Killik.

Perhaps it is hard to knock take up of ethical funds – the default issue is still a major problem as at least 80 per cent of employees simply tick the box and opt for the default fund. Even the most enthusiastic ethical fans do not believe ethical funds will become default options for a long, long time.

“I think that from an employers point of view it would be unlikely that an ethical fund would be selected as a scheme default as the employer may feel that it was pushing their own view on the staff and that by implication they consider all of the other fund choices to be unethical,” says Smythe.

Currell adds: “It would certainly be a big leap for a negatively screened fund to be a default option. Probably too big a leap.”

Others are more positive that the take-up – whether or not as default – will increase. The environment and its future is no longer an issue that the world can pay lip service to – and in the UK the coming personal accounts will offer employees an ethical option.

George Latham, head of SRI funds at Henderson Global Investors admits that ethical pensions have yet to take off in the workplace. His hope is that will change as more companies take corporate responsibility in general more seriously.

“At some stage that will feed through to how they manage their pension scheme. This is likely to come true in the money purchase (DC) pensions market where employers will increasingly start to look to offer an ethical option and devolve the question to employees,” hesays.

“We understand there is quite a push at the moment within the Personal Accounts Delivery Authority – they have shown signs of interest in making an option within that an SRI option and for the default option to have a long term responsible investment approach.”

Meanwhile, IFAs are catching on. Apparently, about 1,200 now advertise that they offer advice on ethical products, according to the UK Social Investment Forum. More than 3,000, at a rate of 14 a day, have signed up to its online training programme on all things green. The hope is that these IFAs will begin to push the cause to employers.

“I can’t see the trend for care for the environment going backwards,” says Howard-Boyd. “There is no reason why general advice for investments will not move to the broader pension space.”

But it is worth noting that according to the Investment Management Association, just 1 per cent of the £54bn in Isa money with fund managers is in green funds – and that is after a surge in popularity. It shows how far the industry has to go to get employees to jump on the green bandwagon. n