Typically, ethical funds will use positive and negative criteria to screen potential stocks. With "positive criteria" managers will actively invest in stocks that display certain ethical attributes and avoid those companies involved in venal activities - for example, polluting the environment - or which operate in countries where the political and civil rights of its people are violated.
On the other hand, companies that promote products and services which benefit the environment or human life will find favour. Some funds are predominantly concerned with environmental issues and are known as environmental or green funds.
If the ethical PEP proposition sounds too good to be true then it probably is to a certain extent. If you are really interested in maximising your returns, ethical investments will preclude you from some of the top-performing sectors. For example, pharmaceuticals are often blacklisted because many of them are involved in animal testing or Third World activities.
Financials are another area usually excluded. This is because it can be hard to know exactly where some financial institutions. invest their money.
You should also be aware that not all ethical funds are the same. Some funds refer to themselves as "light green", which means that they will avoid one or two controversial areas, such as the arms trade or tobacco, but do not exercise their consciences much beyond this.
On the other hand, some fund managers employ teams to scrutinise the companies they are investing in.
A fund's mission statement will set out its ethical criteria and you should read this carefully if you want to be sure that it suits your requirements.
The screening process employed by ethical fund managers obviously limits the choice of companies you can invest in. Large companies, which can be difficult to monitor by virtue of their size, are often excluded. Moreover, smaller companies are often involved in only one industry, one that may particularly appeal to an ethical or environmental fund. Industries favoured by these funds include smaller independent electricity companies and environmental consultancy firms.
This bias towards smaller companies meant that many ethical investments did not perform very well last year.
In 1997, the FT-SE SmallCap index returned a pedestrian 5 per cent whilst the FT-SE 100, the index of the top 100 blue-chip stocks, grew by nearly 25 per cent.
Some pundits believe that this trend will be reversed this year and that it could be boom time for ethical investments. This is based on the assumption that small companies have yet to realise their earnings potential, as well as historical evidence which suggests that such companies outperform in the first year after the peak of an interest rate cycle.
Further reasons supporting the ethical case is that the rigorous screening process used by ethical fund managers means they are able to identify companies that are not only ethical but also well managed and therefore likely to do well.
More than 20 companies offer ethical unit trusts (listed in the table on the right) but not all are PEPable.
If you have already used up your annual general PEP allowance but want to invest in a single-company PEP, you can still take the ethical route. The Ethical Investment Research Service (0171 735 1351) can give you a list of companies that match your personal ethical criteria. This ethical analyst is used by many fund managers to help them select suitable investments. Single-company PEPs are, however, high-risk investments and only likely to be suitable for people who already have extensive holdings in diversified portfolios.
Ethical PEPs are not for everyone. But if you are concerned about where your money is being invested, these PEPs give you the opportunity to make a profit and satisfy your conscience.
q Sarah Barnett is editor of `What Investment' magazine.
Ethical and green fund performance
Fund Five-year Rank One-year Rank
performance (pounds ) performance (pounds )
Framlington Health 2,523.3 1 1021.9 20
TSB Environmental Investor 2123.5 2 1,252.2 1
Credit Suisse Fellowship 2,074.48 3 1,059.8 14
United Charities Ethical 1892.1 4 1,038.7 17
Sovereign Ethical 1,877.0 5 1022.0 19
Friends Prov Stewardship 1,822.8 6 1,032.8 18
Scottish Equitable Ethical 1,808.6 7 1039.5 16
NPI Global Care 1,787.3 8 1,155.2 5
CIS Environ 1,764.6 9 1,128.3 8
Jupiter Ecology 1,728.2 10 1,054.1 15
Allchurches Amity 1,688.4 11 1,099.3 10
Friends Prov Stewardship N Am 1,666.7 12 1,203.2 3
Aberdeen Prolific Ethical 1,657.8 13 1,092.8 12
Abbey Ethical 1,646.0 14 1,075.4 13
City Financial Acorn Ethical 1,605.4 15 1,094.3 11
Friends Prov Stewardship Inc 1,530.7 16 962.9 21
Clerical Medical Evergreen 1,243.7 17 1,115.4 9
FPAM Ins Ex Ethical UK Equity na na 1,225.7 2
Equitable Ethical na na 1,155.2 4
Henderson Ethical na na 1,149.6 6
NPI Global Care Income na na 1,145.6 7
Average ethical fund 1,790.6 1,101.1
Average all UK unit trusts 1,727.7 1,082.7
FT-SE All Share (xd adjusted) 2,256.7 1,307.2
Some funds are not fully PEPpable. Figures to 4 March 1998 on an offer to bid basis for pounds 1,000 invested.
Source: CIS/Standard & Poor's Micropal.