Choosing the best Ethical funds

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Ethical investment vehicles have attracted some criticism since they first appeared on the scene, but over the years they have gained many more loyal advocates. The most prominent of these appeared a few weeks ago, in the form of the regulator.

FCA chief executive Andrew Bailey points to two investment trends – the rise of both passive and ethical funds – as growth areas of the future. He notes that these offerings should not only “coexist”, but receive some form of backing from the watchdog.

“An industry that enables the support of patient capital and innovation, and of ethical investment and social responsibility, will be one where the trust will be stronger and deeper, and the culture will prosper. The regulator can help by enabling change to happen,” he says.

Mr Bailey’s comments come at a time when ethical funds – and other investment approaches that factor in sustainable or environmental concerns, or even just particular views on how companies should be run – are attracting attention like never before. From advice firms to wealth managers and fund houses, specialists have increased their focus on these areas, citing rising client demand. And research suggests the industry is at a tipping point.

Schroders observes that more than half of investors have increased their sustainable investment allocations in the past five years. On another front, Triodos Bank has forecast the UK market for socially responsible investing to grow by 173 per cent from now until 2027, reaching £48bn in size.

As demand continues to rise, intermediaries would do well to assess which funds are serving clients best while also catering to their beliefs. But this remains difficult for multiple reasons.

Needles and haystacks

Expansion in this space is leading to a confusing array of products. Ethical funds and portfolios may be available, but so are offerings that focus on all manner of other separate concerns, including the likes of environmental, social and governance approaches, impact funds and SRI. 

Such preferences are likely to evolve further, and this is not helped by the fact that the same terms can be used to mean different things, making it difficult to choose, or compare, relevant funds. The problem is compounded by the fact that ethical funds are not given a peer group: when it comes to the Investment Association, many are grouped according to the main asset class or region in which they invest, while others sit in the Specialist sector.

But while interest in ethical investing and related approaches is gathering significant momentum, this has not translated into assets under management. In August, ethical funds held nearly £17bn, according to the IA. This figure alone does sound significant, but it makes up just 1.3 per cent of the industry total and is barely higher than the 1.2 per cent taken up by ethical funds 10 years ago.

If these funds are so popular, why are they so light on assets? Several possible reasons exist.

First, the nature of the funds’ most prominent supporters offers an explanation. Millennials are tipped as the generation that will help such products gain scale – but much of this generation is still too young to generate significant assets, or commit heavily to investing. If this argument holds up, the relevant funds could experience an uptick in assets in the future.

Olivia Bowen, a chartered financial planner at Castlefield Advisory Partners and part of industry body the UK Sustainable Investment and Finance Association, notes that while demand has come from different ages and genders in the past, an uptick in interest from younger individuals is now particularly apparent.

Other issues remain when it comes to definitions. The IA’s measure of ethical fund assets may not count some of the other approaches listed, such as responsible investment funds. Similarly, some funds that now focus more on value-driven metrics, such as a company’s standard of governance or green credentials, may not explicitly define themselves as taking an ethical approach.

As such, Ms Bowen believes advisers looking to embrace the ethical trend should concentrate on their own knowledge in the area, as well as focusing on new sources of demand. “Advisers need to educate themselves regarding SRI and embrace the public’s interest in ensuring their assets are managed with a view to addressing the great risks of our time: climate change, demographic changes, pollution and water security,” she explains.

The bottom line

Many advocates of ethical funds say that the argument on whether ethical investors are giving up performance for their beliefs has now been settled. But even if ethical funds can compete with conventional offerings, it is still important to get the best returns for clients.

With this in mind, we have analysed the best explicitly ethical or ESG-focused funds by five-year returns, as detailed in Table 1. Our analysis looks at the top five equity names, but also takes in multi-asset and bond offerings. 

F&C Responsible Global Equity tops the equity rankings, returning £2,023 from a £1,000 lump sum over five years. 

As our data runs until the end of September, it does not reflect how October’s market volatility affected the funds. But the recent success of the F&C portfolio can be explained by the managers’ allocation decisions, both in terms of region and sector. The offering’s largest geographical weighting at the end of September was a 56 per cent exposure to the US market. 

At the same time, the managers have heavily backed tech stocks, which performed well until the recent sell-off: 23 per cent of the F&C fund’s assets are allocated to IT, with both Apple and Amazon among its 10 biggest holdings.

When it comes to fixed income, other sectors have played a part in the success of investors. Rathbone Ethical Bond, run by Bryn Jones, has a heavy bias to finance.

Changing priorities

The tech effect, as well as the broader strong performance of stocks, is once again obvious for multi-asset managers. Royal London Sustainable World Trust, the top name in the multi-asset section, had a 34 per cent exposure to US equities, with Amazon and Alphabet among its top holdings.

Apple, Amazon and the other ‘Faang’ stocks (along with Facebook, Netflix and Google), which have performed well in recent years but look vulnerable to market shifts, may well become a dividing line for some ethical managers, given some investors avoid many of these. 

Recently, Neville White, of fund house EdenTree, noted that “all Faang companies, with the exception of Netflix, have been subject to sustained and serious controversy” on issues around privacy, tax avoidance and poor labour conditions. 

In the meantime, advisers need to check which way their clients’ ethics lean, and how this fits in with different portfolios. For some, investing in this way may still present an opportunity cost.