Increased awareness of environmental concerns could lead to more people looking at ethical investments says Elaine Gallagher
Rising sales of Fairtrade products and organic food, environmentally friendly cleaning products, and energy-rated appliances all indicate a growing interest in improving our lifestyles and an attempt to safeguard the future of our planet. So why should our investment outlook be any different? Advisers can now extend these philosophies into their investment recommendations via a broader spectrum of funds than ever before. There are around 90 retail investment funds across market sectors, offering greater diversification than ever before.
Managers of green funds use three main strategies to define their investment universe: screening, preference and engagement. This means advisers can respond to particular client preferences or objectives.
'Dark green' funds have the most stringent screening criteria. Managers set out the characteristics that are not acceptable, and eliminate those companies from their universe of potential investments. Criteria may vary slightly from fund to fund, and the managers may conduct screening themselves, or use an external agency.
A preference strategy will rate investments in the light of preferred characteristics, often aspects that have a positive impact on the environment, their employees or customers.
An engagement strategy sees investment managers working closely with companies, to foster the required behaviours.
Specialist sector funds are part of the ethical spectrum, offering exposure to preferred sectors, such as alternative energy companies or even timber harvesting. Clearly some of these funds will also appeal to more 'tactical' investors, who might want to gain exposure to a particular sector, driven purely by investment considerations.
Benefits for advisers and clients
Group pension regulations already provide greater transparency on ethical/socially responsible investment issues in the Statement of Investment Principles, so it makes sense to include this aspect of fact-finding when discussing retirement planning with individuals. The fact-finding process is a good way to establish precisely what ethical criteria might appeal to a client.
A conversation about the nature of ethical funds will also demonstrate the comprehensiveness of the adviser's potential services. Just as with any other investment, advisers can view investment advice on ethical funds in terms of how practical, or economical, it might be to provide the full range of investment services. How feasible is it to micro-manage an ethical portfolio, or what size of portfolio merits professional management? A number of discretionary fund managers offer bespoke services to wealthier clients.
Ethical investment and risk
Investors have tended to invest their portfolios in ethical investments on a piecemeal basis. This is not because they are only 'slightly ethical', but the narrower focus of ethical or socially responsible investment (SRI) funds is associated with higher levels of risk. The negative screening process has a tendency to eliminate some of the largest companies. Screening also excludes some of the more defensive sectors, such as tobacco companies, or supermarkets that have butchery departments or generate a high proportion of turnover from sales of alcohol and tobacco.
The range of funds now available means the client is less likely to have to compromise principles for diversification, since ethical funds are available across market sectors and asset classes. The Investment Management Association identifies ethical funds investing in UK and global equities, in corporate bonds and in specialist sectors.
Advisers can use fund of fund structures to subcontract the decisions to full-time managers if they are not confident of providing a full service to clients, or if it is not economical to do so. By using discretionary fund managers for wealthier clients, an adviser can introduce the opportunity to reflect the client's personal concerns to whatever degree is required, down to individual companies or sectors to avoid. This approach could ultimately be more profitable and less risky for the adviser.
The argument for principles ahead of performance has to be a key part of any decision to invest in a restricted way. Of course, many investors would continue to select an ethical option, even in the light of potentially poorer or more volatile performance, compared to an unrestricted approach or against a mainstream benchmark. The negative screening process tends to tilt funds towards small and mid-cap companies, which has actually resulted in very strong performance for a number of ethical funds in recent years.
Ethical and SRI fund managers argue they have to know their universe of stocks so much better, resulting in superior stock selection. Socially responsible investors also view sustainability and good corporate behaviours as good investment criteria. They believe companies whose managers demonstrate the highest standards of business practices have a good chance of being good investments over the long term.
Specialist sectors, such as new energy, are undoubtedly riskier, with fledgling businesses and the risks associated with developing new technologies. The long-term attractions of investing in these industries might attract wealthier clients, or those with regular premiums to invest.
Investing in green funds need not cost the earth either. Fitzrovia measure total expense ratios (TER) for OEICs ranging from 1.11% to around 1.75%, with only one fund showing a TER in excess of 2%. Insured pension funds charge around 1% per annum.
Ethical and socially responsible investment reflects broader ethical and environmental spending patterns, and is no longer a 'fringe' theme. They offer opportunities for advisers to add value, by creating a new layer of advice. They also help secure long-term adviser/client relationships by engaging the client more closely in their investment decisions.
More and more people are changing the way they live and there is a greater recognition of the environmental impact of our actions. Consequently, many people are flying less, recycling more and becoming more energy efficient. It is highly probable these people may soon start considering how their investment philosophies affect the environment too. As a result, we will inevitably see a greater demand for ethical investments over the coming years.
First mentioned in Cridland Report
Second acquisition of 2019
Guy Opperman has rejected calls to speed up changes to auto-enrolment (AE) despite increasing pressure to boost contribution rates and overall savings pots.
Four key areas to focus on
And 94% for critical illness