Close scrutiny of funds in this sector shows they differ in investment remit, size and management style. There are now 35 unit trusts in the sector, collectively worth about pounds 2bn. The smallest, City Financial Acorn Ethical, has pounds 4.28m under management. The largest, Friends Provident's Stewardship, is worth pounds 572m. Most are in the pounds 20-50m range.
Remember, we are used to buying unit trusts from closely defined retail categories. For instance, a unit trust in the UK Smaller Companies sector must have at least 80 per cent of its assets invested in UK companies and at least 50 per cent of total fund value in small or medium size companies. By contrast, the ethical sector is built from funds using negative and positive screening, but the choice of screens can vary widely. Scottish Amicable's new Ethical fund has just six negative screens, no positive screens, no in-house research and does not pursue dialogue with management on ethical or ecological issues. NPI/Henderson uses nine negative and eight positive screens for its Global Care funds.
NPI/Henderson also uses external and internal research, talks to management and thinks that promoting company improvement is a key issue. "If we are not changing corporate culture by engagement with them, then we might as well pack up," observes NPI/Henderson researcher Toby Belsom. "The future of our sector must lie in both anticipating and promoting change to meet future developments. A good, imaginative fund will find technologies which will acquire a market by meeting social needs for cleaner processes."
The rationale of this approach is that it invests in young, growth companies trying to anticipate long term trends on issues such as pollution and public transport. This implies that most ethical/ecological funds will be overweight in smaller company shares. Before you invest, bear in mind that about 80 per cent of the value of daily trading on the London Stock Exchange is in FTSE 100 shares.
They are the 100 largest shares measured by market capitalisation. Funds using stringent negative screening will hold no more than 25 to 40 of these shares. As many as half of the next 250 shares, known as mid-cap, are acceptable to funds using a full range of negative screening. But finding acceptable small-cap and fledgling shares is far easier.
"This is partly because their business activities tend to be narrower and easier for us to research," says Mr Belsom, "but also because these are precisely the type of firm trying to develop new technologies, and new approaches. Their management is also typically younger and more adaptive."
Individual funds from the ethical/ecological sector also fall into a range of other retail sectors such as UK Specialist, UK All Companies and Global Specialist, which define their underlying asset allocation. "There is no single, dominant theme or consistent pattern of asset allocation in the ethical/ecological sector," says Alan Brunsden, fund manager of Lloyd's TSB's Environmental Investor unit trusts.
Currently worth more than pounds 26m, the fund invests only in UK companies, with 55 per cent of assets in FTSE 100 shares, 40 per cent in mid-cap and 15 per cent in small cap.
"We are a stock picking fund, investing with a relatively narrow remit into companies which have strong, positive environmental programmes. This means we have a defined area of interest and know more about it than larger, generalist funds," adds Mr Brunsden.
By contrast, the Sovereign Ethical fund, worth about pounds 25.5m, holds just 27 per cent in FTSE 100 shares. Mid-caps account for 19 per cent and small caps for almost 33 per cent. But the most important difference is Sovereign's exposure to "fledgling" shares, which account for 12.07 per cent of portfolio value. This exposure to small company shares has served Sovereign well, with the Small Cap Index returning growth of more than 16 per cent in the second quarter of this year.
However, over investment periods of under five years, small and medium- sized company shares have displayed greater volatility.
You will also find no really successful income equity funds in this sector, because the small and mid-cap shares most often held tend to have relatively high price-to-earnings ratios. In ordinary language, this means that they offer returns by capital growth rather than dividend income.
These factors all go to suggest that investment into this sector should be made over the medium to long term. If you are tempted, you should always be prepared to research these funds individually as well as seeking help from an independent financial advisor (IFA).
`The Independent' has published a free 20-page Guide To Ethical Investment, sponsored by the David Aaron Partnership, offering a wide range of information. Write to: The David Aaron Partnership, Shelton House, Woburn Sands, Milton Keynes, MK17 8SD or call 01908 281544