J Ö N K Ö P I N G I N T E R N A T I O N A L B U S I N E S S S C H O O LJÖNKÖPING UNIVERSITY

The f inancial performance of ethical funds

- A c o m p a r a t i v e a n a l y s i s o f t h e r i s k - a d j u s t e d p e r f o r m -a n c e o f e t h i c a l a n d n o n - e t h i c a l m u t u a l f u n d s i n U K

Master Thesis

Author: Elena Shloma

Tutor: Johan Eklund

Carl-Henrik Olaison Jacobsson

Jönköping June 2009

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Master Thesis in Economics

Author: Elena Shloma

Tutor: Johan Eklund, Carl-Henrik Olaison Jacobsson

Date: June 2009

Title: The financial performance of ethical funds. A comparative analysis of the risk-adjusted performance of ethical and non-ethical mutual funds in UK

Key terms: Socially responsible investments, ethical funds, corporate social responsibility, risk-adjusted performance, management fee.

Abstract

The review of the ethical funds literature shows the significant growth of the Socially Re-sponsible Investments (SRI) in the last few decades. The increase of the interest towards SRI indicates that ethical issues have become more essential for the investors. However the number of surveys reveals that financial performance remains of an important concern for the socially responsible investors. Therefore the benchmark analysis of the expected re-turns and management fees of the ethical mutual funds is chosen as a topic for this thesis research. The risk-adjusted measures are used to analyze and compare the performance of the ethical and non-ethical mutual funds in United Kingdom. The analysis does not indi-cate the significant difference in the expected returns between the two groups of funds. However this study concludes that on average ethical funds charge higher management fees. Thus investing in ethical funds is more costly but gives about the same returns as in-vesting in conventional funds.

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List of Abbreviations

BAT: British-American Tobacco

CSR: Corporate Social Responcibility

DEI: Direct Ethical Investment

EIRIS: Ethical Investment Research Service

FTSE: The Financial Times and the London Stock Exchange Group

ITG: Imperial Tobacco Group

KLD: Kinder, Lydenberg and Domini Research & Analytics, Inc

MSCI: Morgan Stanley Capital International

OEIC: Open Ended Investment Company

OLS: Ordinary Least Squares

PMInt: Phillip-Morris International

SIF: Social Investment Forum

SRI: Socially Responsible Investments

UK: United Kingdom (refers to the United Kingdom of Great Britain)

US: United States (refers to the United States of America)

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Table of Contents

1 Introduction ............................................................................... 11.1 Background ............................................................................................11.2 Problem discussion ................................................................................31.3 Method ...................................................................................................51.4 Purpose statement .................................................................................51.5 Research questions................................................................................61.6 Originality of the research.......................................................................61.7 Scope and Delimitations.........................................................................7

2 Background and Literature Review ......................................... 92.1 Profile of the ethical investors...............................................................112.2 Corporate Social Responsibility............................................................122.3 Ethical funds.........................................................................................132.3.1 Mutual funds.........................................................................................142.3.2 Socially Responsible Investments ........................................................152.3.3 Financial performance of ethical funds .................................................17

3 Method and Data ..................................................................... 193.1 Method .................................................................................................193.1.1 Modigliani and Modigliani model ..........................................................203.1.2 Cross section regression ......................................................................213.2 Data......................................................................................................233.2.1 Samples ...............................................................................................233.2.2 Data gathering......................................................................................243.2.3 Data for the cross-section model and Ethical Rating............................26

4 Empirical Results and Analysis ............................................. 304.1 Characteristics of the data sample .......................................................304.2 Results of the matched pair analysis ...................................................334.2.1 Financial performance ..........................................................................334.2.2 Management fee ..................................................................................374.3 Results of the regression analysis ........................................................384.4 Analysis of the results...........................................................................41

5 Conclusion .............................................................................. 43

6 Suggestions for the further research .................................... 44

References ................................................................................... 46

Appendix ...................................................................................... 49

List of Figures Figure 1 The SRI through the ethical funds.......................................................10Figure 2 The data gathering procedure.............................................................24Figure 3 The selection of the non-ethical funds.................................................26

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Figure 4 The distribution of the funds in the sample among the sectors ...........30Figure 5 Annual Management Fees. .................................................................32Figure 6 Front Loads.........................................................................................33

