The value of virtue

When even charities are ignoring their ethical principles when it comes to DC investment, what chance has SRI with the broader workforce, asks Paul Farrow


Most people probably do their bit for the environment by recycling their empty wine bottles, tin cans and newspapers every week. But for many people that is as far as it goes.

But entrusting your retirement pot to an ethical fund provider is an altogether different matter – or so it would seem. All the evidence points to ethical investing in the defined contribution sector struggling to make an impact – take up today appears as low as ever.

It is not as if access is a problem. According to the National Association of Pension Funds, the number of options available to employees has increased over the past five years. The proportion of schemes offering an ethical option in 2005 was 40 per cent; in 2006 it was 38 per cent, 40 per cent in 2007, 39 per cent in 2008 and 55 per cent – the highest on record – in 2010.

Mark Pearson, head of investment marketing at Aegon Scottish Equitable, says: “Funds are offered for credibility. There is a view that schemes have to offer an ethical option. But while they have been around for a good while now, there has not been any real uptake.” Fidelity admits that trustees and plan sponsors are keen to understand what funds are available within the ethical fund category but this has yet to be translated into higher take up – even though almost one in five plans on its platform have access to so-called green funds.

Julian Webb, head of DC at Fidelity, also says that during the market downturn there has been no real evidence that investors have either actively moved in or out of the funds.

“Given that ethical and SRI funds have been available for 20 years or more take up rates have remained very low. It would appear that there is little interest beyond those DC members who actively seek them out,” he says. “Flows into these funds have also been modest with less than 0.5 per cent of our total platform assets being invested in these funds.

Michelle Cracknell at Skandia says that its sales tell a similar story and that the recent market volatility does not appear to have led to a change in investors’ decisions to invest ethically. “Investment into the 30+ funds in our range, which qualify as ’ethical’ or ’socially responsible’ differs slightly each month, but as a proportion of total fund inflows it has remained fairly stable.”

A look at the performance figures hardly flatters the sector. The five biggest ethical funds in the ABI pension sector have performed dismally over the past five years – not against non-ethical funds but against their peers. Not one fund has delivered above average performance over either one, two or three years. F&C Stewardship, which is the biggest fund by far, is fourth quartile over five years too.

Fund managers, advisers and consultants believe that communication could be a negative factor. Almost two-thirds of people (62 per cent) surveyed by EIRIS, could not name or describe in detail any ethical financial products or services.

Awareness was even found to be low among those that stated they were interested and likely to consider ethical credentials when next choosing a product or service; almost half (48 per cent) of those in this sample could not name or describe in detail any ethical financial products or services.

Cynicism also plays its part. According to the same EIRIS survey a third of people would not buy ethical financial products and servicesbecause they ’do not trust the claims of financial providers’.

So is there any hope that ethical investments will ever become a dominant force in the DC sector? There is a belief that younger generations, who won’t remember the time when there were not any recycling bins, will take more of an interest in investing ethically. Cracknell says: “I still think that it is highly likely that there will be an increasing amount of money that will go into this sector. Consumer trends suggest that individuals’ attitude to social responsibility is on the increase and by definition, with increase in fund value and DC pensions, the funds available for this type of investment are likely to go up.”

Steve Pyne at Holden & Partners already says that he is seeing more interest for ethical funds from new joiners (and younger) to schemes because ethical issues such as climate change are, perhaps, closer to home and on their minds.

He adds: “It is different to those workers in their 40s and 50s, many of which would be in a life-styling option, but the option doesn’t cater for ethical investment too much. In fact, those people looking to make extra contributions have been more than willing to consider non-ethicaloptions.”

There is another glimmer of hope for the ethical factions. In the distant past ethical funds simply screened out what was ethical and what was not. But there has been a shift in attitude and strategy. Certainly in the defined benefit space the onus is on ESG principles – Environment, Social awareness and Governance. This has opened up the remit and gives pension fund managers greater freedom with stock selection.

“Many DC schemes I come across have a very narrow range of funds – which are traditionally heavily screened. When you exclude so many stocks it makes it very difficult to outperform,” says Rachel Whittaker, senior associate at Mercer. “The information given to employees is simply an overview and a list of names so it is difficult to convey the message of what the fund is attempting to do.”

But what of today? Everyone seems to have jumped on the green bandwagon for some part of their lifestyle. Whether it is in the newspapers, on BBC1’s Question Time or Radio 4’s Today programme, global warming is on the agenda and politicians have had little choice but to take note. It is why David Cameron got on his bike and installed a wind turbine on his roof.

But while the majority of Britons are only too willing to recycle, for many that is as far as it goes. It would seem that unless an ethical fund becomes the default option, take-up will remain low.

