Ethical and climate change funds that claim to be socially responsible are failing to invest in companies that support the environment, a new study claims.
The report by independent financial adviser Holden & Partners reveals most ethical funds are "surprisingly mainstream" in their overall portfolios, with very little investment in committed environmental companies.
"Some funds that are branded as ethical do not look any different to non-ethical funds when it comes to the companies they are investing in," said Mark Hoskin, partner at Holden & Partners, which specializes in offering ethical and environmental financial advice.
"A socially responsible investor will choose a fund precisely because it is branded `ethical.' They won't necessarily look at the underlying investments because they trust they will be ethical. But some investors would be surprised to see what their holdings really are," he said.
Socially responsible investment (SRI) funds use a form of ethical screening to select which stocks and sectors they will invest in, using a mixture of negative and positive criteria.
Each fund has its own interpretation of these positive and negative factors -- one may categorically choose not to invest in a company that has any involvement in animal testing, while another might invest in companies that carry out legally required animal testing only for the production of life-saving medicines rather than, say, cosmetics.
However, the study reveals that several ethically branded funds hold stocks in oil giants such as Premier Oil, Shell, Neste Oil and BP.
"This throws up questions about the screening process used by some companies," Hoskin said. "Can it be an ethical fund if some of its biggest holdings are in oil?"
Credit Suisse Fellowship Fund's top 10 holdings include HSBC, Glaxosmith Kline, Vodafone, Schroders and Associated British Foods. It holds just 2.5 percent of its money in environmental companies. Likewise, Legal & General's ?126.7 million (US$249 million) ethical fund has just 0.747 percent of this invested in environmental stocks.
"None of these top 10 companies stands out as particularly ethical," Hoskin said. "An investor might expect a more ethical weighting."
A spokesperson from Legal & General said: "Our ethical fund is an index-based fund based on the whole economy and isn't pretending to only operate in a particular fashion and only choose to invest in, say, wind farms. We are not making any judgment on what is ethical and what isn't -- we filter companies based on what market research tells us consumers consider to be ethical.
"On that basis, it is perfectly accurate to call it an ethical fund, because we invest in companies that contribute to the entire economy and operate under ethical practices based on what consumers tell us they believe to be ethical," he said.
Those that do have bigger environmental holdings include Henderson Industries of the Future fund, 51.1 percent of which is invested in environmental solution providers like solar power firm Solarworld.
Jupiter's ?291.25 million ecology fund invests 50 percent of its holdings in companies such as Bioteq Environmental Technologies, which builds water treatment plants, and Augean, a specialist waste and resource management group.
Jupiter, F&C and Norwich Union all have dedicated ethical research teams that actively analyze and decide upon the companies in which they can and cannot invest.
Standard Life regularly petitions its investors to see which environmental issues they are most concerned about, adjusting the holdings in its ethical funds to reflect this. Last week, the firm announced its SRI funds would no longer be investing in airlines after a third of its investors called for it to drop holdings in the sector. More than half of the investors said the climate was one of three top concerns.
Climate change funds, which invest in environmental companies, are a big growth area, according to many fund managers.
James Vaccaro, investment director at Triodos Renewables, a purely environmental retail fund, said: "Companies are under pressure to develop alternative sustainable energy sources for the future, and investors should benefit from this demand."
In the past three months, at least six climate change funds have been rolled out by investment companies, including Allianz, F&C, HSBC, Jupiter and Schroders. Strictly speaking, these funds do not necessarily fall into the same definition as an "ethical" fund as they generally do not follow the same strict screening process. Instead, they will typically invest in any company working on climate-related projects or solutions.
"We see climate change primarily as an area of importance as an investment theme rather than purely in ethical terms," said Farley Thomas, who runs HSBC's climate change fund.
"We have been very careful not to specifically brand our fund `ethical' -- it's just an amazing coincidence that something which is a great investment also happens to be ethical. We see it more as a mainstream global investment area," he said.
HSBC's biggest holdings are in energy provider Eon, Vestas Wind Systems and international industrial services group Suez. The fund will only invest in firms that generate at least 10 percent of revenues from climate change activities, but Thomas said he would not exclude sectors such as nuclear power.
"The reality is that the world needs alternative energy and the best way to support that is to invest in companies based on their overall sustainability and ethical behavior, regardless of their sector," he said. "Alternative energy, like windpower, is not yet mass-produced, but nuclear energy is a proven large-scale energy source. Ultimately, whether we invest in a nuclear power company or not depends on its performance."
Virgin Money launched its climate change fund last month. It said it will "invest in all industry sectors, but only in companies with lighter-than-average environmental footprints for their sector."
Ten percent of the fund is instead in "solution providers specializing in offering solutions to environmental problems," with the rest invested in the European market.
Holden & Partners, however, believes Virgin Money's climate change fund does not display a big enough commitment to the sector to be given the name that it has.
Hoskin said ethical investors might be disappointed when they find out where their money goes.
"There are some genuinely focused climate change funds around, such as HSBC and the Impax environmental markets investment fund, which state that they will only invest in companies with revenue generated specifically from good environmental practices," Hoskin said.
"But Virgin Money's fund doesn't have this sort of criteria. Climate change funds are new and there is a lot of interest in them, but a lot of companies are fudging things a bit. It's a great marketing push to call something `climate change' at the moment, and we think Virgin Money has done this," he said.
Virgin Money said: "Our climate change fund invests in companies across all sectors, but only those that do a better job than their peer group in minimizing their environmental footprint. The effect of this type of investing will be to see the stocks of lighter-footprint companies outperforming those of heavier-footprint companies.
"In our view, nothing can bring greater pressure to bear on company management teams to lighten their footprints than seeing their competitors' share prices outperform theirs. We think this benefits both investors and the environment in a more tangible way than the traditional approach, which in our view is just one small part of the answer," Virgin Money said.
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