Why virtue is more than its own reward

Ethical investing: who says money and morals don't mix? We show how to make a principled profit

As global warming and genetically modified foods become increasingly important issues, many of us are realising that the way we invest can have an effect on the environment.

As global warming and genetically modified foods become increasingly important issues, many of us are realising that the way we invest can have an effect on the environment.

Interest in ethical and socially responsible investing (SRI) among private investors is persuading companies to change their approach. They are starting to see that to succeed commercially, they need to be more responsible. If not, consumers and investors are likely to go elsewhere.

According to the Ethical Investment Research Service, about £3.3bn was invested in ethical funds at the end of December, compared with £2.6bn in December 1999. This is a rise of almost 27 per cent, compared with a rate of growth for unit trusts as a whole of around 10 per cent over the same period.

New funds are being launched all the time to satisfy this demand. HSBC and Scottish Equitable recently added ethical funds to their range. NPI has launched a socially responsible with-profits bond, which will be managed by Henderson Investors. NPL is considering social issues across its entire organisation. Some 25 per cent of its new business is now coming from socially responsible investment, compared with 1 per cent just five years ago.

Investing ethically is not a new trend but it has been slow to win mainstream acceptance. It has been around since Friends Provident launched its flagship Stewardship fund in 1984, setting the standard for the competition. But only a trickle of ethical funds followed in subsequent years. Investors did not really take to them: performance was unimpressive and those who opted for them tended to be people who had strict ethical views rather than "serious" investors.

The trouble with "dark green" or strictly ethical funds is that many stocks are exclu-ded for failing to meet the narrow investment criteria. Such exclusions have a negative effect on returns as a restricted investment environment increases risk and volatility.

The growth of SRI funds (see page 15) has boosted the popularity of ethical investing because performance is not sacrificed. The point about ethical investment is to find companies which fit your particular criteria. If they don't, you won't invest in them, or if they start to behave badly, you disinvest. But with SRI, the fund manager engages with firms to ensure they adopt best business practice, irrespective of the sectors covered. There have been many stories of multinational companies exploiting cheap overseas workforces or child labour; SRI talks to such firms to make sure they stop these practices - or they lose the investment.

The evidence suggests that this is working. Well-managed companies are introducing codes of conduct or human rights policies and engaging in dialogue with the shareholders.

The CIS Responsible Shareholding Unit surveys all the companies in which it has stakes - from FTSE 100 firms to small stocks - to determine what progress they are making on social issues. This includes policies on the environment, attitudes to customers, fair trading practices and community involvement programmes. The findings, so far, have been positive. Three in five firms have a member of staff in charge of social responsibility; nearly half have made decisions on social responsibility grounds against their immediate commercial interests; and four out of five have increased their spending on social responsibility in the past two years.

However, investors must be alert. "The results indicate considerable variation in areas of concern," Laverne Picart, at the CIS, says. "We have found that businesses show good intentions, though there is often less evidence of concrete actions being taken to put these into practice."

The Government is keen to see both the expansion of SRI and an increased understanding of how it works among consumers. Campaigners hope an opportunity will arise when stakeholder pension schemes are launched in April. MPs are keen to use stakeholder to promote SRI; by 21 February 2001, 66 MPs had signed an early day motion calling on the Government to oblige stakeholder pension providers to properly promote an ethical stance.

Last summer a chance to force pension funds to invest ethically was missed. The initial proposal was watered down to one of disclosure after intervention from the National Association of Pension Funds. The NAPF was concerned that ethical investing would adversely affect the performance of pension funds. Yet many ethical funds have a good performance record (see page 14).

With a number of organisations continuing to campaign, it should hopefully just be a matter of time before pensions widely embrace SRI principles. Once this happens, ethical policies could infiltrate all aspects of our finances. There is already a range of ethical mortgages available. There are also ethical savings accounts on the market; Triodos Bank runs an Organic Saver account whereby 25p for every £100 invested goes towards the work of the Soil Association, which has promoted organic food for more than 50 years.

If you haven't yet used up this year's tax-free individual savings account allowance, you may want to consider an ethical fund; there are now 38 which can be held in an ISA.

It really is a good time for investors to consider, if not ethical, at least SRI funds. Their performance is a welcome development allowing investors to be more socially responsible yet not miss out. But check the small print to see just how green your SRI fund is before taking the plunge.