Is ethical investing a good idea?

Ethical investing can make you feel good and make you money at the same time.

This week is National Ethical Investment Week, so I thought it would be worth finding out more about the subject.

Is ethical investing practical and can you make money?

Funds

The simplest way to invest ethically is to put your money into some ethical investment funds. These funds will then buy shares in companies that are seen as ethical.

There are three main problems with this approach:

1. Costs

At lovemoney.com we’ve said many times that we really like cheap index-tracker investment funds. These funds invest in every stock in an index and are a cheap and simple way to invest in the stock market. You can read more about them in Two simple ways to invest better in shares.

From an ethical perspective, however, most index trackers aren’t great. If you buy a FTSE 100 tracker fund, you’ll automatically invest in BP, Shell, BAE (an arms manufacturer), and British American Tobacco amongst others.

One alternative is an ethical index tracker fund. For example, the Legal & General Ethical Trust tracks a ‘filtered’ version of the FTSE-350 index.

In other words, certain companies that are regarded as non-ethical are removed from the index. In February 2012, 115 companies were filtered out of the index, leaving 235 companies in the fund.

The excluded companies were ‘substantially involved’ in a range of activities including:

Animal testing

Intensive farming

Nuclear power

Tobacco

Arms industry

Gambling

But the problem with this L&G fund is that the charges are relatively high at 1.15% a year. There are several conventional index tracker funds that charge 0.5% a year or less.

Your other option is to go for an ethical fund where a fund manager picks ethical companies for the fund. Many of these funds charge even more than 1.15%.

2. Performance

It’s perfectly possible that ethical funds might outperform more general funds over the next ten years.

I’d just argue that the risk of poor performance is higher with ethical funds than with conventional funds. That’s because ethical funds have fewer companies to pick from as potential investments.

That means an ethical fund will be less diversified than many conventional funds – as a result the risk of poor performance is higher.

3. Definitions

The other potential problem is one of definitions – what exactly is ethical? For example, you might think nuclear power is unethical whereas I think it’s very ethical as it generates electricity without emitting any carbon.

So choosing an ethical investment fund that isn’t too expensive, performs reasonably well, and is aligned with your personal principles could take a lot of time.

Advantages

But investing in ethical funds does have its advantages. Firstly, investing ethically may just make you happier.

And secondly, you could argue that investing ethically does reduce risk in one way.

If you accept that our climate is changing rapidly, there’s a real risk of an environmental crisis at some point. And that crisis could inflict serious damage on the global economy and many businesses.

Just as few investors saw the financial crisis coming, the environmental crisis could be a surprise too, and trigger massive stock market falls.

If you had invested ethically, you might not suffer as much as some people as you’d be invested in the some of the industries that were set to prosper in the post-crisis world. These could include water, solar power and electric vehicles.

I’ve heard this argument a couple of times from ethical investing fans. I accept it’s controversial, and I’m not even 100% sure that it’s valid, but I think it’s worth considering.

A couple of funds

Anyway, if you do want to invest ethically, I thought I’d highlight a couple of funds that are worth looking at.

These aren't tracker funds, they employ fund managers and have relatively high costs - nevertheless I think they have potential.

Both funds won awards at last week’s ‘Heroes of ethical investment’ event which were sponsored by Barchester Green Investment, an IFA firm that specialises in ethical investing. Barchester Green is enthusiastic about both funds.

Kames Ethical Cautious Managed Fund

This fund invests in a mix of UK shares, bonds and cash, and aims to be lower risk than many stock market funds. It will never invest more than 60% of the portfolio value in the stock market.

The fund is classified in the ‘Mixed Investment 20-60% Shares’ sector and has delivered decent performance in recent years. Look at this table:

So if you’d been invested in the fund for the last three years, your money would have grown by 33% which isn’t too shabby. Of course, performance could be very different over the next three years.

The fund avoids alcohol shares, the arms trade and the tobacco industry. However, it does invest in oil production services. The annual charge is 1.25%.

Cheviot Climate Assets Fund

This fund also invests in a mix of shares and bonds, but Cheviot’s fund is more tilted towards shares than the Kames fund.

The fund focuses on companies that provide solutions to environmental and ethical problems and its recent performance is pretty decent too. The fund grew by 16.49% over the last year.

The annual charge is 1.5%.

Ethical alternatives

Of course, if you have spare cash, you don’t have to stick it in the stock market.

You could open a savings account with an ethical bank such as Triodos or Co-operative Bank.

Or you could go for a half-way house between cash and shares – invest in a bond that will help to pay for green energy projects such as wind turbines and solar panels.

You could get a return of between 6 and 8% a year if you invest in one of the green energy projects offered by a business called Abundance. Read more in Invest in green energy with Abundance.

So if you want to adopt the ethical route, you have plenty of options. And you can get a decent return on your cash if you get it right.

More on investing:

Why women make better investors

Seedrs: Earn 22% a year on a £10 investment

Tracker fund sales soar to record high