Benchmarking sustainable funds’ performance

Part of what held such funds back was that managers were missing out on strong performance by avoiding certain companies. For instance, funds ignoring so-called ‘sin’ companies such as the large tobacco firms would have missed out on substantial returns in the past two decades.

Funds attempting to invest in a sustainable way do not all follow strict ethical guidelines, but investors still need to be aware of what companies sustainable funds will avoid - or which they will narrowly back - and whether they believe the rewards of the investment approach outweigh potentially missing out on returns from certain industries.

But in spite of their restrictions (or perhaps because of them) there are several top-performing sustainable funds out there.

Success stories

The concept of sustainable investing encompasses a broad swathe of funds and investment products, from ethical funds and those investing on environmental, social and governance (ESG) issues all the way to alternative energy funds such as solar or wind.

Starting with the sustainable equity funds, there are, as of yet, no widely recognised indices or benchmarks for funds looking to invest in a sustainable way.

It is somewhat difficult, then, to compare like with like, but there have been some considerable success stories in recent years.

The Kames Ethical Equity fund is one of the longest-running funds with an ethical mandate in the open-ended fund universe.

The fund has been run by Audrey Ryan since 1999 and under her tenure it has delivered a return of 220.7 per cent, outperforming the FTSE All Share index total return of 136.2 per cent and the IA UK All Companies sector average return of 139.9 per cent.

The fund operates with a ‘negative screen’, in which the FTSE All-Share index is run through a series of quantitative measurements in order to exclude any company that fails to meet a set of strict ethical criteria. This means no mining, no arms manufacturers and no alcohol.

This culling of many of the large-cap names in the index means the fund tends to have a bias to mid-sized and smaller companies, which has helped performance in the past decade as that area of the market has outperformed.

But the fund is highly rated by analysts, with a ‘silver’ rating from Morningstar and A-grade from Square Mile, and for those investors happy to miss out on the potential returns from ‘sin’ businesses, the fund offers one of the best routes into investing sustainably in the UK.

Away from the UK, a fund group with a very strong track record of sustainable investing is First State Investments. First State’s team, led by David Gait, has generated strong performance on both its Asia Pacific Sustainablilty and Global Emerging Markets Sustainability funds for many years.

Both funds have significantly outperformed their index and sector peer group. The Asia Pacific fund is the top-performing fund in the IA Asia Pacific ex Japan sector in both five and ten years, beating the flagship First State Asian equity fund, Angus Tulloch’s First State Asia Pacific Leaders.

The Global Emerging Markets Sustainability fund is not actually within the IA Global Emerging Markets sector, after being forced out recently due to not fulfilling the requirement to hold at least 80 per cent in companies listed in emerging markets. However, it has beaten every fund currently within the sector in the past five years.

The team also runs a global equity fund, First State Worldwide Sustainability, but that has yet to generate the same level of outperformance as its two stable-mates since its launch in 2012.

The Sustainability funds are run with the express purpose of investing in companies contributing positively to the sustainable development of the countries in which they operate, whether through the environment, healthcare, “responsible finance” or infrastructure. These themes have been especially important in developing markets.

Thematic investing

Aside from funds investing to certain sustainable or ethical criteria, sustainable investment also encompasses funds investing in specific sustainable areas, such as water or agriculture, as well as alternative energy funds.

For investors looking to invest in sustainable energy funds, there are two major options: sustainable energy equities, for which there are several open-ended funds available; or investing directly in alternative energy infrastructure projects, for which there is burgeoning demand in the investment trust arena, with several new trusts having been launched in recent years.

Open-ended alternative or clean energy funds have yet to set the pulse racing in terms of performance, with all of them having suffered a torrid 2011, though they have delivered better returns in the past three years.

Pictet Clean Energy has been leading the pack recently, and Pictet as a fund house has a range of funds designed to cater for investors interested in sustainable investment, boasting water and agriculture funds as well as the Clean Energy fund.

However, when it comes to comparing performance between renewable energy investment trusts, things are trickier. Of the AIC sector for Infrastructure: Renewable Energy only one product has a three year track record – and that is a venture capital trust (VCT).

The purpose of the trusts is to deliver a high and inflation-linked income stream but, so early in their lifetimes, it is unclear which trusts can deliver best on that mandate and, as the sector is in its infancy, the trusts’ share prices are moving around somewhat independently of their net asset value (Nav) as investors try to pick the winner.

The best-performer until recently was Greencoat UK Wind, which investment trust broker Winterflood Securities surmised may be because it is one of the older trusts and had delivered on its promises so far.

But the trust was hit harder than most of the sector by the falling oil price, which investors interpreted as a negative for renewable energy.

Investors looking to put money in the sector may be better off waiting to judge which trust best delivers on its investment objectives before taking the plunge. For those willing to get in early, the trusts’ premiums to Nav are much lower than on conventional infrastructure trusts, which may present an opportunity.

matthew.jeynes@ft.com