Many DC schemes I come across have a very narrow range of funds – which are traditionally heavily screened. When you exclude so many stocks it makes it very difficult to outperform

“The case for being more environmentally aware makes sense but it hasn’t seen the explosion in green investing that perhaps it should have, but 85 per cent of employees simply tick the default box,” added Pearson. “That could either mean that employees aren’t equipped to make a decision or that they don’t care.”

But having ethical funds as defaults is not, says the experts, straightforward. For instance, it could be deemed to be the choice of the trustees, or employer – but will they then be forcing their views on the world on employees? This could especially become an issue if the fund underperforms. Pearson added: “It is interesting to note that Nest never talked about an ethical fund as a default option.”

Patrick Connolly at AWD Chase de Vere admits that while many investors are keen on the thought of investing ethically, most decide not to when they realise that it could potentially have an impact on their overall investment performance and lead to more volatility.

He added: “If less investment stocks or sectors can be selected then it is more difficult to build a diversified portfolio. It is also really difficult to get access to some asset classes while investing ethically, such as commercial property. Could you justify government gilts as being an ethical investment?” Webb says: “The only thing that is going to increase asset flows is if these funds are used as defaults. However, this seems unlikely given the increasing need to reduce volatility and improve diversification for DC members.”

If less investment stocks or sectors can be selected then it is more difficult to build a diversified portfolio

Lee Coates, an ethical financial adviser, says that one of the big problems is that corporate advisers don’t see ethical as a burning issue and that unless a trustee has a particular passion for green issues then the subject will not be raised at meetings or in communications to employees. “There is still prejudice against ethical investing – too many consultants and advisers use a ’protect your back’ mentality and simply look at risk profiles and do not bother to talk about the options on top, which would include ethical funds.”

Coates is also concerned that many organisations such as charities do not follow their own principles when it comes to their own pension schemes. He is currently writing to charities and NGOs to examine whether they adopt ethical principles to their work operations. The aim is to ’out’ those that contradict their principles.

Coates adds: “Many charities’ default funds are unethical, yet many of their pension funds for employees are being funded by donations. These are donations made in good faith without the knowledge that they could indirectly be funding sweatshops and children working in mines. Most people are blissfully unaware of this and are shocked when they discover the reality. We will be publishing those charities that do abide by their principles on our website when we get the findings.”

The quest by Coates is an intriguing exercise and the outcome could be telling. If charities cannot make the effort to adopt ethical funds as a default option then why would private companies take the steps to engage their employees?


Goldthwaite: Still a future for ethical funds
Goldthwaite: Still a future for ethical funds

It is the granddaddy of ethical funds. The F&C Stewardship fund, which launched on June 1 1984 under the Friends Provident brand, has been flying the green flag ever since. The fund broke ground as the first pooled ethical vehicle in Europe. It enabled private investors not only to access a diversified portfolio that ruled out companies based on concerns such as tobacco and gambling, but also introduced screening on environmental and human rights issues for the first time.

More than a quarter of a century on and the fund is by far the largest ethical fund – the pension version is £1.1bn according to Morningstar. Not surprisingly, given its size, it is the one fund that advisers recommend time after time.

Yet performance over the past decade has been sketchyin six out of the past 10 years it has underperformed the average fund in its sector. The financial crisis has been particularly unkind and it has delivered third and fourth quartile performance in every discrete year since 2007. On the other hand, it achieved first quartile numbers in 2006-7, 2004-5 and 2003-4. In 2002-3 it was a second quartile performer.

The financial crisis has had a detrimental impact. The fund came under fire last year when Lee Coates, an ethical financial adviser for 20 years and a former supporter of the fund, stopped recommending the fund. He was appalled with the decision for the Stewardship fund to invest in banks, ironically just before the financial crisis took hold. He was angry that investors did not get to approve the decision.

F&C said that its performance has been nothing to do with the banks, but one bad year has dragged the longer-term figures down. It blamed the underperformance figures on 2008, when its high exposure to small and medium sized companies caused the fund to fall by about 40 per cent. The fund excluded many FTSE100 stocks on ethical grounds, so it missed out on the better performing large caps, it said.

Friends Provident, which is responsible for marketing the fund, admits that it has not been an easy period to sell ethical wares. Those trustees that didn’t understand fully understand the fund will be the ones that are unhappy.

“Ethical is a very easy story to sell in rising markets and trustees are very enthusiastic as they can enjoy the prospect of positive returns and still play the ethical card,” says Lillian Goldthwaite, manager fund strategy selection at Friends Provident.

“The market is the bootstrap test and trustees are discovering that their default fund is not as balanced as they thought – it is not just ethical funds where this is evident. We haven’t heard a peep from those that understand the fund.”

Goldthwaite insists there is still a future for ethical funds, although she admits that they will and should never be one of the first considerations for pension schemes. “In the past advisers thought 100 per cent equities was the right direction for default funds, now they are steering the boat towards diversified growth. You have to consider the right assets and the right level of risk as a starting point, before beginning to introduce an ethical overlay. But to be honest that is the right order.”