Ethical stocks are a red herring, but these funds offer a solution

We look at how the widespread axing of dividends impacts ethical investors.

A lot has been said about the perils of income investors following a spate of dividend suspensions and cancellations by UK plc, but what does it mean for ethical investors?

With news that India’s carbon emission has fallen for the first time in 37 years owing to a reduction in fossil fuel consumption, and calls for governments to ensure that Covid-19 economic recovery plans are not at the expense of the planet, climate change and sustainability remains high up the political agenda. 

But the equity income market is somewhat of a red herring for ethical investors, as it is difficult to filter out ethical with ‘non-ethical’ stocks, as what constituents as ethical is hugely subjective, says interactive investor.

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The ethical investing sector is still maturing, and there is little guidance to help income investors find ethical stocks that match their values. The FTSE4Good UK 50, for example, tracks the performance of the largest 50 companies from the FTSE 100 index using a ‘best in class’ approach, selecting companies that score better on ESG issues when compared with their sector peers. 

All the constituents in the index pay a dividend – some considerably more than others – which makes it a good source of reference for ethical investors, in theory. But while companies with exposure to significant controversies like tobacco, weapons systems and coal are automatically excluded, the index includes stocks like global mining groups Rio Tinto (LSE:RIO) and BHP (LSE:BHP) as well as oil which many investors would not consider as ethical investments.

Funds and investment trusts with an income tilt don’t have all the answers, either – again, investors need to be able to make sure that the ethical credentials are aligned with their own. But they do have potential to at least offer a diversified income stream.

ii picks

Teodor Dilov, Fund Analyst, interactive investor, says: “For equity income, we like BMO Responsible UK Income which at present offers a healthy yield in excess of 4%. The fund, managed by Catherine Stanley, targets long-term income and growth by investing mainly in UK shares. 

“The fund applies both positive and negative screens to promote ESG themes like climate change while weeding out businesses that derive turnover from activities such as the production of alcoholic beverages and involved in the manufacture of genetically modified seeds or crops (among other) from its investment universe. As a result, the fund usually has a large exposure to mid and small cap companies. 

“What constitutes as ethical is determined by BMO’s responsible investing team, who also draw on an independent responsible investment advisory council which is presided over by Justin Welby, Archbishop of Canterbury.

“We also like Unicorn UK Ethical Income, which currently has an impressive yield of over 5%.  The fund is an ethically screened version of the Unicorn UK Income fund, and fund's universe of stocks is sourced directly from its sister fund. 

“An external service is used to screen out companies that generate revenues from prohibited sectors or those with environmental, social or governance concerns.  This translated to a zero-tolerance policy towards companies involved with tobacco, gambling, genetic engineering, animal testing and pornography. For alcohol, defence & weapons and nuclear power, a 5% maximum revenue derived from such activities is applied. 

“The portfolio is skewed to small and mid-cap stocks and as such can demonstrate greater level of volatility compared to some peers.

“Finally, investing predominately in UK bonds, Rathbone Ethical Bond is a good diversifier to an income portfolio. The fund, which offers a decent yield of 3.7%, has significantly outperformed the average return of funds in the Investment Association’s Sterling Corporate Bond sector in the medium to long-term. 

“The fund excludes bonds issued by organisations wholly or materially involved in a number of activities including the manufacturing of alcoholic beverages, tobacco and fur as well as companies involved in the production or sale of pornographic material.”

Myron Jobson, Personal Finance Campaigner, interactive investor, says: “It used to be the case where ethical investing was as simple as omitting traditional sin stocks like oil, tobacco and arms firms from your investment universe. But the world has moved on and companies can earn their ethical stripes by promoting environment, social and governance factors – ranging from renewable energy and cracking down on plastic waste – for the betterment of the wold we live in.

“The inclusion of companies like Royal Dutch Shell (LSE:RDSB) in the FTSE4Good UK 50 index may raise an eyebrow, but some investors argue that the company boost ‘green’ credentials because of its renewable energy division as part of plans to become a net-zero emissions energy business by 2050 – and the FTSE Russell Group clearly subscribe to this school of thought. It goes to show that investors need to look under the bonnet of each proposition marked ethical to ensure it marries up to their ethical stance before committing their cash.”

At what point a company stops being unethical and starts to become ethical is open to interpretation and a matter of personal opinion and, therefore, there is immense scope for disagreement. But it is far easier to tag funds and investment trusts as ethical because the managers of such investments products explicitly state what they constitute as ethical in their investment prospectus. 

To make it easier to find suitable ethical investments, interactive investor publishes an ethical investing long list l that is broken down into three ii ACE investment styles: Avoids, Considers and Embraces to help steer investors.

We also launched our ethical ACE 30 rated list, the UK’s first, last year, and an interactive investor ethical growth portfolio in January 2020 for investors who want a ready-made, balanced, multi asset portfolio run within a socially responsible investing framework.