Going ethical this ISA season

Smoking isn’t good for you, but it’s been very good for UK investors’ returns over the past decade. If you’re not entirely comfortable with this statement, perhaps you might like to consider a few ethical funds for your ISA this season.

Let’s put some numbers around tobacco’s gains first though. If you’d invested £10,000 in the British tobacco industry 10 years ago, that money would be worth around £41,500 today. If you’d put your £10,000 into the UK stock market, you’d have £17,000¹. That’s quite a difference.

Objectively, tobacco is a smart investment. The companies don’t have to (and/or aren’t allowed to) spend big money on advertising. They have recurring demand and barriers to entry. And because they have strong cash flows and light capital expenditure, they tend to pay good, steady dividends that contribute significantly so investors’ total returns.

Subjectively, though, they are an area many people prefer to avoid. Depending on people’s personal views, other industries that often fall into the ‘unethical’ bucket include arms and weapons, gambling, alcohol or mining stocks.

So where do you draw the line?

Of course, nothing is black and white. Take an industry like healthcare, which has also beaten broader UK equities over the past decade. Your £10,000 investment there would be worth £23,500 today². At first glance, the sector should be a shoo-in as an ethical candidate. But, as always, there are nuances. The sector contains pharmaceuticals, for example, which have varying reputations regarding socially responsible behaviour.

These quandaries occur not just in investing, but in our day-to-day lives, too. We buy a bunch of chocolate bars on the high street without giving the brands a second thought, yet stories of cocoa farm mistreatments are rife – how do we know what we are really buying? Clothing retailers are another prominent example.

Ethical fund managers make these kinds of background checks part of their core business. Lesley Duncan, manager of Elite Rated Standard Life Investments UK Ethical fund, is particularly stringent. If a company that is in her portfolio falls foul of her and her team’s ethical standards, they will sell out completely. It’s one of the reasons we like Lesley’s approach, particularly for those who really do want to make sure they’re not exposed to certain sectors or corporate behaviours.

Investing to do good, not just avoid bad

Another positive trend in ethical investing, however, which is becoming increasingly popular, is to look for the good as much as to screen out the bad. Sue Round, who has been managing the Elite Rated EdenTree Amity UK for more than 25 years, recently brought a couple of their preferred investments—in chocolate!—to my attention. The fund currently has both Patiserrie Holdings and Hotel Chocolat in its portfolio and Sue emphasises that both companies have strong ESG [environmental, social and governance] credentials, while having also experienced impressive growth over the last decade.

Sue describes an ethical and responsible supply chain as “one of the most significant challenges to the food and beverage industry” and highlights how Hotel Chocolat is a rare example of a chocolatier that also grows its own cocoa to ensure better control over employees’ working conditions. So who says you can’t have your (chocolate) cake and eat it too?

An ethical bond fund

Another fund I really like, which puts ‘positive screening’ front and centre of its process, is the Elite Rated Rathbone Ethical Bond fund. Its manager, Bryn Jones, won’t invest in a company unless it has at least one positive ESG quality. Bryn’s been running the fund for more than 12 years now and it has beaten the average corporate bond fund by just over 10% during his tenure³. Because it buys bonds instead of equities, the fund also offers something different in the ethical investing space, with an income focus and a historic yield of 4.5%⁴ – pretty attractive in our low rate environment.

So while ethical investing is indeed an area with many shades of grey, the most important thing to know is that there are options. Personally, I like the idea of not just avoiding the companies I dislike, but of putting my money into businesses that are trying to change in the world, while also looking after my own financial future. I think that should be the definition of ‘good’ investing.

¹FE Analytics, FTSE All Share Tobacco vs FTSE All Share, TR in GBP, 09/03/2007–09/03/2017
²FE Analytics, FTSE All Share Health Care, TR in GBP, 09/03/2007–09/03/2017
³FE Analytics, Rathbone Ethical Bond vs IA Sterling Corporate Bond sector, TR in GBP, 01/11/2004–09/03/2017
⁴FE Analytics data, 28 February 2017

^{This post is amended from a blog we wrote for our sister company, Chelsea Financial Services, published on Every Investor, 27 October 2016}