Opting for ethical investments is an ever-more-popular strategy, as UK investors seeking to combine financial decisions with their concerns for the planet look more closely at the growing market for funds which apply ethical investment criteria.

However, there may be a ‘trade-off’ between personal ethical concerns and the performance of funds in ethical investment portfolios, depending on the type of screening used within the fund, according to the funds research specialist Morningstar.

The first problem to be addressed is the way that companies approach the definition of ethical investments. The definition of what constitutes an ethical investment varies from fund to fund, and while some have very strict ethical criteria and are regarded as dark green investment funds, this will necessarily result in a more limited field of play and may significantly increase the risk level of the fund.

On the other hand, some ethical investment companies apply less stringent criteria, in order to have a wider range of companies in which they can invest, and thus offer light green investment funds.

The popular perception of ethical investing is that negative screening is used to totally exclude industries and products relating to tobacco, military and defence, animal testing, global banking (due to its activities relating to Third World debt), or the traditional ‘smokestack’ or pollutant industries.

However, certain ethical funds adopt a ‘best in class’ screening approach, which does not avoid entire industry groups, but attempts to identify the least offensive groups in each area. While this enables the fund to remain more diversifed than its dark green cousins, many investors may feel uncomfortable owning the best large oil company, says Morningstar.

It is essential that a proper balance be struck between investor preferences and funds performance, and for this, quality ethical investments advice from an unbiased, independent financial adviser is key.

As the US confirms it will pursue BP for the costs of the Deepwater Horizon cleanup, possibly mopping up BP’s total compensation budget of $20bn in a single claim, we are reminded that holders of ethical investments were shielded from the entire debacle, as their cash would probably not have been invested in oil.

The US is realistic about the future, and has stated that even this mega-lawsuit is unlikely to prevent similar cases of unplanned ecocide in future, due to the high risks involved in underwater drilling for oil.

We have also learned that the chemicals used to clean up the 5 million barrels of oil – Corexit 9527, if you’re interested – have provided an ecological nightmare of their own. Oil and these chemicals don’t go away, they merely get broken down, and disperse throughout the sea, much of it sinking to the bottom and being absorbed by plankton. The toxic plankton then work their way up the food chain, and are consumed by large plankton eaters and all kinds of fish, according to the Marine Environmental Research Institute (MERI).

The bottom line is that, if you live near the Gulf of Mexico, some particularly oily fish could soon be appearing at a chip shop near you.

However, another angle to the story is that it is hard to remain totally distant from the oil industry, and any of us who put fuel in our car are customers of BP or one of the major oil companies. Even if you have given up your car in favour of taking your bike, there’s no escape - bicycle tyres are also made from oil. So is dry cleaning fluid. So is plastic. So are dishwashing liquids, deodorants, binbags, shampoos, house paint, synthetic rubber, pill and vitamin capsules, even your credit card. And (before you get up on your high horse about it) your toilet seat, as well.

In the world of finance, if you have a pension, you are very likely to have some of your money invested in the oil & gas industry, perhaps without knowing it. Bear in mind that when BP’s share price tumbled by over half last summer, it wiped billions off the value of the larger pension funds as well. With your finances, however, there is an answer.

Taking the oil out of your funds investments

From a saver’s or investor’s point of view, the key to avoiding indirect investments in future ecological disasters is by considering ethical investments which avoid oil and gas.

The UK now has over 40 ethical investment companies that apply their own individual ethical investment criteria to a range of nearly 100 ethical investments.

By taking ethical investments advice from an unbiased, independent financial adviser, investors can build balanced ethical investment portfolios that will ensure their cash avoids not only oil and gas, but a whole range of other controversial activities, products, and industrial sectors.

So why do only 8% of us currently have ethical investment portfolios? The answer is: a lack of understanding of the ethical investment criteria applied by individual companies, and some scepticism about the real, concrete impact that ethical investments have, in improving the world and making a positive contribution to social change and environmental protection.

With many ethical investment funds  including holdings that many people would categorise as unethical – for instance oil and gas, or the large global banks which profit from Third World Debt, the first question we have to ask must be:

How ethical are ethical investments?

