Read full details of the ethical 12, mentioned in our article below, here.
UK equity funds screening for sustainability-related or ethical investment criteria are outperforming their peers, according to research by New Model Adviser®. But while more providers are lauching into the space, some advisers think many mainstream managers are reluctant to acknowledge the shortcomings of their approach.
Funds carrying names such as ‘sustainable’ or ‘ethical’, among others, are often referred to as part of values-based investing (VBI).
Research suggests VBI matches what investors are looking for. According to data on investor preferences, put together by London-based investment firm IW Capital, 24% of investors would refrain from pursuing an investment decision because of ethical concerns over the product or service.
Of 2,004 respondents, almost a third said the ethical, social or environmental impact of the company they were investing in was just as important as the financial return. However, a look at performance shows investors may not have to choose ethics over returns at all.
There are many UK equity funds available in the UK that fund researcher Lipper has assigned an ‘ethical’ flag to. These have variously labelled themselves ‘responsible’, ‘environmental’, ‘sustainable’, and ‘ethical’.
Of those, 12 funds have performance data for the past five years (to 31 December 2017). We restricted our research to just those 12. These ethical funds come out on top over one, three and five years against the average performance of funds in the Equity - UK (All Companies) sector (see our gallery here).
The average one-year performance of the 12 ethical funds was 16.39%, or 3.6 points above the average return rate for all UK equity companies. Over three years they beat the all-company average by 2.11%. These ethical funds, at 76.11%, outperformed the market average over five years by 8.6 points. Over one and five years these 12 ethical funds also outperformed the FTSE All-Share index.
While returns might be sliding down the list of priorities for investors when compared with their personal values, these returns illustrate why fund firms are taking VBI more seriously.
He said changing investor preferences will translate into demand for a different type of investment solution.
‘Before fund providers were creating funds with the anticipation there may be demand,’ he said. ‘Now it is being driven by that demand.
‘We are no longer the tree-huggers in the corner. [Ethical investing] is becoming more commonplace, not just among specialists but also other fund managers.’
He said 40% of Jupiter’s ecology fund portfolio was held by other fund managers at Jupiter whose funds were not explicitly VBI.
Further evidence that VBI has hit the mainstream, according to Thomas, is the proliferation of so-called environmental solution companies. An example of such a business would be a solar panel manufacturer.
‘When I took over the fund in 2003 we had 310 companies on the global universe of environmental solution companies,’ he said. ‘Now there are more than 1,200 companies.’ ‘I don’t like the term but this is mainstreaming.’
Impact investing seems to be the current buzzword in VBI. BlackRock’s BSF Impact World Equity fund launch hit the headlines last year and Aberdeen Standard Investments launched its UK Equity Impact – Employment Opportunities fund two weeks ago.
Aberdeen Standard’s Lesley Duncan (pictured below) will run the fund. The Oeic has launched in collaboration with The Big Issue, which will receive a percentage of the fund’s management fee. It will invest in companies that promote and implement good employment practices.
Environmental, social and corporate governance (ESG) is another form of VBI. ESG is gaining traction in the investment industry, with three funds labelled ESG launched in the UK last year. ESG investment criteria usually means positive selection of companies that perform well on each area, or engaging with companies to help them make progress on ESG issues.
However, Lee Coates, director of Cheltenham-based advice firm Ethical Investors, is not convinced values-based investment strategies are really becoming more mainstream. ‘Fund managers will often say they have ESG fully integrated into their strategy,’ he said.
‘When you ask in what way, they will just say it is fully integrated as if something they dismissed 10 years ago is now natural. Really it means carrying on buying the stocks they want to buy. If someone asks them, they have a good story on a couple of the stocks,’ he said.
This is one example of ‘greenwashing’, running a layer of ethical marketing or rhetoric over business as usual.
Coates said more meaningful change was occurring elsewhere, though, with an increasing take-up in the idea of divesting from fossil fuels.
‘Things are changing,’ he said. ‘The amount of money being moved out of oil and coal is huge. This is more in the institutional investment space though.’
On the retail side Coates (pictured above) is frustrated by what he sees as the short-term and irresponsible attitude of many fund managers. He said this was holding them back from even considering divesting.
‘There is a belief among fund managers they do not have to bother with that sort of thing. Ask if they commit long term to companies they invest in and the answer is “yes.” But ask them “what about climate change?” and they will say it is too far into the future to have an impact on any of the stocks they buy because they do not hold them for more than a year.
‘They are not being pressured by retail investors to adopt responsible criteria so they conclude nobody wants it,’ he said. ‘Therefore they have no mandate to do it.’
Coates said the mere fact investors had not demanded sustainable approaches did not mean they would be happy with what he sees as inherent risks being taken by mainstream investment funds.
‘That is like saying because the client did not say they were risk-averse they were put into pork belly futures [and] they cannot complain if the price drops because they should have told the adviser they were risk-averse.
‘Likewise, fund managers are using the ignorance of the public about how the investment industry works as their excuse for not having to make changes,’ he said.
Ryan Hughes (pictured above), head of fund selection at AJ Bell, has visited 80 fund managers in the past nine weeks. ‘ESG is definitely becoming something that every investor group is talking about in their investor presentations,’ said Hughes.
However, he agreed more often than not ESG amounted to no more than ‘one line’ in a company’s investment philosophy, and was at ‘the periphery of what they do, not at the core’.
‘There is still a very long way to go for it to become a mainstream decision-making criteria,’ he said.
He sees potential for the future of the ESG, if done properly, to make a positive difference in the world. More so perhaps than ethical screening, which allows investors to filter out companies or industries of a certain kind, such as tobacco, animal testing or alcohol.
Pushing for popularity
The strategies and stock-picking behind the labels will be key in pushing VBI further into the mainstream. But a recent EU initiative might be responsible for a significant rise in popularity and take-up.
The High-Level Expert Group on Sustainable Finance, formed in 2016, delivered its final report last month. Top of its list of recommended actions was ‘establishing an EU sustainability taxonomy’.
One thing everyone can agree on in the VBI space is that no-one can agree on how to categorise the various investment strategies, as Hughes explained.
‘Most people you speak to on the street are not aware of any socially responsible investments. We are a long way from it becoming mainstream but better labelling would help the public understand what we do,’ he said.
It is a cop out to put the onus on investors, who are trying to get their heads around how the fund management industry works.
Fund managers also need to start offering the products they know the public wants. Specialist advice firms do exist, which make sense of the various screens and labels on their clients’ behalf. More importantly for the mass market, perhaps, is the launch of a new targeted advice firm. It will offer to reinvest pension and ISA money in ethical portfolios for as little as £300 or £400 for an independent advice and implementation process.
Determined investors and advisers are finding their way through the muddle to some excellent solutions that offer returns while making a positive impact. But the issue of whether some funds are merely paying lip service to sustainability without any meaningful change to their strategy bears tougher scrutiny.
If the risks do materialise from, as Coates would have it, unsustainable investments, questions will be asked about how much ESG really was part of their approach.