Ethical investors begin to wield power

Ethical investment has come a long way in a very short space of time. Not so long ago it was a niche area that received little coverage and managed very few assets.

As environmental and ethical issues have moved very firmly onto the political agenda, responsible investment has also become more mainstream.

In Brussels, there are plenty of people working for a better world and some of them might have money to invest. So how can they make their money work in ways that cause the least harm, or even do some good? They have more options than ever.

Over time, the area has grown into Socially Responsible Investment (SRI). Total funds under investment by the end of 2005 were estimated at more than €1 trillion.

The European Social Investment Forum (EUROSIF), estimates that between 2003 and the end of 2005, the amount of European SRI assets being managed increased by 106% on a like-for-like basis. When rising market prices were taken into account, growth was estimated at a more likely 36%. Even so, this shows a rapid pace of growth and acceptance.

There are different approaches to asset selection by fund managers, split into Core and Broad SRI. In general terms, most SRI asset selection either excludes investments that breach certain policies or includes investments with positive traits.

Broad SRI looks among other things at tobacco, human rights and weapons screening while Core SRI adds other ethical and positive screening criteria.

SRI has also embraced the idea of active engagement. The aim of engagement is to own blocks of shares in companies to lobby from within for change. Traditionally, fund managers use active engagement to improve returns for shareholders. Under SRI, active engagement is used to influence corporate behaviour, with fund managers taking shares in companies whose activities are not compatible with SRI. Active engagement has taken hold most firmly in the UK, where the City of London has a strong influence over boardrooms and fund managers have the resources to commit to the sort of in-depth research that can produce changes.

Stephanie Dunn, SRI analyst at Dexia Asset Management in Brussels, explains: "Engagement should not only be a tool to target ‘bad’ companies, but is also a way to build positive relationships with ‘good’ companies and help ensure that they stay that way."

The majority of SRI investment is actually carried out by pension funds. Despite an increase in specialist funds that target individual investors, the real money will remain with pension fund managers and institutional investors. It is believed that in 2005, only 6% of investment was retail. This helps to explain, even if only in part, why engagement can be such a potent weapon. The average CEO is well aware of the power of even just one disgruntled pension fund manager.

Among European nations, SRI and active engagement are championed by the UK. Following a long way behind, in terms of assets being managed, are the Netherlands and Belgium. Growth in SRI is notably strong in both Spain and Austria. In terms of simple exclusion policies though, Belgium is by far the European leader.

As time passes, SRI funds become more flexible and are changing shape. Initially, ethical investment was a concept in equity selection only. While most funds are still mainly equity-based, some are now moving into corporate fixed-income products.

This represents a shift in asset allocation policies. Some funds are even looking at public fixed income offerings, which will require entirely new thinking and methods.

This change in asset allocation strategies has yet to hit home though. Virtually all SRI funds concentrate on companies with large capitalisations. Small and medium caps are only just on the radar.

In time, this will spawn a new range of higher risk, smaller company funds. When this happens, it will almost certainly be possible to invest solely with good intentions.

• Stuart Langridge is an independent financial adviser.

Ethical investment has come a long way in a very short space of time. Not so long ago it was a niche area that received little coverage and managed very few assets.