Socially Responsible Investing – 3 things to consider

15 November 2017

This article first appeared on the FT Adviser website on 9th October 2017

Fraser Donaldson - Insight Analyst (Funds and DFM)

The first article I ever penned for the financial press, about 30 years ago, was simply called Ethical Investing. I was of course proud that it was published, and, being an area I had not given lots of thought to up until then, thought it was a great idea full of ‘feel good’ investment opportunities.

It was a long time ago and, although I only recall a handful of unit trust options (according to UKSIF, the first retail ethical fund was launched in 1984), I was mightily impressed by the knowledge and enthusiasm of the fund management teams running the funds. They were specialists and really believed in what they were doing.

This got me thinking about what has changed over the last 30 years or so.

So, in 1984 the Friends Provident Stewardship fund was launched. The 1980’s was a time of excess  where financial markets were booming, yuppie culture was well engrained in the city and the ‘greed is good’ mind-set of some in the industry was viewed as a good thing. Perhaps not the best time to launch an ethical fund, dubbed as ‘The Brazil Fund’ by some, not because of supporting good works in the amazon rainforest, but because of the more derogatory view that you had to be ‘nuts’ to invest in it.

I wasn’t even aware of the term ‘socially responsible’ back then, but even at the time I had the feeling that ‘industry’ could not carry on in that vein. I claim no specialist knowledge or insight, but if the future of the financial services industry was in the hands of people who only thought of money and no consequences, making cash and not things, something was going to give.

Without getting too evangelical about it, the public began to get more interested in the environment, social reform and wellbeing. Greenham common protests, Greenpeace, global warming, third world exploitation by big companies and the start of a health revolution all became big news in the eighties. Who can forget ‘The Green Goddess’ and Jane Fonda?

Back in the eighties, ethical investing would be considered niche. A measure of success of this industry is that interest has been such that this category has been broken down into several sub-categories. Probably still known as just ‘ethical’ to most, some cursory background reading also sees the following:

  • Green
  • Environmental
  • Socially responsible
  • Sustainable
  • Ecology

And a new one to me, ESG (environmental, social and governance).

The momentum was there and the ‘ethical’ industry has never looked back since those early days. In terms of numbers, 1996 saw investment in ethical funds top £1bn and by 2004 had reached £5bn.

According to the Investment Association (IA), 2007 saw 1.2% of all funds under management invested in ethical funds. Ten years on, and that figure is still the same at 1.2% invested. In fact it has remained at 1.1% or 1.2% each year in between. The difference is that 1.2% in 2007 was £5.9bn, but in 2016 that same 1.2% was £12.4bn. More than holding its own with funds not run to an ethical mandate.

There are more than 60 ethical unit trusts and OEICs available, a handful of investment trusts and in the world of discretionary management, looking at model portfolio services, we are aware of at least 75 portfolio options run on an ethical basis. And of course the majority of discretionary managers that run bespoke portfolios (65 out of 75 that are listed on Defaqto Engage) will agree to run a portfolio of investments to an ethical mandate.

So, for those that hold strong beliefs or simply feel they should be doing their bit, there is plenty of choice out there. So, how do you chose the right fund or portfolio for the client? As with all investment, start with the client and find out from them what a good fit is, what they believe in and how much of a compromise they are willing to take. That established, you need to look at what is available in the market and how each of the options available differ.

Having started this article contemplating how things have changed over the last 30 years or so, the one area that has not perceptively changed over the years is how the funds and portfolios are put together and managed. There are three key areas that come in to consideration when putting together a portfolio:

1)      Applying negative criteria

2)      Applying positive criteria

3)      Engagement

1. Negative criteria:

Negative screening takes out those companies that do not meet the ethical criteria laid down in fund objectives. This is usually the starting point for putting together an ethical fund. Companies that are involved in any number of the following could be excluded:


Testing on animals (medical/non-medical)


Production of greenhouse gasses


Use of pesticides


Non-sustainable forestry

Oppressive regimes

Other pollution


Nuclear power

Health & Safety Breeches

Abortion/contraception issues

Human rights violations





An element of compromise is required for negative screening as it is very difficult to be absolutely sure that a company or, in some instances, its subsidiaries or even suppliers are not investing in, or profiting from, any of the above.

