"THE ETHICAL CHOICE "

New research shows that socially and environmentally aware investors have been among those hardest hit by the stock market carnage.

A survey from data provider, Moneyfacts, examined the performance of ethical funds, conventional non-ethical funds, index trackers as well as the FTSE 100 over a number of investment periods.

It found that despite enjoying strong investment returns in recent years, the average ethical fund is now lagging behind the performance posted by traditional or non-ethical funds over not just one but also, five and 10 year periods.

It seems going green is no longer paying off, with the average ethical fund has fallen 9.1% over the past 12 months compared with a much smaller drop of 5.7% for the average non-ethical fund.

But ethical investors have still slightly outperformed the FTSE 100 index of the UK's largest firms which has dropped by about 10% in the past year.

The change in fortune for ethical investing represents a remarkable turnaround on the situation just 12 months ago, when the typical ethical fund had outperformed the average non-ethical fund by 3.3% over a one-year period.

Richard Eagling, of Moneyfacts, says: 'In many respects the last 12 months have been a testing time for ethical funds.

'Falling markets have seen their performance falter more than their mainstream rivals, although given that they have less opportunity to invest in defensive stocks such as oil and tobacco, this should come as little surprise.'

Ethical funds operate in exactly the same way as conventional funds - in that they buy baskets of shares in a chosen sector - but before they make the decision to invest in a company, an ethical fund manager will run checks on the company to find out if it has interests in a number of 'positive' and 'negative' criteria.

Ethical portfolios have traditionally been classified as either 'dark' or 'light' green.

Dark-green funds for example exclude companies involved in arms, gambling, the fur trade, pornography, tobacco and those with a poor track record on human rights.

Light-green funds, or socially responsible investment (SRI) funds on the other hand tend to use a 'preference' tactic where they invest in companies in each sector that score highest on various social, environmental and ethical criteria.

They may invest in industries such as aviation, banking, drugs and oil - areas that would be excluded on stricter funds.

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A chief reason for the underperformance of ethical funds is that typically they would have missed out on the strong performance of commodity sectors such as mining and oil and gas. And to compound the problem, ethical funds have a strong bias towards smaller and medium sized companies, which tend to be hit harder during a downturn than blue-chip firms. Any exposure to banks would also clearly have had a major impact upon fund performance.

Just seven of the 57 ethical funds surveyed recorded positive growth over the last year, with the best performance, at 3.2%, posted by Henderson Industries of the Future. Most of the top performing ethical funds over one year, such as the aforementioned Henderson vehicle, are located within the Investment Management Association's Global Growth sector.

On the other hand funds with a predominantly UK focus have fared less favourably, including some of the most popular ethical/SRI funds.

For instance, F&C Stewardship Growth, Prudential Ethical Trust and Scottish Widows Environmental Investor have all fallen by 20% over the last year. In addition, AXA Ethical has fallen by 24% whilst Old Mutual Ethical has plummeted by 25%. But none of these come close to matching the underperformance achieved by Sovereign Ethical, which has posted massive losses of 33%.

Ethical funds may be lagging over the short term but over the longer term there is still evidence to suggest that investors can profit from their principles. Significantly, over three years ethical funds, with 16%, have marginally outperformed against non-ethical portfolios, which on average delivered 15.6%.
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