List of Tables

Table 1 The Ethical Rating................................................................................29Table 2 The size of the funds in the sample......................................................31Table 3. The funds which have the tobacco companies among the 5 largest

holdings and the tobacco companies they invest in..............................32Table 4 Summary of the empirical results .........................................................35Table 5 The output of the OLS regression #1. ..................................................38Table 6 Correlation Matrix .................................................................................38Table 7 The output of the OLS regression #2. ..................................................39

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1 IntroductionThe background part of this thesis provides a small introduction to the concept of the ethi-

cal investments and explains the reasons why some analysts assume that there should be a

difference in financial performance between ethical and conventional funds. Further the

purpose of the research and the main research questions are formulated. Finally the origi-

nality and the delimitations of the thesis are discussed.

1.1 BackgroundThis thesis analyses the performance of the ethical funds in UK. When analysts and inves-

tors call one fund ‘ethical’ they generally imply that the fund is focused on the socially re-

sponsible investments (SRI). Ethical funds are also known as ‘green’, environmental and

socially responsible funds. Different nomenclature is used in different countries(Beal and

Goyen, 1998). Within this thesis work all the terms are used as synonyms and refer to the

funds which promote SRI and marketing themselves as been ethical. These funds allow in-

vestors to integrate their personal values and social concerns with their investment objec-

tives (DEI). The SRI approach implies that ethical funds screen the companies according

to some type of ethical criteria and invest in these which show a high quality of corporate

social responsibility (CSR). Generally the CSR is defined in the academic literature as a way

of solving the potential conflict between the management of the company and the wide

spectrum of the stakeholders, including employees, customers and the general community

(Bird et al. 2007). The question concerning the area of the management’s responsibilities

towards the stakeholders is addressed by many analysts. From the neo-classic economists’

viewpoint the main responsibility of the management is to maximise the market value of

the company (Bird et al. 2007). However some other analysts, investors and even govern-

ment include the social and environmental issues into the CSR. For example Kinder,

Lydenberg and Domini Research & Analytics, Inc., which create the one of the most

commonly used CSR indices, evaluates companies based on the following issues: commu-

nity relations, diversity, employee relations, human rights, and product quality and safety,

environment and corporate governance (KLD). Within this research the broad definition

of the CSR is used. The SRI and CSR are often interpreted by the analysts as the same con-

cept. However SRI looks from the viewpoint of the investors, while CSR looks from the

viewpoint of the firms. The more detailed description of the SRI performed by the ethical

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funds and its relationship with the CSR is discussed in the Background and Literature Re-

view chapter.

Every year the studies on the socially responsible investments show the increasing interest

towards SRI among the individual and institutional investors.

For the last decade the SRI market has been growing every year. The amount of the social

responsible investments (SRI) in Europe has increased from €1.033 trillion in 2005 to

€2.665 trillion at the end of 2007 (Eurosif, SRI Study, 2008). Over the same period the

MSCI Europe index grew 16.16%. According to the Eurosif research it means that the real

market growth for the total SRI market is 85.5% over two years. The 2007 Report on So-

cially Responsible Investing Trends in the US demonstrates that one of nine dollars in-

vested in the market funds is invested in SRI portfolios (SIF). The same study documented

the increase in the number of ethical funds and the amount of the socially responsible in-

vested assets. According to Avanzi SRI Research, there were 388 green, social and ethical

funds domiciled in Europe on 30 June 2006.

These trends show that nowadays not everyone agrees that ‘the main responsibility of the

business is to increase its profits‘(Friedman, 1970). Apparently the growing number of ethi-

cal and sustainable funds proves that there is a demand for SRI. It seems that high return is

not any longer the only main factor which influences the investment decisions. Some inves-

tors want to make sure that their money do not support the war in Sudan, or are not in-

vested in tobacco industry. They might be concerned about particular ethical issues, like

environmental protection, ethical employment practices, conservation and recycling and

others. This implies that it is possible to find a fund which not only manages your money

to achieve the highest returns, but as well satisfies your non-material needs.