They are as ethical as the investor who buys them. In other words, there are ethical investments to suit all shades of investor, some responding to demands for less ethical industries to be included, in order to bump up the performance of the fund. Ethical investments are graded from light green investment funds, to dark green investment funds that have more strict ethical investment criteria. At the light green end of things, don’t be surprised to find oil and gas, animal testing for drugs but not cosmetics, or nuclear power among fund holdings.

What is the definition of ethical investments?

If you are an ethical investment company, you write your own definition. Each company will define, and usually display, their own ethical investment criteria on their website. This may, for light green ethical investments, mean that they simply seek out companies which (rather vaguely) strive to make a positive difference to society. These funds take the broadest definition of ethical investments and, for those investors still interested in seeing the financial muscle of the ‘smokestack’ industries in their portfolio, accept oil and gas and nuclear holdings as necessary ‘evils’ in the transition from fossil fuels to renewable energies. By asking for ethical investments advice from an unbiased, independent financial adviser, you can look inside any fund to check the industries and companies in which it invests.

How can they justify oil and gas, nuclear power, the large banks within ethical investments?

Oil and gas holdings are large, stable companies that – ethical issues aside for a moment – can be growth drivers for many unscreened (non-ethical) and light green ethical funds alike. The oil companies claim that, pound for pound, they do more research into renewable energies than many small specialists in the field – although some people compare this to Jack the Ripper claiming he was doing good work to cut the overpopulation of London.

Nuclear power – many investors accept nuclear power as the lesser of 2 evils in comparison to fossil fuels. Large banks – again, many investors like to see the large financials as big, stable,  household names in any investment fund, and see no conflict in having an ethical fund which avoids the largest global banks, but includes smaller, more local banks, provided they are not majorly involved in Third World Debt.

While most UK investors are now practising an environmentally friendly lifesyle, and want to make a difference by investing their cash in an ethically responsible way, currently only 8% have already made their first ethical funds investment, according to the UK Sustainable Investment and Finance Association (UKSIF)*.

UKSIF claims that 38% of UK adults would be more likely to consider an ethical fund if they had more information about the ethical investment criteria that determine where their cash would be placed by ethical investment companies.

Additionally, 43% of the public said they would be prepared to switch to an ethical fund, if its credentials and ethical investment criteria were externally verified.

While there are currently nearly 100 ethical investments and funds on the market in the UK, 41% of UK adults said they would like a greater variety and range of options, before making ethical investments.

Demand for quality ethical investments advice is also underlined in UKSIF’s research, with 37% of people willing to consider an ethical investment, if more information were available specifically showing how an ethical fund impacts on the world and on the industry and communities where it makes its investments.

Public perceptions of ethical investments were spurred by the BP oil disaster in the Gulf of Mexico in April, while existing ethical investors benefited by being largely untouched by the (for some) dire consequences of the tumbling BP share price, which had lost half its value by July.

However, ethical investments were called into question again in a more recent survey by London-based ethical watchdog Holden & Partners, who found that of 42 funds in the UK marketing themselves in the ‘UK and Global ethical’ category, some 72% (34 funds) had oil and gas holdings.

*UKSIF National Online Survey 2010

The public believes that banks should apply strict ethical investment criteria when choosing companies to which they will lend money, or in which they will invest, according to the ethical investment watchdog Eiris, which published the survey*. This could imply that banks would desist from lending to companies involved in controversial areas generally regarded as unacceptable by ethical investment companies, and therefore excluded from ethical investment portfolios.

Activities likely to be included in this category would be arms manufacturing, defence, the tobacco industry, nuclear power, the pollutant industries, and those medical or pharmaceutical companies that use animal testing as part of the research process.

However, the exact definitions of what constitutes ethical activity is a matter for debate, as the ethical investments industry has no strict investment code in this regard – despite the fact that the UK ethical investment sector was born in 1974, and now features over 40 companies, offering a range of some 100 ethical investment funds.

