Let me start by putting the case for not investing in ethical funds. Many will argue that the perfor...
Let me start by putting the case for not investing in ethical funds. Many will argue that the performance in general is below average, primarily from the fact that fund managers have a restricted number of companies in which to invest. Perhaps the biggest negative of all is the inability of ethical funds to make an actual difference to society surely there cannot be enough money invested in ethical funds for them to make any practical difference?
As an IFA and ethical fund investor, I believe ethical funds offer excellent growth prospects to potential investors and are perhaps likely to show the way forward as regards fund management.
No one can have escaped the issues of climate change over the last few months. The real impact of this is yet to be felt and there is little doubt that many companies will make huge global losses as a result of this.
The predictions for the future really do not make good reading. Add to this the current issues we are facing concerning foot and mouth disease and the way food is generally prepared throughout the world and there is clearly enormous concern about environmental and social issues.
Having painted this rather bleak picture, it is worth considering whether there are any solutions to this problem. There is no doubt that financial services companies could make a real contribution towards encouraging positive changes via the way they allocate their money. This is particularly true of insurance companies and investment houses, whose total assets account for more than 25% of the UK stock market.
Insurance companies and investment houses have the power to change how companies are run and ensure they take responsibility for what they are doing to society and the environment.
We need to add the fact that the Government is increasingly asking companies to give more information on how they run their organisation. Speaking to industry managers and environmentalists recently, Tony Blair said he would like to see more reporting on environmental and social issues. He added: "The pioneers of environmental reporting companies like BA, BT, British Gas and BP are seeing increasing benefits from both improved efficiencies and public image as a result.
"This is something that all companies should be doing and I am issuing a challenge to all the top 350 companies to be publishing annual environmental reports by the end of 2001."
What this indicates is that people must not think of ethical fund management as something that will disappear over time. There is no doubt that behind the scenes Government involvement will mean ethical issues become much more prominent over the next five years.
The leaders in the field of ethical investment have always appeared to be Friends Provident. Its Stewardship Fund was certainly the first major ethical fund in the marketplace and led the way in terms of ethical investment in many people's eyes. While there are now a number of other companies running ethical funds, it is Friends Provident once again that may well take this whole issue forward.
Friends Provident has launched a new concept called REO (responsible engagement overlay), which is an attempt to ask all of its funds managers to engage with the companies in which they invest. The problem historically for ethical funds on areas such as animal testing is that they will simply not invest in this kind of company which gives them no power to make changes within that organisation. Friends Provident is not asking fund managers to stop investing in these companies but rather asking them to use their power as a shareholder to question the decisions being made.
Surely this lead is the one the industry has been waiting for. It gives investors the power to change the companies in which they invest for the first time. However, the real question is how many other leading insurance companies will follow suit.
It seems clear that insurance companies and investment houses, not only in the UK but also worldwide, will actually start to have a much bigger influence on the way companies run themselves.
Ethical funds have always tried to change society but their power up to this stage has been extremely limited because they do not invest in the companies they really want to change.
The changes gradually creeping into the financial services industry will give more power to the investor. No leading company can possibly ignore the threat of withdrawal of investment as insurance companies and investment houses are powerful influences on the share price of any organisation.
We therefore come to perhaps the key issues in terms of ethical investment: why invest in ethical funds when all investment will effectively have the same impact?
There is no doubt that the issues involved in ethical investment can only work if non-ethical funds also support their causes. Having said that, ethical funds in themselves are excellent investment opportunities for a number of reasons. For example, if we look at the issue of climate change, few fund managers have yet to analyse the possible risks and threats arising from this, even though it has the potential to affect the valuations of many major corporations. The oil, power generation and transport sectors are particularly vulnerable to changes in the regulatory machine controlling the emissions of greenhouse gasses. The exact magnitude of this risk is unknown but there is no doubt it will be large.
In addition to this, food manufacturers, the building and constructions sector and car manufacturers in particular will also feel the impact of climate change and probable Government intervention. Where ethical funds have an advantage over general investment funds is that they will be seriously avoiding companies that are likely to be affected in these areas. They will generally be focusing on such areas as telecoms, technology, education and training, leisure, multimedia and recycling, all of which could be considered potential growth areas over the next few years.
The approach we are now seeing from the leading ethical teams is very different from that of the traditional ethical investor. Instead of focusing on the strict negative criteria and then looking at a vastly restricted investment universe, the approach of these companies is to focus on companies that are making a direct difference to society and, in so doing, creating long-term sustainable development and growth.
This is great news for the ethical fund investor. Although it is not their money alone that will make these changes, there is no doubt that the original concept of ethical investment and making a change to the way that the society is run is starting to take hold of this country.
However, as I have made clear, ethical funds themselves still offer fantastic growth possibilities for investors. The argument that they have underperformed over the last few years just does not hold water and there is no doubt that, over the last year, ethical funds in general have outperformed the UK market.
I now believe ethical funds should make up at least 10% of every investor's portfolio and perhaps even more once many of the leading providers start to make their funds global. At the current time, the majority of players are restricted to the UK.
The message I would give to advisers and potential investors is that ethical investment is changing and changing for the better. Let us hope that more of the major insurance companies and investment houses become committed to this area.
Andy Bracken is associate director of Timothy James and Partners
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