Sin wins when it comes to making a good profit

Ethical investment tends to pay less but it may help you feel better, says Iain Morse

And up-market private-client stockbrokers such as Rathbone also offer to manage ethically private-client portfolios with starting values of £100,000 or more.

But ethical investment is close to mainstream and deserves serious scrutiny before you commit your cash. Ethical investment - or socially responsible investment (SRI), as it is more commonly known in the industry - used to be all about avoidance. In the 1980s and 1990s, funds ran rigid sets of negative screens eliminating industry categories such as oil, arms and tobacco, investing only in a morally acceptable residue. "These remain important," says Julie McDowell, head of SRI research at Standard Life Investments, "but priorities on avoidance change with time."

And over the past five or six years, there has been a distinct change of emphasis at this end of the market. It still goes on, of course, but a number of concepts , some fuzzy, some well defined, are tending to replace or at least mitigate the consequences of negative screening.

The biggest change, not confined to SRI managers alone, lies in attitudes to corporate governance and the use of shareholder voting rights at companies' annual general meetings. Even in the 1990s, many institutional investors had a spotty record on voting, but it would now be exceptional if voting rights were not used. SRI managers can claim part of the credit for the change.

These days, everyone agrees that such matters are important. But there is much less consensus over a wide array of SRI-related issues. "It really is a matter of how far they can be quantified into the pricing of a share," says Ted Scott, manager of F&C's Stewardship Fund. The difficulties of quantifying the unquantifiable are best exemplified by the use of SRI "best in class" tie-breakers.

Best in class is a vague concept that hinges on rating or scoring companies in the same industry or other peer group, then ranking these companies by preference. The only problem with this is that the scores given vary widely from manager to manager. And some buy the data used in scoring from providers such as the UK-based Ethical Investment Research Service(EIRIS), while others do their own in-house. All this means that there is little consistency in approach between SRI funds.

A couple of examples make this point. "We don't invest in banks other than UK mortgage banks like Northern Rock," says Scott. In fact, F&C has some of the most rigorous screening of any UK SRI manager. It can only invest in 35 per cent of the FTSE All Share measured by market capitalisation. But at Henderson Global Investors matters are different. "Our Global Care Income fund currently holds shares in HBOS and HSBC," says Nick Robbins, fund manager, "because in our judgement they have made improvements to their practices." Lloyds TSB sits on the middle of Henderson's scale of acceptability, but it will not currently invest in Barclays or Royal Bank of Scotland. Meanwhile, the Ethical Bond Fund, run by Rathbone Unit Trust Management, holds bonds issues by Lloyds TSB Bank and others, amounting to 30 per cent of its portfolio by value.

There is no shortage of further examples like this which leave an uneasy feeling about the consistency of SRI. The likely response is that each fund needs to be looked at on its merits. Some are narrowly themed around industries such as new, "green" technologies, others only employ very short lists of negative screens and nothing much else to guide their investment process. Some major differences also exist in the way that different funds monitor which shares they do and do not buy.

There are currently 42 SRI unit trusts - and their size, charges and performance vary enormously. Aegon and CF Banner, for example, both levy initial charges of 5.5 per cent, while Norwich Union and Halifax charge nothing. Performance varies widely too, and many of us will also want to compare the returns from these and mainstream funds.

Here lies a problem, however. SRI funds are not given their own category by the Investment Managers Association (IMA) - but are instead muddled within larger, more generalist categories such as the UK All Companies, UK Equity Income or Global Growth sectors.

Of the 42 funds in existence, only 16 have been running for 10 years or more. Of these, the best-performing, Henderson's Global Care Income, returned 121 per cent to the start of September this year, with F&C's Stewardship Fund and Scottish Widows Environmental Fund both returning over 110 per cent.

The remaining funds have all returned less than 100 per cent, with the worst performer, Henderson's Global Care Growth, only 20 per cent.

Over the same period, the total return from the FTSE All Share has been 115.46 per cent, while the FTSE 100 has returned 113 per cent. Meanwhile, the average return from funds within the UK All Companies, UK Equity Income and Global Growth sectors has been 117.09 per cent, 134.07 per cent and 68.17 per cent respectively.

Compared directly with their unrestricted equivalent funds, ethical ones almost always come away as worse performers. However, if you're willing to accept potentially poorer performance in exchange for the peace of mind that you are not helping the development of industries that you don't support and believe in, then they are still investors' best option.

On investment performance alone, there is some (very) anecdotal evidence to suggest that you may be better off investing in the exact stocks that ethical funds shun. In the US, an independent fund management firm launched a VICE fund three years ago, which invests only in industries such as gambling, tobacco, alcohol and defence. Over three years, it has delivered an average annual return of 20 per cent, and is ranked 22nd out of more than 700 funds in the sector in which it is classified.

Ultimately, however, as F&C's Stewardship Fund has demonstrated - it is possible to invest in SRI funds and achieve a good return - and like all mutual funds, the key is in choosing the right manager.

"The conclusion to be drawn from this performance data is simple," explains Julian Parrot, who is an IFA at Edinburgh's Ethical Investment Collective, "choosing the right manager is more important with SRI than with mainstream funds."