Ethical Screening

Screening is where companies are excluded from selection because of their involvement in certain activities such as armaments, gambling or tobacco. This approach often applies in conjunction with inclusive strategies which favour companies which can demonstrate positive contributions to the environment or the community such as biofuel production, wind farms, organic farming or recycling for example. All of the major ethical funds screen against tobacco, weapons and armaments. However, there is a wide variety of strategies used to screen out other factors, such as animal testing, unsustainable farming techniques, and human rights abuses. The screening approach does not inevitably preclude entire sectors. For instance, a company may be included if it is involved in the manufacture of armaments, but excluded if it exports these arms to countries ruled by oppressive regimes.

Ethical funds are often defined according to their "greeness", or shade of green, depending on the strictness of the criteria they choose to apply. Dark green investors narrow their investment choice because of the strictness of their ethical criteria. They may only invest in funds which select companies which proactively work towards improving the environment and operate a vigorous screening process, avoiding companies which do not confirm to their rigorous requirements. Light green investors normally tend to be less restricted in their choice of investments, excluding less companies in their investment selection, usually by a process of negative screening.

Our ethical questionnaire can help you to consider not just your attitude to investment risk, but also your attitude to social and environmental issues which are important to you. This can then be matched with our "off the shelf" portfolios, or you can use our filtering system to reduce the funds which do not comply with your criteria. This can help you to create a well diversified investment portfolio which precisely matches both your attitude to risk and your ethical concerns.

Light Green Ethical Funds

Light green funds, are inclined to reflect the weightings in the wider investment markets, since fund managers have a less restrictive mandate. They may invest in larger companies, which tend to be inherently less volatile and hence risky. Light green funds can include investments in animal testing, pesticides and the fur trade, but usually exclude armaments, alcohol, tobacco, gambling, pornography or nuclear energy.

Medium Green Ethical Funds

Apply stricter criteria than light green, but may still allow some exposure to companies with poor workplace relations, or companies responsible for ozone depleting chemicals. Investments tend to be made in smaller companies, mainly UK, Europe and North America, with some investments in other markets.

Dark Green Ethical Funds

Dark green funds, on the other hand, apply strict ethical criteria. In addition to the exclusions applied in the light green funds, dark green funds with strict ethical screening may limit their performance by only investing in companies which actively seek to improve our environment or benefit the community.

Most fund managers running ethical and SRI funds will have a research team who assess and monitor the criteria and produce an approved list of companies from which investments can be selected. If companies fall foul of these guidelines, they can be removed from an Investment House's panel of qualifying ethical investments.

Historically, ethical funds have been classified as either "dark" or "light" green. Dark green funds automatically exclude all companies involved in tobacco, armaments, gambling, the fur trade and pornography. Often they also screen out companies who use child labour abroad or employ third parties who do so.

Oil companies can be excluded on the basis that they work with regimes characterised by widespread human rights abuses.

Lighter green funds utilise a "preference" strategy. Instead of excluding a sector, they invest in companies which adhere to various social, environmental and ethical criteria. This opens up companies in sectors which would be shunned by dark green funds. The classic dark green/ light green approach has been increasingly replaced by caused based stock picking. As environmental concerns have increased, companies which favour renewable energy resources and sustainable development are favoured.

Other causes include animal testing, environmental impact, equal opportunities, human rights, intensive farming, genetic engineering, nuclear power, sustainable timber and military involvement.

The additional auditing, due diligence and research undertaken by ethical fund managers can lead to better informed investment decisions.

The Investment House may carry out background research on the key environmental and social issues facing a company and the sector in which it operates, analysing the company's environmental and social performance. This will include third party research from relevant organisations including Non-Governmental Organisations, trade associations and brokers.

There are many ways that an Investment House can apply diligence when selecting which companies qualify for an ethical investment fund. Often, ethical fund managers use a mixed approach- entirely screening out certain sectors, favouring investment in companies with ethical practices and actively engaging with the board of companies on ethical issues.

