Listen to UK advocates of socially responsible investing (SRI) and you’d likely believe the battle between screening and engagement had long, decisively, been won. Few companies or sectors would be automatically out-of-bounds for pension fund allocations to equities anymore. Instead, pension funds are increasingly looking to well-managed companies with responsible approaches on issues ranging from supply chain and labour rights to environmental impact.

Then, in June this year, came the decision of the $240bn (e191bn) Norwegian government (oil) pension fund to divest from Wal-Mart over alleged abuses of workers’ rights and it seemed screening was back in style.

In fact, screening as an SRI strategy had never gone away. The fact that screening has been most popular among retail funds - the so-called sandal-wearing contingent - may also have obscured the fact that it remains a going concern in continental Europe, accounting for €266bn (6%) of the European pensions market (Eurosif figures).

The figures for simple screening tend to be relatively high because of its “straightforwardness,” says the report. “It is fairly clear-cut to practice weapons or tobacco-screening on a large scale since it does not require much stock analysis.”

So it seems funds can still take one of two approaches: they can screen out companies engaged in that sector, or they can engage with sin-stock companies in the hope of making them less sinful.

“There’s quite clearly a trend towards engagement,” says Colin Melvin, director of corporate governance at Hermes, the BT pension fund, with the evidence on his side that the increase in screening is coming from the same body of pension fund managers. “There is a recognition among the largest funds that screening is hard to achieve consistently.”

It is precisely the issue of consistency that provoked the US backlash over the oil fund’s decision - not just from Wal-Mart itself but from the US ambassador to Norway Benson K Whitney.

There are two crucial issues for screeners. The first is that the more exposed the sector, often the better its corporate governance of the market leaders. You could call this Nike syndrome.

Scan the membership of organisations such as the Ethical Trading Initiative (ETI), a private - voluntary sector partnership lobbying for ethical supply chains, and you’ll find fast-moving consumer goods (FMCG) luminaries including Gap, Tesco and Asda (a Wal-Mart company). Likewise social reporting from top-tier oil and tobacco companies.

“Governance has become rather broad among forward-thinking funds,” says Melvin. “it is more responsible ownership. it is a huge opportunity for those interested in corporate change and those interested in corporate returns.”

Conversely, less exposed equities listed in less transparent markets could well escape screening simply because information on them is so hard to come by.

In a speech made at the Norwegian Institute of International Affairs, Ambassador Whitney claimed the Norwegian oil fund, which makes recommendations on divestment to the government, disproportionately screened out US companies because the fund instigates investigations based on public reports and greater exposure increases negative publicity. Google Wal-Mart and you’ll see what he means.

“Norway found Wal-Mart unethical for allegedly discouraging unions, but the government’s pension fund stands silent about firms in its portfolio from countries in which no unions, or only state unions, are allowed,” said Whitney.

“In these countries, the workers can’t complain, there is no free news media to report violations, and no regulations to violate, so the Norwegian ethics process now ignores them.”

“We can never be 100% sure that we catch the absolutely worst companies in the portfolio,” said ethics committee spokeswoman Gro Nystuen, “but that’s not our mandate”. What is perhaps more surprising is that SRI advocates in Europe would defend geographically defined two-tier ethics. Stephen Hine, head of international relations at Ethical Investment Research Services (EIRIS), points out that “our clients would likely say that they expect larger and developed market companies to abide by high standards and indeed many do so”.

The second problem is process. It isn’t just some of pension funds’ divestment decisions that have been questionable; it is the process of ethical screening. One of the criticisms made by Ambassador Whitney was that, although an ethics committee evaluates equities according to specific criteria, politicians make the final decisions according to a process that is clear to no-one. Sweden’s Second AP fund divested its shareholding in Wal-Mart after failing to influence the retailer through engagement over the same issues. The result was the same. The process was significantly different.

Where SRI-oriented pension funds invest will depend on three factors: their values, regulatory constraints, and their risk-and-return expectations.

Screeners claim that limiting their investment universe does not harm performance. “In the long run, performance depends on the skill of the pension fund manager,” says Rory Sullivan, head of investor responsibility at Insight Investment. (Insight has both screened and engaged funds.)

“There is evidence that engagement can be effective,” says Sullivan. “Benchmarking has improved over time. Investors can give effect to their ownership responsibilities and companies are happy to talk about social and environmental issues - for them, it is a welcome opportunity to articulate what they’re doing and why.”

Among Europeans, UK pension funds pioneered engagement not just out of pragmatism but because of a fiduciary duty that obliges them to invest across markets and leaves little room for screening. Elsewhere, that hasn’t necessarily been the case. But what if the trend is not towards engagement but a return to screening? Sullivan points out that local authority pension funds in the UK are “getting stick” for their investments. They are certainly increasingly exposed thanks to the efforts of non-governmental organisations such as Campaign against the Arms Trade.

They won’t as long as returns matter. Although there seems little unambiguous evidence to date that this has been the case with screened funds, it makes sense that limiting your investment universe will have a negative impact on returns. Pension funds - even those that screen - tend to draw the line at the point at which their returns would suffer.

it is a tricky business, this line-drawing. Eurosif claims the arms trade and human rights “are proving much more popular than tobacco as areas of focus”. Yet contributors to the defence industries can be pretty difficult to identify, given the fact that the latter use components made by technology firms, which tend to have a clean bill of moral health.

Pension funds are unlikely ever to plough their equities allocation into a rancid porn empire.

But they may well think twice about screening out defensive stocks. Some sectors, such as tobacco, are too small for their exclusion to make much difference - not that that has stopped pension funds from holding tobacco stocks. That isn’t the case for technology firms operating in the defence industries.

In the meantime, pension funds, advisers and SRI advocates will no doubt continue to argue about what it is they’re doing.

“The SRI agenda is evolving in Europe,” says Sullivan. “Yet there is no consensus on what is SRI - on the approach. It does appear that engagement is more popular. The UK has adopted a certain model and has not embraced screening. In Europe, screening has been the preferred model to date. it is too soon to say which model will prevail.

“The question becomes: will pension funds just rely on exclusion? My view is: yes, exclude, but you need to invest somewhere.”

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