The scope of an investor’s ethical and social goals is certainly one possible step in determining the suitability of specific funds. However, before you decide to align your investments with your ethical beliefs, it's worth noting how the available funds tend to perform relative to less const
rained offerings. With this in mind, we'll take a look at how ethical funds have performed relative to their unconstrained competitors.
At Morningstar, we don't place socially-screened funds in their own category--instead we place them in categories with funds that generally invest in the same asset-class, region, and style. So if a fund focuses on small-cap UK equities, we place it in the UK Equity Small Cap category, and so forth. To examine their risks and potential benefits relative to non-screened funds, then, we'll look at how they have fared within their respective categories.
Ethical UK Equity Funds
The news is largely discouraging among UK equity funds. On average, ethical UK large cap equity funds have consistently underperformed their Morningstar category peers over 1, 3 and 5 years, with volatility close to the category average. Within the Morningstar UK Large-Cap Blend Equity category, the CIS Sustainable Leaders Fund is the strongest ethical fund performer over the last three years and also fares very favourably relative to its non-ethical peers, clocking-in at 21.8% per annum and residing in the sixteenth percentile. Although they are large-cap oriented, most of these funds tend to be overweight in small- and mid-caps relative to their peers. This small- and mid-cap bias has worked in their favour until recently, as large caps have only recently started to rebound. Socially responsible offerings also tend to avoid resources industries such as mining and energy, which have been among the market's strongest performers.
Ethical Global Equity Funds
Among Global ethical funds, the results are mixed. The majority (66%) of Global Large-Cap Blend Equity funds that are socially screened and available for sale in Europe underperformed their category medians over the past five years. The picture was better among small- and mid-cap ethical funds, however, with 71% outperforming the Global Small/Mid Cap Equity category median. UBS (Lux) Equity Fund - Global Innovators--which focuses on firms involved in renewable energy or in reducing energy consumption--shines as a top-performing offering within its Global Small/Mid-Cap category, returning 28.2% per annum over the last three years. The fund has also fared very well recently, sitting in the top quintile while a handful of its peers dive in the red. Investors should expect a bumpy ride here though as volatility is relatively high. One of the more well-known global equity ethical funds is the Jupiter Ecology Fund, which invests in companies providing solutions to environmental and social issues. Its skipper, Charlie Thomas, follows a disciplined investment strategy, returning 26.4% per annum over the last three years. The fund is more intrepid than its typical ethical global peer, however, swaying more towards growth stocks lower down the market cap line--and its longer-tem performance reflects those risks. The fund racked up big losses in 2001 and 2002, and badly underperformed its peer group in 2003.
Ethical Fixed Interest Funds
Within the fixed-income realm, there is currently a smaller number of ethical fund offerings, available within the Sterling Corporate Bond and Euro Corporate Bond, Euro Diversified Bond and Euro Global Bond categories. Investors should pay particular attention here to the total expense ratios (TERs) of these funds. For example, Rathbone Ethical Bond Fund's TER is 1.34%, compared with 1.05% for the median fund in its Sterling Corporate Bond category. This is a relatively high levy for fixed-income funds which erodes its already stumpy returns. A cheaper top-quartile "ethical" alternative in this category, which also boasts a stronger long-term track record, is the Norwich Sustainable Future Corporate Bond Fund. This has a TER of 1.04% and has generated 3.74% per annum over the last three years.
Ethical Funds Often Have Elevated Risk
One pattern that emerges among ethical equity funds is that they court more risk than their peers. Many are focused on companies further down the market-cap ladder than their rivals, which imparts additional business risk and share-price volatility relative to larger-cap offerings. Further, ethical sector restrictions can weigh on performance should the permissible sectors stumble or those consistently ruled-out deliver significantly healthier showings (as been the case with resources issues in recent years).
Look Before You Leap
There is no clear cut answer when it comes to the value of ethical investing. However, before taking the plunge, it is crucial for investors to identify the nature of their ethical considerations and to understand the biases built into many of these offerings. We've taken a first cut here, but you can easily use Morningstar.co.uk to evaluate funds for yourself. Simply navigate to any funds' Morningstar Report, and you'll find clear, easy-to-understand portfolio statistics along with a wealth of performance, risk, and cost information that can help you make the right decision. And because one-fund does not make a portfolio, you can use our Instant-X-Ray tool to see how your choices might interact with a broader portfolio. Just enter the fund names and the per cent of assets (or amount) you want to allocate to each offering, and Instant-X-Ray will give you a clear display of your total portfolio exposures by asset class, region, economic sector, market-capitalisation, and style.
