A health warning for moral investors

Ethical funds may not match your expectations, says David Prosser

Last week's instalment of the cash-for-questions soap opera is another reminder that those to whom we give responsibility do not always share our ethics. Unit trust managers are no different - they make money (even if it is on our behalf) from investing in the shares of companies whose activities many investors would find abhorrent.

That is one reason for the growth of ethical unit trusts, which now manage more than pounds 600m of money. Amazingly, though, there is still no standard definition of ethical: every fund employs its own set of criteria.

That throws up some surprising results. Donors to the Imperial Cancer Research Fund, for example, have always presumed that their money goes towards the fight against cancer. Imagine their shock then when it emerged that some funds had been invested in tobacco companies. In this case the investment manager departed. However, private investors should not assume that they are immune. The truth is that most ethical investors have precious little idea about where their money is invested, except that it is in a fund branded ethical. Take human rights. You might expect ethical funds to avoid a company involved with countries blacklisted by Amnesty International. In fact, according to Eiris, an ethical investment research organisation, all but three of the 17 ethical unit trusts it monitors would not exclude such a company, even if the company were involved with up to five Amnesty blacklisted nations.

The stance on other issues is just as inconsistent. On the testing of cosmetics on animals, for example, Eiris can point to only three funds that automatically avoid retailers that are suspect. Anthony Milford, head of Framlington Investment Management and fund manager of ethical unit trust Framlington Health, admits : "There's no way we can run a health fund without investing in companies that test on animals."

The list goes on. While all ethical trusts will avoid arms dealers, just three funds ban investments in companies that have been involved in the "sale or production of strategic goods or services for weapons systems". Pollution is another example. South West Water will next month defend itself in court against charges that it allegedly poisoned customers last summer. But Elaine Morgan, one of Scottish Equitable Ethical's UK fund managers, says: "Some water companies do get through our screening because we are pitched more at the ethical market than environmental investors."

Karen Eldridge, head of client services at Eiris, says the problem is that "everyone's ethically different. Some might think that water companies are wonderful because they're providing a service that everyone needs."

For that reason, Ms Eldridge says, Eiris rejects the idea of a single definition of an ethical fund. "We would say the more choice, the better and we wouldn't endorse the idea of one definition." To some extent, ethical investors can use Eiris's guide to ethical unit trusts (Money & Ethics, pounds 12.50) tocheck which funds best meet their criteria. But unfortunately Eiris only studies funds' UK holdings and many funds have large international investments.

In theory, part of a financial adviser's job should also be to screen funds to ensure the investments they make are appropriate to your ethical stance. Or you can always check the funds yourself. Jim Murdoch, spokesman at Friends Provident, which runs the largest ethical unit trust, Stewardship, says: "We will issue our criteria for free and all our investments are listed in the annual report and accounts." Most ethical trusts will do the same.

But while that will tell you in which companies the fund holds shares, you still cannot tell whether those companies meet your own criteria.

Perhaps a more serious threat to the growth in popularity of ethical investment funds has been the perception that such funds automatically underperform. Earlier this year Friends Provident surveyed 200 independent financial advisers (IFAs) and found that just 1 per cent actively recommend ethical funds. Most said ethical funds were, by definition, poor performers.

That view is unfair. As the table above shows, some funds have done poorly. But there have also been some top-performing ethical unit trusts. An investor who put pounds 100 into Framlington Health five years ago, for example, would get pounds 222 back today. With the same investment in Friends Provident Stewardship, your pounds 100 would now be worth pounds 182.

Those are excellent performances, even compared with many non-ethical funds.

Good cause ... good returns?

Fund Size of Performance (pounds )* fund (pounds m) 1 year 5 years

Abbey Ethical 34 109 157 Abtrust Ethical 3 106 n/a Allchurches Amity 27 109 151 CIS Environ 98 108 180 Clerical Medical Evergreen 19 110 133 Credit Suisse Fellowship 36 120 210 Eagle Star Environmental Opps 16 100 158 Equitable Ethical 16 100 n/a Framlington Health 49 119 222 Friends Provident Stewardship 304 116 182 Jupiter Ecology 31 108 174 NPI Global Care 31 104 170 Scottish Equitable Ethical 20 120 166 Sovereign Ethical 15 116 163 TSB Environmental Investor 15 113 165 Average UK growth UT n/a 111 175 Average intnl growth UT n/a 104 168

*What pounds 100 has grown to, after charges, including net income, in the past one/five years. Source: Micropal