The socially responsible investments can be defined as ‘…a set of approaches which in-

clude social or ethical goals or constraints as well as more conventional financial criteria in

decisions over whether to acquire, hold or dispose of a particular investment’ (Cowton,

1999, p. 60). SRI implies screening of the companies included in the investment portfolios

based on social, environmental and good corporate governance criteria, shareholders advo-

cacy and community investing and others (SIF, Socially Responsible Investing Facts). The

society of the socially responsible investors includes both individual and institutional inves-

tors. Institutional investors, including the ethical funds, represent the largest and fastest

growing segment of the SRI in the world (SIF).

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However, there is some skepticism about ability of the ethical funds to provide about the

same returns as the conventional funds and give their clients an additional moral satisfac-

tion free of charge. It is argued that ethical funds have higher transaction costs and man-

agement fees because they need to collect special information concerning the ethical prac-

tices of the firms (Michelson et al., 2004). Therefore one might expect to pay more for in-

vesting in the ethical funds. Making the decision about putting money in the certain fund

investors traditionally consider the costs of the investment and performance of the fund.

There are some surveys and studies which show that investors who put money in the ethi-

cal funds are different from the conventional investors and they have different motivations

when making an investment decision (Beal et al., 2005, McLachlan and Gardner, 2004).

However the same studies indicate that the costs of the investments, as well as financial re-

turns remain an important consideration when investing in ethical funds. Therefore the

need to analyze the performance and the management fees of the ethical funds remains.

This thesis seeks to investigate what is the difference between investing in the ethical and

conventional funds, from the perspective of costs and profit. Within the framework of this

research the attempt is made to compare the costs and the returns of the investment op-

portunities offered by ethical funds with investing in non-ethical funds. The research is

conducted in two directions, comparable analysis of the financial performance of two

groups of the funds and the analysis of the difference in the management fees charged by

the funds. The object of the research is the group of the Unit Trusts and Open Ended In-

vestment Companies (OEICs) in United Kingdom. Unit Trusts and OEICs are pooled in-

vestments that provide investors with the ability to invest in a larger number of shares si-

multaneously. They are both open ended which means that the size of each fund can vary

according to supply and demand. Both the Unit Trusts and OEICs represent the same in-

vestment concept, the main difference is when you invest in a Unit Trust you buy a unit,

which means a portion of the total fund, OEICs issue shares (Trustnet, Unit Trusts and

OEICs Guide). Both the Unit Trusts and OEICs are types of mutual funds, and are used

as the representatives of the society of institutional investors for the purpose of this re-

search. The UK market is chosen as the object of the research since it is the largest SRI

market in Europe (Eurosif European SRI Survey, 2008).

1.2 Problem discussionWhile social responsible investors integrate the environmental and social values in the in-

vestment decision-making process, return on investment remains of important concern to

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them (McLachlan and Gardner, 2004). In the Sparkes’s survey (1998) it was shown that on-

ly one third of the investors would invest ethically if returns were slightly lower than for

comparable conventional funds, however this percentage drops rapidly if the return for

ethical funds are significantly less than for conventional funds (cited in McLachlan and

Gardner 2004, p 12). Moreover to encourage the socially responsible investments the ad-

vocates of the ethical funds often emphasize that ethical funds provide at least the same re-

turns as the conventional funds (DEI). There are even some expectations that ethical funds

are doing financially better than conventional funds. The main reason behind these expec-

tations is that ethical funds screen the companies and choose to invest in these which are

concerned about the corporate social responsibility (CSR). There is some evidence that

CSR behavior has a positive effect on the market value of the firms and that ethical firms

are more sustainable than non-ethical firms. Therefore the portfolios that consist of the

shares issued by the firms with high quality of CSR are considered to be more sustainable

and produce higher returns. There is a number of reasons to expect the positive effect of

CSR on the corporate financial performance. First of all, companies with the high stan-

dards of CSR avoid paying the consequences of the non-ethical behavior, such as lawsuit

judgments, government fees and others(Bird et al., 2007). There are even examples when

such behavior leads to the bankruptcy1. Second, CSR is believed to create the intrinsic mo-

tivation for the employees, which is proved to be associated with the more efficient per-

formance (Millington et al., 2007). In general the ethical firms are expected to perform bet-

ter in the longer time horizon than firms which are not concerned about ethical issues

(Cummings, 2000).

