This article originally featured on FTAdviser's Canary Towers blog.
We frequently receive enquiries about socially screened funds of various types here at Morningstar. That isn’t surprising: There is increasing interest in such vehicles, and the socially-screened fund landscape is a complex one.
The first key is to clarify what the end investor’s specific requirements are with respect to social screens. There are ethical funds, religious funds, sustainability funds, and environmental funds, all in many different stripes.
Moreover, just because a fund is mandated or named in a way that might suggest it is suitable does not mean it will be.
For example, a fund using a “best-in-class” approach will not avoid entire industry groups, but will simply attempt to own the least offensive companies in each area. That has the advantage of helping the fund stay more diversified than it otherwise could, but an investor with strict environmental standards may well feel uncomfortable owning, say, the best large oil company.
One must therefore understand not just the broad aim of each fund, but also the definition of its social criteria and how that plays out in terms of its holdings to ensure they’re suitable for your needs.
Beyond this, one needs to assess the likely impact on performance or risk of the screens applied. If entire industries are out of bounds, that can lead to above-average risk and reduce the ability to the portfolio manager to add value via industry selection.
There will always be some trade-off in these respects, and it is imperative that investors considering a screened fund understand this before proceeding and that the proper balance be struck between client requirements and additional risks that may result from stricter screens.
Finally, in addition to screened funds, there are also offerings that attempt to invest in companies that are involved in improving the environment. Such offerings may be broad “ecology” funds that invest across the spectrum of water treatment, pollution control and alternative energy, or just focus on one of those specific areas.
Such funds will generally not be suitable as core equity fund substitutes given their concentration in relatively few industries, but can be bolted on to existing portfolios for investors who desire exposure to the area.
For more on ethical investing, read our recent article Show Me the Meaning of Being Ethical.
Christopher Traulsen is director of fund research, Europe and Asia, at Morningstar.