The criteria used to assess the suitability of a company for SRI funds are as follows:

• Product based - Products that provide solutions to environmental and social problems. These include clean energy, waste management, water management, transport, sustainable living and beneficiaries of legislation.
• Product opportunities - Companies which are developing products that have environmental or social benefit and can demonstrate that they are addressing their key environmental and social impacts.
• Leading company assessment - Companies that demonstrate leading practice amongst their industry peers.
• Limited impact company assessment - Companies that have relatively low environmental impacts and therefore can manage these appropriately using a 'light touch' approach. (This will not necessarily involve written procedures or processes. Sector examples: software companies.)
• Small company assessment - Companies whose management have a commitment to improve performance and can demonstrate that key social and environmental risks are managed well.
• Continuous improvers - These companies are typically working towards continuous improvement in policies, processes or performance in the areas of Corporate Responsibility. They are also demonstrating how their impacts are managed and reporting on progress.

Socially Responsible Investments as well as adhering to agreed negative criteria, actively seek out firms which make a positive contribution to society, for example:

Criteria to include	Criteria to exclude
AIDS research	Abortion
Animal welfare	Acid Rain
Birth control	Agrochemical production
Communications	Alcohol production, retailing or distribution
Community involvement & relations	Animal farming
Conservation products	Animal testing (cosmetic or medical)
Disaster relief	Armaments Trade
Education and training	Deforestation
Energy conservation & efficiency	Embryonic research
Environmental protection & technology	Employment practices which are exploitative
Equal opportunities employment policy	Environmentally damaging practices
Fair trade with developing countries	Factory farming
Firms with environmental aims	Fur trade
Forestry	Gambling - casinos, lotteries & betting shops
Green technology	Genetic engineering
Health & safety	Hardwood exploitation from non-sustainable sources
Healthcare sector	Human rights abuses - companies which operate in countries with oppressive regimes
Healthy living & eating	Land abuse military
Land use	Mineral extraction
Organic farming & foods	Motor industries
Overseas Development	Nuclear power
Plant welfare	Oil companies
Pollution control	Oppressive regimes
Positive products and services	Ozone depletion
Public transport	Pesticides
Recycling equipment	Polluters
Renewable energy projects	Pornography
Research (selected types)	Third World debt/ exploitation
Safety concerns	Tobacco
Sustainable 3rd World aid	Water pollution
Waste management	-
Waster recycling or sustainable forms of waste management	-
Water management	-
Water purifiers	-
Wind, wave or geothermal energy	-

Best in Class

Preference or "best in class" strategies are sometimes used by fund managers who apply ethical guidelines to give a preferred selection when all other factors are equal such as sector type and financial performance. So a fund manager who has to invest in companies which test on animals for medical research may be faced with companies with very similar financial performance, but will utilise ethical criteria, such as how the animals are treated, to select the company to invest in. If you accept that animal testing for medical research has to exist, then giving these companies an incentive to be more ethical than their competitors may help improve the ethical stance of the whole industry.

Engagement

The engagement approach does not screen out, include or prefer companies but rather the fund manager will actively encourage companies to adopt social and environmental best practices. An Investment House fund manager may use their influence as an investor to force a company to introduce environmental protection measures or standards of practice relating to the treatment of overseas workers. For example, Ford were pressured to disassociate from the Global Climate Coalition, a lobbying group which opposed the Kyoto treaty aimed at reducing global warming. In the late 1990s a further change occurred based on the belief that ethical or socially responsible investment should go beyond the 'avoidance' or 'supporting' approaches described above. Often called an 'engagement' or 'influencing' approach, here the investment fund will not apply any screening criteria to its investment choices. Instead, the fund manager undertakes to create a dialogue with a certain number of companies in the portfolio on a specific number of social and environmental issues. The aim is to encourage them to adopt the best business practices.

This essentially involves lobbying companies on social and environmental issues. The effectiveness of such a policy depends on the resources available and the commitment of those involved. Positive Focus: Best Of Class is the term applied to a policy, which favours those companies within each industry sector, which display the most progressive social and/or environmental policies. Industries Of The Future is gaining recognition a term, which applies to the practice of focusing investment on certain industries, which the fund manager believes will provide enhanced returns over the longer term.

