What is an Ethical Fund? 20 questions – and answers!
What is an Ethical Fund?
It is termed an Ethical Fund, because the companies that it invests in have been through an ethical screening process. Usually the fund will be a Unit Trust or an OEIC which are also known as a ‘collective investments’.
What is a ‘collective investment?’
It is a collection of shares in different companies held within one fund (the unit trust or OEIC). Collective investment provides the opportunity for people with smaller amounts of money to invest in a wide range of asset classes at a minimal cost, as the costs are shared with other investors.
How many ethical funds are there to invest in?
There are approximately 60 ethical funds at the moment, but this can vary from time to time.
How many different companies does an ethical fund hold?
It can vary from about 20 to 120, but generally speaking it will hold in the region of 60 to 70
different company shares.
Why does it hold so many companies in the one fund?
The spread across a wider number of companies, provides investment diversification which reduces investment risk. Studies have shown that the optimum number of holdings is 60 to 70 to minimise risk and that holding more, does not reduce the risk further.
Why is it likely to be less expensive to invest in collectives than in direct stocks and shares?
The economies of scale come into play here, as the dealing charges (charges for buying or selling a stock) tend to be a fixed charge, regardless of the amount of the transaction.
As the dealing charges for unit trusts and OEICs are split between all of the unit holders, the actual cost is minimal to the individual investor, whereas if you had your own portfolio, you would have to bear the full charge yourself.
Can I choose what companies are held in my fund?
Unfortunately not, but we can help you choose funds that are suited to your ethical principles. For larger sums of money, you have the option to select individual stocks that meet your personal criteria, but generally it is not cost effective for you to hold a stocks and shares account with smaller sums of money.
Are all ethical screening processes the same?
No, different fund managers use different ethical screens it depends on the remit of the fund and some screens are more strict than others. As an example all ethical funds screen out arms and tobacco, some companies screen out animal testing, some screen out banks.
Some companies outsource the first level of ethical screening to EIRIS who is an independent organisation. Very often there are at least two separate levels of screening and many companies have their own in-house research team.
Do all of the funds have the same investment risk?
No, there are ethical funds in most financial sectors, we can choose the most suitable ones for your risk profile and we can also put together a portfolio of ethical funds from different sectors to get the risk balance that suits your attitude to risk.
Are ethical funds higher risk than mainstream funds?
In the past, there was a higher level of risk with ethical funds due to the limited stocks available for investment, these were generally equities, but the industry has developed over the years and now there is a much wider selection of funds covering all asset classes and risk profiles. So, no providing you are invested in the funds that suit your risk profile, which is the same for mainstream investment.
Are all of the investments in the UK?
There are quite a few UK ethical funds, but there are many global and European ethical funds. There are also emerging market funds for example the ‘BRIC’ countries, Brazil, Russia, India and China. Although these funds tend to be higher risk, they are often included in a portfolio in smaller proportions to provide exposure to these fast growing markets.
What kind of areas can I invest in?
There are approximately 60 different ethically screened funds to choose from. Some are generalist funds, so they are invested in most sectors, as with their non-ethical counterparts – but they do not hold the sin stocks! These are screened out.
There are also ‘thematic’ funds, the key is in the name, so these may be invested one particular industry for example renewable energy or water purification, sustainable forestry, recycling etc.
Can I hold them in my pension or ISA?
Yes, in fact most pension funds today are made up unit trusts and OEICs, only the older pension arrangements have the old traditional with profits funds.
You can invest your full ISA allowance in unit trusts and OEICs or if you wish to keep the Cash component separate, then you can just invest in unit trusts and OEICs in the equity component.
How do I decide which funds to choose?
It would be advisable to have some help with this from a financial adviser who specialises in ethical investment. Most ethical funds may seem ethical, but as most ethical advisers work closely with the ethical fund managers, they know which ones are truly ethical and which ones are just ‘window dressing’. We would be able to help you with this. We regularly review the fund’s stock holdings, performance and charges to make sure that the funds are doing what they say they do.
Who checks the companies that are held in the funds?
The fund manager and his research team regularly review the holdings in their fund. They meet with the companies that they invest in, known as ‘engagement’, to discuss any issues or questions that may have been raised by the team.
It is regular practice for the fund manager to attend the company’s board meetings or AGM.
Often a client may raise a question as a result of learning about an issue in the media and we will follow this up with the fund manager.
How do the returns compare with mainstream funds?
Ethical funds perform more or less on a par with mainstream funds. There will always be exceptions, for example the dramatic falls of 2008, in this instance although the ethical funds in the main did not fare any worse than the mainstream funds, they were slightly slower to recover. This was mainly due to lack of exposure to the banking industry, tobacco and oil!
The variance now is minimal and can easily be seen from fund performance statistics.
How do the charges compare with mainstream funds?
The charges are generally the same, there is no distinction between ethical and mainstream – although the ethical investor is getting additional value from the ethical screening of the stocks for no extra charge.
Which are the top performing ethical funds?
There will always be top-performing funds, some ethical funds have been in the top 10 of their sector over the past 10 years e.g. F&C Stewardship, Aberdeen Ethical World, Standard Life Ethical.
But in reality, it is rare for a fund either ethical or mainstream to remain in pole position for a prolonged period, it is therefore important to select funds that can provide consistent performance, rather than chase the current leaders.
What is your favourite fund?
I would have to say the Jupiter Ecology Fund! It has always been a favourite of mine, because of the holdings and the commitment of the team who manage the fund – but this is not a recommendation to buy this fund – always take financial advice before investing.
What should I do if my question has not been answered here?
If you need help on Ethical Funds, call me, Kathy Booth or my partner Nick Abbott we would be happy to help! Kathy – 07795 662855 Nick – 07919 621109