Do-gooders do nicely

Ethical funds can offer the shrewd investor guilt-free profits.

Making money while doing good sounds like a standard plank in New Labour's manifesto. When it comes to investment, however, things are not quite so simple, and sifting through company accounts to decipher whether or not a particular blue chip is guilty of exploiting Third World labour or is party to the production of greenhouse gases is likely to prove a complicated and time-consuming task.

According to a survey by Friends Provident, out of a total UK unit trust industry worth pounds 120bn, only around pounds lbn is invested in ethical funds. Lee Coates, director of the financial advisers Ethical Investment, has no doubt as to the reason: "It is the insurance industry which is most to blame." he says. "With the exception of Abbey Life, which has its own ethical fund, most direct-sales forces have no ethical products to sell."

He also worries that many independent financial advisers (IFAs) have insufficient product knowledge. "What we have discovered from our own clients is that many IFAs simply don't ask potential investors whether they are interested in ethical investment. It's not that their commissions are any less, it is just that many are unaware of the products on offer."

There is perhaps another reason why, in the caring, sharing 1990s, ethical funds have not achieved a greater share of the market and that is the widely held belief that such funds underperform. Such a belief is seriously misguided.

Performance figures for all UK equity pension funds over the last year show that ethical funds take seventh, ninth and 11th spots; there are only six ethical funds in the sector and all are in the top 31 out of a total of 210 funds. A similar picture emerges in the UK equity growth sector over the past 12 months. Credit Suisse's Fellowship Trust ranks fifth out of 165 funds and the worst performing ethical fund is in 26th place.

Given the relatively small number of funds that describe themselves as ethical - there are around 27 unit trusts and three investment trusts - these are extraordinary figures. So what lies behind the success?

One reason is that ethical funds are severely restricted in the number of companies they may invest in. Although most funds will retain some blue chip "leaders", the vast majority of FT-SE 100 companies will be out of bounds. Multinationals are usually so diversified that the chances of them breaching at least one of the investment restrictions set down by the ethical funds' trustees are that much greater. ICI, BP and Shell will not feature on any ethical funds' buy lists because of their questionable pollution records.

Such restrictions appear, however, to help rather than hinder performance. "In many ways, having less stocks to choose from makes life a lot easier," says Richard Lowman, fund director at Friends Provident's Stewardship Trust, the oldest and largest ethical fund. "We can focus our attention on fewer companies and get to know the board a lot better."

Another reason put forward to explain the recent outperformance is that by investing in companies which already have paid the price of putting green policies in place, they are buying nearer the bottom of the market.

Stewart Morgan, of the independent financial advisers Chase de Vere, has undertaken research into ethical funds and believes there is a case for ethical investment even for those who might not see themselves as necessarily "ethical" investors. "I would not advise anyone to invest all their money into ethical funds. However, in a diversified portfolio, there is a case for investing in ethical funds from a purely financial viewpoint."

The investment policies of the various ethical funds differ greatly. Anecdotal evidence suggests that many investors buy into ethical funds believing they are doing their bit for the environment when in fact the fund may be more concerned with avoiding investment in companies involved with gambling or the sale of alcohol. As Mr Morgan explains: "The moment a client tells me what they don't want to invest in, that usually knocks out 80 per cent of the choice anyway."

The Ethical Investment Research Service (EIRIS), which helps ethical fund managers to decide which companies are acceptable investments, produces a guide, "Money & Ethics", which lists all ethical investment plans currently available along with detailed information about the investment policies of each of the funds. Sensitive investment areas are divided into 24 categories. These range from intensive farming and pesticide production to pornography and nuclear power.

Chase de Vere (0800 526 091), Ethical Investors (01242 604550), 'Money & Ethics' is available from EIRIS, Bondway Business Centre, 71 Bondway, London SW8 1SQ, price pounds 12.50.