There is one sector that has returned 18.58% annualised since 1987. The good news for socially responsible investors is that it is sustainable forestry and institutions have been leading the way in developing the sector
Ethical funds still only account for a modest proportion of total assets under management and most financial advisers have little experience or interest in what is still regarded as a 'niche area'.
It may be true that the demands of being an intermediary are too great to allow any but the most committed to look beyond the traditional model. However, there is evidence to suggest that advisers who ignore the quiet revolution that has been happening around them, do so at their peril.
Many advisers may still not have heard of the UK Social Investment Forum (UKSIF). However, a glance through the membership list (at www.uksif.org) should provide a good enough starting point to suggest our major financial institutions are taking social responsibility a little more seriously than the majority of intermediaries.
How much longer will advisers dare ignore ethical/socially responsible investment? The FSA is promoting its "treating customers fairly" campaign. Is it fair for 80% of investors to express interest in ethical investment but never get beyond first base?
UKSIF and the Ethical Investment Association ( www. Ethicalinvestment.org.uk) have been lobbying for examinations to test advisers' competence in ethical investment. Work is also in progress on an International Standard for the Competencies of a Personal Financial Planner, which the CII will integrate into their qualifications framework and whcih will include an understanding of ethical investment.
UKSIF has recently launched a "toolkit" on its website to help financial advisers offer more ethical investment. EIRIS, the most widely recognised screening organisation in the UK, has recently issued a web-based research tool with Morningstar.
Yet despite the growing acceptance of the link between profitability and ethics, the willingness of the investing public to invest ethically and the drive to publicise socially responsible investments (SRI) to advisers, there is still a question as to whether they have the right tools for the job.
Institutional investors (pension funds and charities for example) may have a somewhat different understanding of ethical investment than the average intermediary. Perhaps the term SRI is more suited to the institutional sector, which implies a less proscriptive approach. SRI may include a broad policy of engagement (talking to companies rather than excluding them). It may also involve a best in class approach, which favours more responsible companies in specific sectors, rather than excluding those sectors completely.
When intermediaries talk about ethical investment they imply a more subjective approach, which includes negative screening, not just of some companies but whole sectors such as tobacco, oil or pharmaceuticals. It may also include a more positive focus, for example on environmental technology, healthcare or social housing.
While this is the most common form, socially responsible funds are also available for less focused retail clients. Existing UK-based ethical funds have tended to fall into two camps - UK or global equity.
The first fund of its kind was inevitably a UK growth fund. In the absence of any precedent it relied for its research on sending questionnaires to companies, backed up by newspaper reports and other documentary evidence. It was easier to keep on top of the job by restricting investment to UK companies they could keep an eye on.
In an era when the environment was yet to become a dominant issue, the fund also reflected the society's Quaker roots, with exclusions on tobacco and alcohol, which these days are seen by the majority as a lesser priority. A second breed, which then started to place an emphasis on environmental issues, took the view that if the universe was to be restricted by ethical policy it would be better to trawl a larger pond. These became the global growth model.
Most providers that have since joined the bandwagon, but often with less sincerity or commitment, have chosen the simple expedient of following existing models.
The result is that of the 34 listed Oeics and unit trusts available there are;
• only two balanced funds
• only two funds in the equity income sector (which are not identified as such)
• only three fixed interest funds - none of which have any international exposure
• only one European (ex UK) fund.
• no property funds
• no money market funds
Even beyond the Oeic /unit trust sphere there are no ethical with profits option (since the demise of NPI) and only three investment trusts, which focus on environmental technology, although the first ethical hedge fund has just been launched.
Only two fund managers offer an equity fund and a fixed interest fund within their own group. Meanwhile, gilts are off limits to many ethical investors.
The list of shortages goes on but it is clear that there is a distinct lack of diversity and a limited ability to generate income.
To compound these problems, while fund managers accept that a socially responsible approach can help to reduce risk and help improve long-term performance, a comprehensive screening policy, which rules out important sectors, can lead to higher volatility compared with their peer group.
Another problem is that ethical funds have often been entrusted to relatively inexperienced fund managers with few resources to carry out the additional research required. However, as ethical investors are perhaps even more inclined than the average investor to want a simple life rather than a roller-coaster ride on the equity markets, it makes the issue of proper portfolio construction even more important.
walk in the woods
While the financial services industry has quite rightly embraced Sandler's recommendations to place the emphasis of advice on risk and asset allocation, it appears ethical investors are excluded from the new promised land: if you want to be an ethical investor you get equity investment.
On the other hand, there is also the analogy with the charity stunt: the risks that seemingly ordinary people are prepared to make for a good cause. Ethical investors often want to invest at least some of their resources in something a bit more interesting than the average blue chip. They then need more diversity than the UK collectives market provides, which suggests advisers may wish to look further afield to construct their clients' portfolios. It may take a bit more effort but ultimately, the effort will be rewarded in terms of client satisfaction and loyalty.
While advisers need to take due account of the extra risks associated with some offshore funds they should not be afraid to exercise discretion. The added attraction of funds with distributor status can also help the income-starved ethical investor.
In the fixed-interest class there are established funds in the US and EU which may provide exposure. One novelty is the Danish residential mortgage market, which has been providing consistent and attractive yields with minimal volatility for decades.
While not wishing to fuel a sectoralready in danger of overheating, property is a good example of an asset class, where offshore funds may provide a more attractive option.
In addition to the general attraction of relatively high yields and real assets there is a variety of more focused funds, such as student accommodation, social housing, healthcare property and retirement accommodation, which fulfil a social function.
Commodities have also received more then their fair share of attention over the past year or so. Yet, in addition to their high level of volatility, only three have maintained their real value over the long term, according to World Bank Commodity Price Data. No prizes for the first two, gold and oil, but the third may be a more of a surprise; it is timber. The volatility of timber as a commodity is relatively small. Forestry is almost as old as the hills themselves.
Our view in the UK is of a market barely kept afloat by tax-breaks for wealthy private landowners. Internationally however, the industry has seen consistent, massive investment over the past 20 years from the institutional sector. There is good reason for this; sustainable forestry is unique in its ability to generate consistent real returns, which compare favourably with any other sector, yet are totally uncorrelated. According to the National Council for Real Estate Investment Fiduciaries "the annualized return since the index's inception in 1987 through the first quarter of 2001 was 18.58%".
Environmental issues becoming global business issues.
80% of investors interested in ethical investing.
CII working on ethical investing qualification.
SRI and ethical investing are different.
There are only 34 ethical funds in the UK, mainly with UK or global growth mandates.
Time to consider a wider universe of ethical funds, for example, forestry.
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