Going ethical may salve your conscience – but will it help you to turn a profit?

It's all very well, investing in 'green' firms, but it's far from simple. Julian Knight and Chiara Cavaglieri untangle investors' options

Public attitudes to ethical investment are changing. These days, many investors are as concerned about investments that sit comfortably with their environmental and social principles as they are about securing healthy returns. As a result, ethical investment has come a long way from the launch of the first, the F&C Stewardship Income Fund, back in 1987.

At the start of National Ethical Investment Week, new figures show that 10 years ago only £1.5bn was invested in ethical funds, today that figure stands at around £7bn.

"Buying a green and ethical investment is a positive choice. Your money not only works hard for you, but can also help society and the environment," says Penny Shepherd, the chief executive of UK Sustainable Investment and Finance.

However, ethical investing still pales in comparison with the £400bn invested in non-ethical funds in the UK. So why are we still hesitant to push our money into greener investments? For many people, understanding exactly how to invest money ethically is the biggest hurdle.

Ethical banking is faring well in the aftermath of the banking crisis, which has led many people to lose faith in high-street banks. The Co-op group reported a 17 per cent increase in pre-tax profits in the six months to July and its financial services unit saw a 50 per cent rise in the number of customers opening current and deposit accounts.

Credit unions, which are locally run, for the benefit of members, are another option for ethically conscious cash investors. An extensive range of products is on offer at credit unions, ethical banks and building societies, from current accounts and individual savings accounts (ISAs) to child trust funds. It is quite feasible for investors to have all their financial services met by these institutions. Rates can be competitive too – Co-op's three-year, fixed-term deposit account pays a healthy rate of 4.5 per cent.

When it comes to seeking greater returns on the stock market, however, investors will find things are more complicated. They can either take it upon themselves to handpick and research individual stocks and companies, or, more commonly, take a back seat and invest in ethically screened funds where this research has been done for them. These actively managed unit trusts and open-ended investment companies (Oeics) work in the same way as standard funds, buying baskets of shares in a particular sector, but the fund

manager will run checks on the companies chosen for investment.

As things stand, nearly 100 green and ethical funds are available, covering corporate bonds, managed funds and equities. The Schroders Global Climate Change fund, for example, invests in companies that provide goods and services designed to limit climate change. The Jupiter Ecology Fund, managed by Charlie Thomas, has an in-house environmental team, checking specific criteria to ensure that they only invest in firms committed to protecting the environment.

Ethical funds like this are often labelled dark green or light green. Light green, or positive, funds seek out shares in firms which pursue some aspect of ethical or environmental policy.

"Positive screening does not reduce the universe of available shares," says Dr Robin Keyte, from Well Money Clinic, an independent financial adviser. Typical positive screens might be community involvement; employee welfare rights; environmental policy, packaging reduction, sustainable forestry."

At the other end of the scale, "dark green" funds will employ negative screening to exclude shares of firms with certain activities, such as alcohol production, animal testing, environmental damage or gambling. Fund managers may also use their positions as shareholders to engage with the companies in which they invest and try to encourage more ethical practices.

Many pension plans also offer access to these ethical funds, including Aegon Scottish Equitable, Aviva, Friends Provident and Standard Life. Company pension plans will often offer an ethical option for employees but, if not, investors can expose themselves to ethical funds through a self-invested personal pension plan (Sipp).

Investors wary of actively managed funds may prefer to track a stock market index of ethical companies. In 2001, the FTSE4Good UK index was introduced to allow investors to invest in socially responsible firms. But difficulties in determining which companies should and should not be included mean that potentially controversial firms such as BP and Tesco can be considered suitable – which may not sit comfortably with many ethical investors. This highlights the difficulty for many wannabe ethical investors in comparing one ethical fund to another.

Nick McBreen of IFA Worldwide Financial Planning says: "The inevitable consequence of heightening awareness and demand for ethical or socially responsible investment is that the label will become over-used or mis-used."

Climate change funds can often fall

LONG HAUL 'I BELIEVE MY GREEN FUND WILL DO WELL – IN TIME'

Ethical investing is not exclusively for those looking to ease their conscience. Many hope to reap the financial rewards of being green too.

Dr Jan Kiso (above), 38, originally from Germany but now living in Chelsea, London, began ploughing his money into the Jupiter Ecology Fund three years ago, through an ISA investment. The fund specialises in six investment themes: clean energy, water management, green transport, waste management, sustainable living, and environmental services.

"I was looking to take advantage of the low-carbon technology movement, and Jupiter was the only fund that actively focused on the issues I was interested in," he says.

For Jan, the impulse to invest in the Jupiter Ecology Fund was financial rather than ethical. As an employee of the Department of Energy and Climate Change, his interest in this type of fund is perhaps understandable, but his motivation was first and foremost the potential for high returns. Despite this, the fund's performance in the past few years has been sorely affected by recent stock-market lows, recording a fall of 13.6 per cent in 2007-08 and growth of just 1 per cent in 2008-09.

Although concerned about recent performance, he is content to be in it for the long haul and prepared to leave his money invested for at least 10 years, when he is optimistic that things will have improved.

"I wanted a fund that embraces the whole idea of sustainability – an area I believe will outperform the market in time," he says.