Despite the fact that the European eco-investor has yet to play a significant role, there is growing interest from corporate and local authority pension funds in ethical and 'socially responsible' investing. The WM Company reports a significant in-crease in enquiries over the last six months, as to the benefits of an ethical investment policy.

In the UK, the issue has been taken up by pensions minister John Denham, who suggests that because of their rigorous screening processes, ethical pension funds can often outperform. He has stated he wants the investment and pensions industry to be a force for good, and he is known to be considering stricter green re-quirements on funds' asset allocation.

A number of local authorities have formulated plans for an ethical investment policy. Lincoln, Edinburgh, Hampshire, Kingston and Merseyside have all put some of their money into ethical investments, via pooled funds.

Nottingham has a £1bn ($1.7bn) pension fund and county treasurer Roger Latham has laid out a clear agenda for the local authority. We believe there is something to be gained here, and in a world where 0.5% per annum can make all the difference to a fund, taking environmental impacts into account can give positive long term returns."

Institutions elsewhere in Europe are also taking up the ethical investment approach (see page 27). But the European market as a whole remains un-der-developed. The UK has 63% of European pooled funds under management, according to the Ethical Investment Research Service. There are now around 50 trusts and funds in the UK, with total assets of £1bn, of which Friends Provident manages over £800m.

Friends Provident says that 80% of the top companies in the UK now report on the environmental impact of their activities and social responsibility is a regular item on the boardroom agenda of the world's largest companies.

Generally speaking, the criteria used to select a company considered suitable for a socially responsible fund can be split into two groups. The first are those which make a positive contribution, while the second are those which are known to have a negative social or environmental effect.

Positive selection will result in support and encouragement of companies that are associated with issues such as conservation or ethical employment practices. Negative arises from the avoidance of companies linked with nuclear weapons, animal exploitation, oppressive and other ills of society.

Wolfgang Lotze of the Siemens pension fund says that although the German firm leaves investment policy entirely in the hands of the fund manager, there have been occasions where it has divested, "and if we feel strongly, we might adopt this policy again," he says. Despite the existence of a strong environmental lobby within Germany's red/green alliance, he does not expect the pensions and investment industries to have ethical standards imposed by government.

The UK government's pensions review has been urged to consider making ethical choice a central feature, encouraging high standards of corporate behaviour and enabling community investment. A Friends Provident spokesperson suggests that, "we need to have an ethical option in government and occupational pension provision. Such an option would certainly be popular; a recent EIRIS/NOP survey found that 73% of the population think their pension scheme should have an ethical investment policy."

The attempt to persuade trustees to adopt ethical policies is gaining pace. One example where this is happening is the £13.5bn Universities Superannuation Scheme (USS) for lecturers and other university employees in the UK. A small group of USS members have written to the chairman of the USS Trustees asking him to adopt an ethical investment policy.

And does it work? Experience in the US suggests that ethical shareholder resolutions have proved to be an effective vehicle for influencing companies' strategy. Ethical investment does not necessarily require avoidance at all, but may involve the positive, proactive involvement of invest-ors to promote change.

In most cases, however, funds are not proactive. If a share is unacceptable they tend not to enter into discussion with the companies they in-vest in. If a company's practice goes against the ethical criteria of the fund then the share is simply sold.

Ethical funds have, overall, performed well compared to their unscreened counterparts. WM have carried out research which found that an ethical universe achieved an identical return to a similarly unconstrained universe of funds. In addition, the research found that an ethical universe increased returns by about 1% pa without drastic increases in volatility.

Dominique Biedermann of Ethos a foundation for Swiss pension funds, runs two sustainable development funds, a Swiss equity fund, launched in early 1997, with Sfr300m in assets and a European equity fund, launched this year, with Sfr50m.

Biedermann says the funds include not only ethical and social criteria but also financial criteria, consistent with sustainable development strategy.

The first portfolio has consistently beaten the Swiss equity index since launch in February 1997 and Biedermann is confident that over the long term, it will continue to outperform, as he believes there is a positive effect. that comes from management of companies that take environmental issues into account.

Ethos has 45 member pensions funds and Biedermann says the ethical investment concept is growing in popularity across Europe, but with a different emphasis from country to country. "In France for example, there is not so much interest in environmental issues, they are more concerned with social analysis." Obviously in Germany, with its red-green coalition, the environmental issue is near the top of the political agenda.

The WM Company carried out some research in late 1996 which looked at comparable returns from green and unscreened portfolios, concluding that over the limited time frame of the research, there was no discernible detrimental effect caused by the green approach.

WM analysed the impact of ethical investment on returns and volatility of returns. They concluded that competitive returns are achievable but at a cost of extra volatility. An Ethical Charity Universe, specifically excluding companies involved in tobacco, alcohol, armaments and gambling, produced an identical UK equity return to that of unconstrained funds, 15.5% per annum during the study period, 1992-1995.

An ex-vices portfolio based around the FTSE All-share index showed that, from January 1992 to May 1996, annualised rolling three year returns were around 1% per annum better than the All-Share. The increase in volatility was 0.2%.

The third investment model examined the Friends Provident Stewardship Managed Fund, with assets of £218m at the end of 1995. This fund beat the WM All Funds Universe weighted average by 2% per annum over a 10 year period. The screening process, involving negative and positive screens, resulted in a very different portfolio from the All-Share index. WM's Alastair MacDougall comments, "There is a small cap effect in focusing on ethical opportunities, so you have to assess what is driving the performance. However, there does appear to be value to be added over and above this, whether by good stock selection or judicious switching"."

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