In additioin to Eiris, the second ethical market watchdog is the UK Sustainable Investment and Finance Association (UKSIF), and together the two organisations present National Ethical Investment Week, which this year took place during the week commencing 8th November.

Because of the differences in defining what does and does not constitute ethical activity, both Eiris and UKSIF recommend consulting an independent financial adviser and taking ethical investments advice when looking at the full range of ethical funds and investment products that are available.

* Eiris national online consumer survey

The rising popularity of ethical investments has been underlined by calls for Government to create a ‘Green ISA’ allowance in the 2011 Budget.

As part of National Ethical Investment Week, the UK Sustainable Investment and Finance Association (UKSIF) has launched a campaign to introduce an Individual Savings Account (ISA) that would invest only in ethical investment funds, and build on the current range of over 100 socially responsible investments in the UK.

Ethical funds and socially responsible investments are those which meet certain ethical investment criteria as defined by the company managing the investment. As each company has its own definitions, ethical investments advice from an independent financial adviser may be needed to explain the structure and holdings of each individual fund.

At a parliamentary reception, UKSIF presented evidence to show that more investors than ever before are searching for ways to invest their money with one of the growing number of ethical investment companies in the UK. The Association’s research has revealed that 27% of UK adults would be likely to invest in an ethical ISA during the next 12 months.

The Green ISA allowance would complement the current ISA allowance and give investors an additional channel to encourage low-tax investments in an ethical stocks and shares ISA. The tax break could make the Green ISA an attractive option even for those with ethical investment portfolios already investing directly into the market.

There are 2 types of ISA account now available in the UK. These are the cash ISA and the stocks and shares ISA.

The ISA allowances for 2010/2011 are £10,200, of which half can be invested in the cash ISA, and half in the stock markets through the stocks and shares ISA. If you do not have a cash ISA, you can invest your whole allowance in the stocks and shares ISA. However, no more than £5,100 can be invested in the cash ISA.

At the same time, UKSIF has called for tax incentives for those wishing to invest in local community organisations where they live. UKSIF’s research has indicated that 32% of adults with savings and investments would take up incentives to support initiatives in their local community.

Interest in ethical funds has surged during 2010, and promises to grow strongly over the coming few years, according to new data from the Investment Management Association (IMA).

Ethical funds investments accounted for £74 million in the third quarter (July to September) of 2010, up 25% over the same quarter in 2009, and compared to £64 million on average in recent quarters.

Interest in ethical investing is no longer limited only to those who wish to invest with conscience in the world’s most ethical industries and companies, according to the Investment Management Association. Many investors are building an ethical investment portfolio based purely on the track record of ethical funds, and good returns on investment. There is a huge unmet demand for advice and information on investing in an ethical fund, they said.

Commenting on the IMA statistics, Penny Shepherd MBE, UKSIF chief executive, which organised National Ethical Investment Week (7-13 Nov), said: “While these new statistics are very positive, research for National Ethical Investment  Week shows there is still huge unmet demand for modern green and ethical investment options. Although only 8% of savers and investors currently hold green and ethical investments, a further 37% say they will consider doing so in the future.

“Our research shows that we are entering a decade of financial responsibility, as more people consider how they can make money and make a difference in the world. Attitudes are changing from ‘greed is good’ to green is good.”

There are currently some 100 ethical funds available in the UK market, from a wide range of ethical investment companies.

A new report has found serious flaws in the ethical investment criteria being applied by certain ethical funds in the UK.

The new report* analysed UK-based investments classified in the “ethical and global ethical” funds sector and discovered that 72% of these funds (or 34 out of a total of 42) had some investments in the oil and gas industry at the time of the analysis, which was carried out in September 2010. The report is sure to challenge the trust of UK funds investors in ethical investments, at a time when there is already  much controversy over the validity of the ethical criteria of funds companies when classifying their funds.

The report emphasises again the need to take investment advice from an independent investments adviser, when considering ethical and other funds choices as part of your investment planning.

