How to make money with an easy conscience

The new millennial managers are raising standards to boost returns, says Mark Atherton.

Ethical investment used to mean poor returns, but that could be changing thanks to the influence of millennials who are joining the fund-management industry. These young managers believe that you can make money with a clear conscience and are adopting hard-headed tactics with this aim, hoping to encourage businesses to change their practices.

This ethos is being used by many funds that do not brand themselves as ethical on the basis that the best longterm performance comes from companies that make a positive contribution.

Ethical funds avoid entire sectors, such as tobacco and arms manufacturing, which restricted the choice of stocks. The new approach is all about engagement and seeking out positive factors, such as concern for the environment and good corporate governance.

John Spiers, of EQ Investors, the wealth manager, says this “positive impact” approach is being used by managers who do not have a specific ethical remit, because they believe it will lead to improved performance.

Among the fund groups that have taken on board the idea of “impact” investing, even for non-ethical funds, are Hermes Investment Management, Columbia Threadneedle, Standard Life and Jupiter.

Charlie Thomas, who runs Jupiter’s Green investment trust and the Jupiter Ecology fund, says: “When I started running the two funds 13 years ago I might have had one or two stocks that my mainstream colleagues also held. That has completely changed. Today the proportion is closer to 50 per cent, and our thinking on ethical questions feeds through to all our fund managers.”

Saker Nusseibeh, the chief executive of Hermes, says: “We believe that companies with strong corporate governance and astute management of their environmental and social responsibilities, such as emissions control or labour rights, not only make a more positive contribution than those that do not, but also provide greater longterm value for shareholders.”

■ The new ethical investing

Fund groups such as Standard Life, Columbia Threadneedle and Jupiter have a mixture of ethical and non- ethical funds, but they use the same social-impact approach when looking at potential investments for all their funds. They examine not just a company’s profit-and-loss figures but also its record on environmental, social and governance (ESG) issues.

The environmental criteria used in ESG issues help to assess how a company performs as a steward of the natural environment, including its approach to climate change, hazardous waste and nuclear energy.

The social element looks at how a company manages its dealings with staff, suppliers, customers and the communities in which it operates. Mr Spiers says: “This involves questions of human rights, consumer protection, animal welfare and a company’s attitude to ‘sin’ industries such as tobacco and gambling.”

Governance examines a company’s leadership, executive pay and internal controls as well as its regulatory record and stance on shareholder rights.

Iain Richards, the head of governance and responsible investment at Columbia Threadneedle, says: “Well-governed companies are better positioned to manage the risks and challenges inherent in business. ESG analysis can also help us identify risks and opportunities that may not be captured in conventional analysis.”

Mark Evans, a sustainable investment analyst at Jupiter, says: “Shell undertook expensive and environmentally risky activities in the Arctic and also with its liquefied natural gas operations off the coast of Australia. Analysis showed the company was engaging in high-cost and environmentally risky activities, which led us not to invest. Meanwhile, BP has sold many of its riskier, high-cost operations following the Gulf of Mexico oil spill and has become more safety-conscious, which makes it more attractive to us.”

How ESG engagement works

Hermes is one fund group that works actively with companies, taking up concerns that its ESG record has identified. For example, it flagged a problem with Walmart, the giant US retailer, even though it appeared to be trading at an attractive valuation. The Hermes team was concerned about a number of labour-rights disputes and bribery allegations in Asia and South America. Hermes has decided to avoid the stock on the ground that social and governance risks would undermine longterm shareholder value.

Andy Mason, a responsible investment analyst at Standard Life, says: “ESG adds an additional lens to mainstream stock considerations to provide further insight and to improve companies’ practices through engagement.”

Mr Mason says Standard Life had meetings with Kier, the construction company, to raise concerns that the company was discriminating against unionised employees.

He adds: “We were comfortable regarding Kier’s response and encouraged that Kier invited us and other investors to take part in a stakeholder session designed to help frame its future strategy, which included its approach to communities, the environment, the marketplace and governance. We believe these steps will support its market position and we have a significant holding in the company.”

In the case of G4S, the security group, Standard Life had been worried about its treatment of prisoners, both here and abroad. Although Standard Life raised the problems with the company, Mr Mason says, “we felt the management of the company wasn’t really tackling the problem and so we significantly reduced our holdings in G4S”.

Best-buy funds

Jason Hollands, of Tilney Bestinvest, the wealth manager, picks out two investment trusts and two unit trusts. His first pick, Foreign & Colonial, though not itself an ethical fund, is part of the BMO Global stable, which includes a number of such funds, and the ethical element influences the thinking of all the managers.

“Foreign & Colonial is a diversified fund with investments around the globe. It is a real ‘Steady Eddie’ holding and a good starting point for building an investment portfolio.”

His second investment trust choice is Alliance Trust, another large fund that gives access to global blue-chip companies. Mr Hollands says: “As with F&C, ethical concerns are embedded in Alliance’s investment approach. It has recently been through a number of changes and the hope is that it will benefit from the reforms.”

His two unit trust choices are from Henderson and Stewart Investors (formerly First State Stewart). He says: “These two investment houses both have the resources to develop an approach which looks at environmental, social and governance factors across all their funds.

Henderson European Focus is a concentrated fund with a strong focus on value in the stock selection, and it has a good longterm track record.

“Stewart Investors Asia Pacific Leaders is a good example of a successful mainstream fund with a strong ethical element. Stewart Investors looks for good corporate governance and transparency from the companies in which it invests.”

Justin Modray, of Candid Financial Advice, the independent advice website, says: “Standard Life takes responsible investing more seriously than most, having a dedicated team that reviews the companies in which the firm’s funds invest to ensure they make a contribution to society.

“One fund which is worth a look is the Standard Life Equity Income investment trust.”