The Guardian: Profits and principles

More people are putting their money into ethical funds. But many might be shocked to learn how it’s being invested

Proinsias O’Mahoney
Thursday February 21 2008

What does the fast-food multi-national McDonald’s have in common with oil giant Shell and uranium miners Rio Tinto? No, not that they have long been the focus of angry protest by campaigners, but that their shares now feature in a wide array of ethical investment funds. Long lampooned in financial circles as the preserve of those who care more about their conscience than a decent return on their money, a new study by Holden and Partners, who advise on ethical investments, says that most of these funds are now “surprisingly mainstream” in their choice of stocks.

Some investors who were initially tempted by the “ethical” tag attached to such funds are now starting to look hard at their portfolios and ask some difficult questions – the principal one being what exactly is meant by the term “ethical”. Take one of the most popular ethical fund providers – Standard Life Investments. The company recently announced that it was dropping airline stocks from its ethical funds after asking its investors to identify sectors that they wished to exclude. But according to its manager’s latest annual report, the fund lists the mining group Xstrata, as well as Expro International Group, an oilfield services company, in its top 10 holdings. Which is worse in terms of environmental impact? An airline, a company that services oil wells, or a mining firm?

Similarly, the top 10 holdings by Marks & Spencer’s ethical fund, launched last year to much fanfare, includes oil companies Shell and BP. Does this sit well with the fact that M&S also announced last year a £200m programme to become carbon neutral within five years?

These are just two high-profile examples: the Holden report says that the same stocks “appear over and over again in the socially responsible investment (SRI)/ethical funds” and “only one out of 58 funds analysed claimed to have more than 50% of its portfolio in environmental stocks”. Indeed, Standard Life and M&S’s ethical funds look comparatively idealistic next to the Aberdeen Ethical Engagement fund, which holds investments in BP, Shell, Rio Tinto and British American Tobacco.

In a fast-growing market, shouldn’t there be tighter control and transparency about how a fund interprets and uses the word “ethical”? One of the most high-profile critics of the screening practices of these funds is US environmental campaigner Paul Hawken. In 2004, he denounced the SRI industry in the US as having “no standards, no definitions and no regulations other than industry regulations” and of making the term ethical “so broad it is meaningless”.

Today he says: “The situation has not got better. [Financial] performance has become the primary driver. They [ethical funds] are doing everything they can to be acceptable to the broadest possible clientele, and with that has come dilution of meaning and standards.”

The issue of performance has, naturally, attracted media and investor attention. SRI advocates proclaim that returns are as good, if not better, than conventional funds. Indeed, some say they could perform even better: the Holden report suggests that ethical funds are losing out by not chasing “pure-play” environmental stocks. It points out that the FTSE ET50, an index of the world’s 50 largest firms engaged in environmental technologies, has appreciated by 150% since January 2006, trouncing returns on offer from conventional portfolios. But it’s hard to pierce the perception that returns would suffer if tougher screening criteria substantially diminished the choice of stocks on offer to ethical fund managers. This concern means that “the return-on-investment tail is wagging the social responsibility dog,” says Hawken.

His critics take a different view, supporting the “best in class” approach adopted by many fund managers. Launched in 2001, the

FTSE4Good index was designed to track the performance of companies that “meet globally recognised corporate responsibility standards”. Far from “straying into the quicksands of judgmentalism”, as the Daily Telegraph opined at the time, the FTSE Group has made clear that its index’s purpose is not to contain “squeaky-clean companies”. Rather, it seeks to engage with companies and to “encourage progress toward greater corporate social responsibility”. In essence, rather than shunning whole sectors, it now aims to favour the best behaved within otherwise controversial sectors. This philosophical shift paved the way for the inclusion of global mining giant Rio Tinto in September 2007.

It’s a far cry from the early days of the ethical investment movement. In 1984, when the Friends Provident Stewardship Unit Trust became the UK’s first ethical fund, it was christened “Brazil” by sceptical City analysts, because only “nuts” would invest in it. Today, the industry is said to be worth more than $2 trillion worldwide and more than £8bn in Britain alone.

But has the industry had to “sell out” to increase its attractiveness to investors? It might not be that simple. Tesco, initially excluded from the FTSE4Good index, rectified its environmental policies to gain inclusion. In 2004, researchers at the University of Dundee found the Tesco case “is not an isolated example” and that FTSE4Good’s approach has “had a clear impact on a significant subset of companies and their stakeholders”.

Hawken, though, does not buy into this gradualist argument: “If the standards are too broad, they cease to describe a better world. Instead they describe nice ways to continue the destructive world that is already in place.”

Also, what is ethical to one investor may well be a cop-out to another. For this reason, there is simply no way round potential investors poring over the small print before committing, says Mark Robertson of EIRIS, the independent ethical investment specialists. “There are almost 100 ethical funds in the UK today. Some employ strict screening; others prefer to adapt the ‘best in class’ approach. We’d suggest investors check the ethical investment approach of each fund to identify those which most closely matches their ethical interests and concerns.”

However, investors with a, let’s say, more cavalier approach might prefer the US-based “Vice Fund”. Unashamedly unethical, its founder, Dan Ahrens, even wrote a book entitled Booze, Bets, Bombs and Butts based on its favoured sectors – alcohol, gambling, armaments and pornography – which traditionally have all been excluded from ethical funds. The fund has outperformed the S&P 500, an index of America’s 500 largest firms, in each of its five years of existence and is ranked in the top 2% of US funds. Ahrens has boasted that it’s not just “sin stocks and arms suppliers” that he prefers. He is also a Microsoft fan, because “we had to throw in a little antitrust” – a reference to the software giant’s long-running court battles over anti-competitiveness. Doubtless, Hawken and other SRI critics would find that poetic – Microsoft shares have long been a staple holding in mainstream ethical funds.

This article appeared in the Guardian on Thursday February 21 2008 on p18 of the Comment & features section.

http://www.guardian.co.uk/business/2008/feb/21/greenbusiness.ethicalliving

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