Most ethical fund providers claim to apply a process known as ‘negative screening’ when assessing companies and stocks for inclusion in their ethical fund. Negative screening means avoiding companies involved in a range of industries and activities commonly regarded as unethical, including oil and gas, military and defence, tobacco, animal testing, the pollutant industries, nuclear power, exploitation of workers, and collaboration with unjust political regimes.

Many ethical funds also apply a process of positive screening, identifying and focusing their investments on companies which promote positive environmental impact, renewable energies, clean technologies, fair trade, clean water production and supply, and responsible employment practices. However, the structure for regulation of ethical funds is still not at a mature stage, despite the fact that the ethical funds sector in the UK, which was founded in 1974, is already approaching its 40th year.

For those interested in funds investments, a worthwhile first step is to make an investment enquiry to a qualified independent adviser, who may also be able to recommend tailored investment portfolios as well as individual funds.

*A Guide to Climate Change and Ethical Investing 2010 by the ethical investment specialist Holden & Partners.

In a recent report*, the ethical funds watchdog Eiris has pointed out that ethical investments companies evaluating manufacturers on a global basis had discovered a widespread disregard for monitoring labour standards among their suppliers.  Some 45% of larger manufacturers in the developed world had no ethical policy in place to ensure that components from sub-suppliers were produced according to standards compatible with ethical investing or inclusion in an ethical fund.

In other words, almost half of the western world’s large manufacturers simply do not know if the goods they source from developing countries are produced using child labour, or other methods of worker exploitation.

Eiris identified a list of those manufacturers it regarded as high or medium risk for supply chain labour standards, and found that 66% of these companies were in the consumer goods sector.

Products most likely to have poor labour standards are toys, consumer electronics, clothing, footwear, and agricultural products, according to Eiris.

Separate research done earlier this year by Halifax** proved, as if proof were needed, that electronic games and toys are by far the most popular choice for children, costing the average household £383 per year. Halifax also showed that over 95% of boys and 87% of girls now own a games console.

*Eiris report ‘A Risky Business’, March 2010   **Halifax, April 2010

Investors in ethical funds have been happy to open their morning newspaper over the past 4 months. What is the reason?

Because most ethical investments seek to avoid the oil and gas business, and have been untouched by the great black slick of misfortune that has befallen BP, since the Deepwater Horizon rig exploded on to the front pages on 20th April.

The oil slick ran to 1,000 barrels a day by 26th April and had reached 5,000 barrels a day 3 days later, reaching the Louisiana shoreline with a spill surface of 4,000 square miles, on 30th April.

The Deepwater Horizon slick was finally capped after 38m gallons had spilled into the Gulf of Mexico, dwarfing the 11m-gallon slick from the Exxon Valdez in Alaska’s Prince William Sound in 1989.

A better advertisement for ethical investment was scarcely imaginable.

Any investment funds with exposure to BP were hit hard, as the company’s share price sank to the bottom of the Gulf of Mexico. Pensions experts calculated, in fact, that a UK pensioner with a potential annual pension income of £15,000 would have seen £400 of that wiped out by the slump in BP’s share price, which tumbled from around £6.50 in April to almost £3 in July, wiping £50bn off the value of the company.

Ethical Funds Investments became possible in 1971 with the launch of the PAX fund in the US, which avoided any companies benefiting directly or indirectly from the Vietnam War.

With their ethical policy, many ethical funds investments were bypassed by the banking crisis of the last five years, due to their low exposure to financial companies, while other ethical funds investments were sheltered from BP and have also been enriched by the recent news that renewable energies – one of the focal points for ethical funds – delivered over 10% of all energy in the EU for the first time.

Ethical investments target only stocks and companies which meet various criteria relating to ethical behaviour. Some ethical funds have an ethical policy based on negative screening, defining the activities, products and companies they exclude. These might include animal testing, deforestation, meat, nuclear power, pollution, tobacco, military and weapons, genetic engineering, exploitation of workers, and oppressive regimes.

Other ethical investments use positive screening, to invest in biodiversity, sustainable forestry, environmental products, green transport, charity work, renewable energies, and water management.