Fund managers have closer relationships with individual companies than most investors. In addition, these companies are often small, meaning SRI fund managers can assert considerable influence.

Managers are looking for companies with ethical potential (such as Marks and Spencer, which has backed organic and sustainable produce).

Shareholders have a vital role to play in encouraging a higher level of corporate performance. One of the ways to achieve this is through responsible shareholding by adopting a positive approach to corporate governance and engagement. Axxis believes that it is important to engage with companies on behalf of its clients to promote more responsible business practice on corporate governance, environmental and social issues. Axxis supports the 'The Responsibilities of Institutional Shareholders and Agents - Statement of Principles' drawn up by the Institutional Shareholders' Committee (ISC).

The main principles are to:

• set out policy on how the fund manager will discharge its responsibilities
• monitor the performance of, and establish, where necessary, a regular dialogue with invested companies
• intervene where necessary
• evaluate the impact of engagement
• report back to clients/beneficial owners.

Engagement focuses on promoting environmental sustainability and social wellbeing particularly where this is either aligned with the improvement of financial performance or risk management. To achieve this, the fund manager's aim is to establish a positive, constructive and ongoing dialogue with the senior management of companies whose shares are held within the portfolios managed by the fund group to encourage them to address the environmental and social impacts of their business activities.

Other funds "engage" with companies by using the manager's power as a shareholder to push for changes to the way it deals with human rights, the environment and corporate governance issues. This means managers will not screen against a good-performing company to the disadvantage of investors, but will try to influence the company for good.

Other ethical fund managers prefer a process of "active engagement", where they encourage companies to adopt environmental and social best practice. Given that many of the companies comprising ethical funds are smaller companies, they can be easier influenced by fund managers, as opposed to large multi-national corporations.

Some SRI funds use an "engagement" approach which "overlays" the fund and does not affect investment choices in any way. In this case the only criteria applied to investment choices are financial and geographical. Rather than screening companies in or out, the fund manager uses their power as a shareholder to encourage companies to adopt socially responsible business practices. However, most UK SRI funds do not use the engagement approach, instead utilising a combination of positive and negative investment criteria.

The engagement with a company will then focus on the key environmental and social issues which they consider to have the potential to affect the company's financial performance or risk profile. These may include:

• management of environmental risk
• management of reputation risk
• maximising cost savings
• development of new business opportunities.

The focus of this engagement may be on a specific industry sector or on a specific environmental or social issue.

Dialogue and Engagement : Encourages more responsible business standards, when there is a strong business case for change . This approach can be done separately to or in combination with screening. Fund managers will engage on areas such as:

• Inappropriate remuneration
• Social responsibility
• Climate change

It makes financial sense as well as moral sense to invest in companies which are planning ahead to create a better environment.

Shareholder votes can be used to support corporate policies concerning a company's social and environmental conduct. A classic example of this is when Greenpeace orchestrated shareholder opposition to the BP Amoco Northstar project in Alaska which received shareholder support of 13.5%. In 1997 the Ecumenical Council for Corporate Responsibility (ECCR) - tabled the first ever environmental resolution at a British company's AGM. The company in question was Shell and the resolution raised questions about the oil giant's human rights and environmental records - it won nearly 11% of the vote - far more than its backers had ever hoped for, and a further 6.5 percent abstained. Since then there has been a wave of social and environmental resolutions at companies' AGMs and even though they have not achieved the majority vote the significant support they do get raises awareness of the issues with shareholders as well as with the company itself. Further, they attract media interest and help to encourage corporate hospitality.

Direct shareholder action can be a powerful tool for anyone who wishes to influence the ethical behaviour of a company. Institutional shareholders such as charities, church bodies and pension funds still have all of the rights of direct shareholding. The institution simply appoints a representative to attend the AGM and that person may vote and speak at the meeting in the same way as an individual investor. A number of charities now target certain companies which they invest in to encourage them to improve their policies or practices.