With more than Pounds 4bn in ethical funds in the UK, there is no doubting the interest in "feel good" investing. But can an investment policy based on such intangibles as ethical corporate behaviour pay a decent dividend?
"I wish I could say, incontrovertibly, yes or no," says Karina Litvack, head of governance and socially responsible investing (SRI) at F&C Asset Management, which runs the oldest UK ethical fund, Stewardship Growth, launched in 1984. "But the problem is, how do you define ethics? Different people use different criteria, so it becomes very difficult to prove a scientific connection between performance and behaviour."
Ethical investment is on the move. No longer is it a black and white decision not to invest in particular companies; decisions now come in a wide variety of shades of green.
"There are so many different ways of investing ethically," says Elizabeth Haigh, investment director at Rathbone Greenbank Investments, the ethical investment arm of fund manager Rathbones. "You can exclude certain sectors such as oil and gas; or go for a ‘best of sector’ approach that targets companies with ethical merits so it may be acceptable to invest in a socially responsible tobacco company, or have a SRI fund that invests in the arms trade."
A steady trickle of surveys has, to a greater or lesser degree, found a connection between corporate behaviour and share price performance. Last year the Association of British Insurers found that companies with a culture of corporate responsibility were likely to offer sound long-term prospects.
A 14-month study by the United Nation’s Environment Programme Finance Initiative’s asset management’s working group concluded that there was a serious threat to share performance if such issues were ignored. In 2003, a study by UBS Investment Research found a link between governance practice and total shareholder return.
But there are two important caveats here. First, the better returns are only made over time, requiring investors to take a much longer term outlook than has been common in the past; and second, the link that can be proved is between corporate governance and performance, rather than the looser term of ethical behaviour.
"You can’t say definitively that companies that take SRI seriously will perform better but those that do also tend to perform well," says Seb Beloe, director of research at Sustainability, a corporate responsibility business consultancy. "The generalisation that is made is that the management must be good and management quality is the most important variable in terms of share price."
Hence the move from looking at ethical investment in terms of morality to terms of good corporate governance. Says Litvack: "It’s difficult for people who run the business to see the threats that are emerging, but if they have a proper board of directors who bring a pair of fresh eyes and will challenge management, that company is likely to identify new opportunities and position itself ahead of others."
The very term ethical investment is losing ground, particularly in a global economy where the definition varies from country to country. In the UK, an ethnically diverse workforce is seen as a ‘good’ thing; in France, collecting data on the ethnic origin of employees is illegal. Think of women’s rights in Europe and in the Middle East; the two are very different. Child labour may be labelled "bad" on one side of the world but be acceptable on the other. Faced with such disagreement, how can investors and fund managers decide?
"Ethical is a very emotive word, one that institutional trustees tend to shy away from," says David Russell, of the Universities Superannuation Scheme, one of five groups that recently launched an initiative to encourage brokers to take longer-term attitude towards corporate analysis.
"Most institutional funds agree that investent decisions cannot be taken on the basis of moral judgments. We represent more than 200,000 individuals who may have a variety of views on alcohol or tobacco. But over the long term we believe it will protect the value of our investments if we focus on good corporate governance and good management."
More importantly, perhaps, there are many studies showing that most analysts and investors believe there is a link between good governance and good performance – a chicken and egg situation that ends as a self-fulfilling prophecy. "Five years ago, ethics was a PR issue," says Beloe. "Now, it’s a core business risk for companies. It is material to how they do business."
With regulatory pressures as well as consumer demand, the corporate world is being forced to take account of long-term issues such as carbon emissions. "There has been a quiet revolution and companies are being forced to talk about how they create their wealth," says Patrick Mallan, director for benchmarking and reporting at Business in the Community.
But the goalposts are already on the move. "What’s the responsible position on tax?" says Beloe. "Is it responsible for a company to pursue an aggressive tax avoidance policy, when the market and social framework in which that company operates depends on corporate taxation? That’s an issue that is only just beginning to be debated."