Investors looking to buy ethical funds take on more risk in the short term, but do not have to compromise returns in the medium to long term, according to Adrian Lowcock, head of investing at AXA Wealth.
Socially responsible investing (SRI) has been a hot topic since the climate change conference held in Paris last year, with many investors now focusing more on ethical issues within their portfolios.
Charlie Thomas, manager of the Jupiter Ecology, said: “I think there are times when we have little bursts, and for certain we are in one of those periods now by that I mean post Paris last year we have seen a step up in terms of enquiry levels by all sorts of people.”
However, SRI is a broad spectrum, covering a number of investment methods, and those looking to invest with more of an ethical mind-set need to decide what their mandate is before looking to buy a fund.
Traditionally, the funds in the space have had a criteria (and blacklist) of the companies they would avoid investing in, but more recently managers have looked at more of a dual approach - using a filter or screening system, but also working with companies to improve their standing.
One organisation doing this is Edentree, which has a range of Amity funds aimed at achieving long term growth through investing in companies “which make a positive contribution to society and the environment through sustainable and socially responsible practices”.
“We have a default negative screen – so our funds offered to clients won’t invest in companies that are materially exposed to things like gambling, alcohol, tobacco etc,” Neville White, head of socially responsible investing at EdenTree.
“We really do believe that ethical screens adds value, that it reduces risk, and that you don’t have to sacrifice long term returns if you want to be ethical or responsible.”
“We still find there is a lot of demand for clients to have those kinds of exclusions because they don’t want to commit their capital or take profit from those activities but I think where we really add value is we have 9 positive criteria, so we are actually measuring and benchmarking potential companies,” he added.
And it hasn’t compromised returns, as the below graph shows the Amity UK fund, run by Sue Round, is comfortably ahead of the IA UK All Companies sector average and the FTSE All Share over the past five years.
Performance vs sector and benchmark over 5yrs
Source: FE Analytics
“Our mantra is ‘profit with principle’ so we definitely believe that if you integrate environmental, social, and governance factors into your investment choices then over the longer term we will deliver more performance for investors” Edentree’s White said.
The £138m fund is also in the top decile for volatility and maximum drawdown (the maximum an investor could lose if they bought and sold at the worst possible times) and is in the top quartile for Sharpe ratio, which measures risk-adjusted return.
However, there is a suggestion among some that ethical investment funds are more volatile than others.
Indeed, AXA Wealth’s Lowcock (pictured) said: “There is more cyclicality in performance but there are periods that it will deliver – and it has done.” 
“If you looked at an ethical fund post-Brexit and an ethical fund that’s really dark green – which means it doesn’t invest in anything deemed slightly bad – for example, doesn’t invest in pharmaceuticals and tobacco – it would have really missed out on those two sectors that did well post-Brexit.”
That is only a short term factor – but it shows more volatility can be created by screening certain sectors, Lowcock adds.
To highlight this, he points to the F&C Responsible UK Equity Growth, which has outperformed over recent years, but has also been more volatile.
Performance vs sector and benchmark over 5yrs
Source: FE Analytics
“It illustrates that over the past 10 years ethical investing has paid off. But also that performance is more volatile – falls and rises are larger than the index.”
“So I think it’s wrong for you to say that you necessarily sacrifice returns, but what you have is a bit more risk – because you reduce the amount of choice [of companies to invest in].”
Again, though, by avoiding certain sectors, many ethical funds have performed well over recent years.
In 2015, for example, some of the largest constituents of the FTSE All Share (that most ethical managers wouldn’t buy due to their screens) like mining, oil and banks struggled thanks to macroeconomic headwinds.
As such, the likes of Standard Life Investments UK Ethical, Premier Ethical and Kames Ethical Equity were all top decile and beat the FTSE All Share’s gains by 14 times. They were also helped by the fact that ethical UK funds tend to have a structural overweight to mid and small-caps.
If investors do want to get into the space, Jupiter Ecology is a standout option, according to Lowcock.
Charlie Thomas, who manages the fund, said: “Our approach is less about socially responsible investing and more about investing in companies providing solutions to the global environmental challenges.”
He says the portfolio is more of a specialist fund focusing on environmental and sustainable issues, though he notes that this, by association, means it does not invest in companies such as tobacco firms and alcohol, as, by definition, these companies are not going to provide solutions to environmental problems.
The big draw for investors, he says, is diversification. While the fund itself may be niche, Thomas says he has seen an uptick in demand from investors looking to broaden their portfolio.
“What we actually bring, even to mainstream portfolios, is a lot of diversification because we invest in sectors that other people are not investing in,” he said.
He says the £475m fund is less about a moral view, but instead is trying to offer outperformance over the long term by investing in companies that provide environmental solutions.
The area is becoming “much more mainstream,” he says, adding that growth is “more significant over the longer term” as the issues become more pressing.
Since taking over the fund in September 2003, the fund has largely outperformed its sector and benchmark, but has been more volatile, with bigger peaks and troughs.
Performance vs sector and benchmark under Thomas
Source: FE Analytics
Since Thomas took charge, the fund has been a second quartile performer, while its Sharpe ratio, which measures risk-adjusted returns, is also second quartile.
Over one year, the fund has been in the top quartile against its peers, though.
“Over the longer term in the global growth sector we’re a second quartile fund since I took over – so we don’t believe that you have to forgo returns,” Thomas said.
