Virtue has its own reward

It is possible to obey your conscience, avoid rogue firms and mix high ideals with high returns.

No one really wants to buy shares in a company involved in destroying rainforests, making landmines, or helping to prop up an undemocratic regime. All the evidence points in the opposite direction. For example, recent research by one company, Friends' Provident, shows that, when asked, 94 per cent of people say they would like their investments to benefit companies that help, rather than harm, the world.

Yet, from time to time, that is exactly what we are forced to do. All too often, we can become trapped in a mindset that derides the possibility of investing in a manner more in tune with our best aspirations.

In the past 10 to 15 years, however, this mindset has been challenged head-on by the rival concept of ethically-based investment. This is the notion that investing in companies which help the world, rather than degrade it, need not be distinct from our other financial priorities.

Until recently, ethical investment was probably one of the great "undiscovered secrets" of the financial world. No longer. The value of individually- invested ethical funds has grown from barely pounds 500m five years ago to more than pounds 2bn today. Hundreds of thousands of savers, large and small, have decided to invest in an ethical manner.

Tessa Tennant, head of research at NPI's Global Care Fund, is in no doubt. "Ethical investment," she says, "is no longer seen as cranky or bad for your pocket. It has entered the mainstream."

So how do ethical funds differ from the non ethical?

They use negative and positive screens to avoid and select certain areas of investment. For instance, the Stewardship Fund, offered by the insurer Friends' Provident, avoids animal testing and the production and sale of alcohol, and it applies no fewer than nine negative screens. Clearly, if you are opposed to animal testing but are less concerned about gambling or alcohol production and sales, this kind of screening matters.

Even so, some critics argue that using negative criteria achieves little in terms of changing the practice of those companies whose shares are not bought by ethical fund managers.

Much here depends on the use of positive screening, and a new style of pro-active shareholding, with fund managers trying to bring about changes in policy among the company managements they deal with.

While some funds, have no positive screening, longer-established ones like the Stewardship or NPI's Global Care unit trust, promote change in this way.

If you want not just to avoid certain business areas but also to support others, then the positive screens used by a fund may be as important as the negative ones when you make a choice between them. Look also at the types of contact maintained between your ethical fund manager and the companies they invest in.

As an example, Clerical Medical's Evergreen unit trust uses seven negative screens, but has only four positive ones. And Scottish Equitable's Ethical fund has no positive screening at all. By comparison, the Stewardship fund has eight positive screens, it carries out its own ethical research, talks to companies on ethical issues and it follows up with on-site visits.

This shows how much these funds can differ, but the use of negative and positive criteria does give them one feature in common: they all hold a higher percentage of shares in small to medium-sized companies, and a smaller percentage in large companies, than their non-ethical equivalents.

Understanding how this can effect fund performance is important if you decide to choose an ethical investment. Shares in small companies are inherently more volatile than those of large ones. This means that if you invest in an ethical fund, you should be doing so over at least the medium term - say, five years - and you should not expect short-term gains.

The other key factor to look at is, as always, performance. There's a tradition in some investment circles of looking at the world in a fairly cynical manner. Okay, so a few companies might contribute a tad to global warming and sell a few ciggies - but did you see their results last week? And look at those share prices. By contrast, these ethical funds just don't cut the mustard.

Or do they? Until quite recently, even some ethical fund supporters tended to think so, almost excusing poor performance by reference to the loftier ideals of their chosen investments. Therefore, ethical funds were herded into a ghetto, their performance measured against each other - not their non-ethical rivals.

Shiv Taneja, fund analyst at Standard & Poor's Micropal, the statistics researchers, says: "It's important to see how these funds have done against their peers and this performance needs to be measured against an appropriate benchmark. We measure like for like for all other unit trusts. Ethical funds should be treated no differently." While it is true that, as a group, many tend to under perform their non-ethical peers, there are better and worse ethical investments to be made - just as with all funds.

Some stand out for superior fund management. For example, the Lloyds TSB Environmental Investor fund grew 81.34 per cent in the three years to May 21, says Standard & Poor's Micropal. The average for other funds in its UK equity growth sector was just 49.81 per cent.

Over the same period, NPI Global Care grew 68.58 per cent, while the average fund growth in the UK equity income sector, of which it is a part, was 56.83 per cent. Similarly, the international growth sector average performance over three years to 21 May was 30.36 per cent, while Family Assurance Charities Ethical Trust, which sits in that sector, delivered 44.78 per cent.

The key, in all such cases, is for investors who want to choose the right ethical fund to either carry out the detailed research necessary for them to choose the right fund or, more easily, to find the right independent financial adviser to do the spadework for them.

Be sure to talk to an IFA who uses appropriate research organisations, including Standard & Poor's Fund Research, the well-respected organisation which checks fund performance on the basis of a wide variety of criteria. They should also be familiar with work carried out by the Ethical Investment Research Service, which carries out both positive and negative screening for many ethical funds. The important point to bear in mind here is that, for those of us who believe that ethics have a real role to play in all aspects of our lives, it is no longer necessary to avoid the issue when it comes to our investments.

There is a growing choice of funds out there to cater for our needs, many with good performance ratings. And the choice, as always, is up to us.

`The Independent' has produced a free Guide to Ethical Investment. The guide, written by Nic Cicutti, is sponsored by the David Aaron Partnership, a firm of independent financial advisers. It can be obtained by writing to Shelton House High Street, Woburn Sands, Milton Keynes, MK17 8SD