2. Positive criteria:

This identifies companies that are actively making a positive impact in terms of ethical criteria. This may include:

Developing alternative energy

Equal opportunities employers

Promoting organic farming

Good employment practises /welfare/rights/health and safety

Transparent environmental reporting

Community involvement /education/ support/sponsorship/traffic management

Pollution control

Life enhancing products

Advancing recycling procedures

Alternative medicines

Environmental management

Good customer relations

Sustainable forestry/agriculture/fishing



3. Engagement:

Now, finding funds that are only investing in companies that are perfect in all areas is almost impossible. This is where the third strand of consideration comes in. Fund managers are likely to be significant shareholders and have an influential voice when it comes to shareholder meetings and could, for instance, vote against the adoption of the company accounts at the AGM in an attempt to bring to the notice of other shareholders the company’s stance.

What you will find when comparing propositions, is a range of options from ‘light green’ (possibly only negative screening or perhaps allowing companies that are involved in non-ethical activities, but only to a small percentage) to ‘dark green’ (apply negative screening strictly, adopt many of the positive criteria and undertake active engagement).

Despite all this choice of different levels of ethical investment, there will still be clients whose beliefs are so strong that application of standard, negative and positive criteria with any level of compromise will not be acceptable. For an adviser this makes suitability, due diligence and manager selection particularly tricky. We are probably looking at bespoke discretionary management here, in other words, bringing in a specialist. Easier said than done.

Just to make things really difficult, where beliefs are that strong, there is a very good chance that the client will know more about the subject than you, the adviser.

Analysing the capabilities of the investment manager is crucial to due diligence here. While most bespoke managers will claim expertise in this area the extent of this needs to be investigated. For clients that have specific requirements and beliefs in a particular area, advisers may find themselves in the unusual position of deferring to the clients’ greater knowledge. Groundwork and due diligence to establish a credible shortlist here is essential.

While the level of due diligence required increases in direct proportion to the strength of the client’s beliefs, this is one investment area where there appears to be no shortage of information. Managers of ethical funds and portfolios are exceptionally proud of what they do and presumably feel it is the ethical thing to do to be as open as possible and provide as much information as possible.

Just one warning here. An appropriate ethical fund that appeals to the clients beliefs sounds like a good ‘suitability’ result. However, there is always the chance that the restrictions and compromises placed on ethical portfolio managers will result in an investment that does not match the client’s attitude to risk.

As with other funds, Defaqto do risk rate some ethical portfolios and advisers cannot afford to ignore this aspect. If there are no, or few client risk profile/portfolio risk rating matches, this needs to be articulated carefully to the client so they understand and can decide whether their beliefs are strong enough to justify taking on more (or less) risk than they would normally.

Recent, and coming regulation, in the financial services industry includes independent governance as one of the key improvements to the industry. As far as I can recall this has always been an element of ethical investment. While I can’t recall the fund, I do recall the world renowned naturalist David Bellamy (of ‘Gwapple me Gwapenuts’ fame) being an independent consultant to the managers providing expertise.

30 years ago, when I first started talking to ethical portfolio managers you couldn’t help but feel that they were treated as oddities in the asset management industry. Now, my feelings have changed and these pioneers are the ones who got it right from the start – good due diligence, sound and repeatable processes and above all transparency. Do the right thing rather than go for the fast buck. On top of that, if you can’t do the right thing, then use your voice as a shareholder to encourage industry to do the right thing.

So, in many respects, nothing has changed over the last 30 years in the world of ethical investment, it is the rest of the asset management industry that is catching up, and the new generation of investors, the centennials, will demand that social responsibility is at the centre of all forms of investment and ultimately will benefit from this.

Perhaps in another 20 years’ time when all companies are run in an ethical, socially responsible manner I will be woken from my afternoon doze and asked the question ‘Grandad, we learned about ethical funds in history at school today. Why did we need them?’ I will then tell the story and their mouths will fall open in disbelief. I can live in hope!

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