In contrast there is as well a number of analysts who believe that the screening process has

a negative effect on the financial performance of the ethical funds. Ethical funds exclude

many companies from their portfolios, for the reasons other than weak financial perfor-

mance. It is common for the ethical funds to avoid investments in the certain industries,

regardless if such investments might provide high returns or not. For example ethical funds

do not invest in tobacco companies, which are often among the biggest holdings of the

mutual funds and give the investors relatively high returns2. What is more, most of the

funds do not put money in the companies with the low quality of the corporate governance

1 For example in case of Enron, Parmalat and Worldcom (Becchetti et al. 2007)

2 The presence of tobacco companies among the main holdings of the companies in the sample is discussed in the Method and Data chapter of this thesis.

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or these which are not concerned about CSR. Therefore ethical investments are believed to

be less diversified and hence more risky for the investors than traditional invest-

ments(Michelson et al., 2004). That is why some analysts assume that ethical funds in gen-

eral show poorer financial performance than the conventional funds

It is argued as well that ethical funds charge higher management fees than conventional

funds, since the screening process involves higher transactional costs for the ethical funds

(Michelson et al., 2004). This thesis research combines the analysis of the financial perfor-

mance of the ethical funds with the analysis of the management fees charged by these

funds in order to investigate the costs and profits of investing ethically.

The arguments above show that there are discrepant opinions whether ethical funds are

expected to perform financially better or worse than conventional funds. Moreover some

analysts point out that there is a lack of the empirical research on the financial performance

of the ethical funds (Kreander et al., 2005, p.1466). In addition the relationship between the

financial performance and the management fee is analyzed to contribute to the conclusions

about costs and returns of investing in the ethical funds.

1.3 MethodThe matched pair analysis is used to compare the performance of the ethical and conven-

tional funds. The two matched samples of the ethical and conventional funds were created

and the performance of the each ethical fund was compared with the performance of the

similar non-ethical fund and with the benchmark. This method was chosen because it al-

lows to investigate if the investment approach of the ethical funds has an effect on the fi-

nancial performance of the funds assuming other characteristics being equal. The financial

performance is analyzed using the risk-adjusted Modigliani and Modigliani (M2) measure.

The risk-adjusted measures are commonly used for the benchmark analysis of the funds’

financial performance, since it facilitates the comparison of the different funds. The differ-

ence in the management fees between the two groups of the funds (ethical and conven-

tional) is analyzed using the matched samples and an additional regression model.

1.4 Purpose statement The main purpose of this study is to analyze if there is a difference in the performance be-

tween ethical and conventional funds. These two groups of the funds provide different

services, have different clients and invest in different companies. Thus there is a general

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expectation that ethical and conventional funds should show different financial perfor-

mance. Particularly this study is focused on the difference in the portfolio returns and the

management fees between two groups of the funds.

1.5 Research questionsBased on the problem discussion the following main questions emerge:

Is there any difference in the performance between ethical and non-ethical funds?

Is there any difference in the management fee between ethical and non-ethical

funds?

In addition the following question will be answered to expand the research on the fund’s

financial performance:

Is management fee charged by the fund related to the performance of the fund?

1.6 Originality of the researchWhile this thesis is based on the previous researches in the area of SRI, there are some dis-

tinctions which contribute to the studies on the ethical funds.

First, in the previous researches such measures as the Sharpe ratio, the Jensen measure and

the Treynor ratio are used to estimate the risk-adjusted performance. Despite the fact that

these measures are the most commonly used to compare the funds, they have received

some criticism for been difficult to interpret (Wiberg, 2008). Thus in this work the Modi-

gliani and Modigliani (1997) M2-measure is used, since it is considered to be more easily

understood by average investor and therefore more helpful for measuring the risk-adjusted

performance.

Second, in the previous studies performance of the ethical funds was compared with the

same benchmark for every fund. It means that all the funds in the sample were from the

same investment universe. Within the framework of this thesis research the attempt to

overcome this limitation is made. The sample includes the ethical and non-ethical funds in-

vesting in the different sectors like UK market, Global market, Asia and Pacific market and

others. Obviously it would not be correct to compare the funds in the sample with the

same benchmark. For this reason the appropriate benchmark was chosen for each of the

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funds. The benchmark sample includes for example FTSE All Share index for the funds

investing in UK, or MSCI AC Asia Pacific ex Japan index for the funds investing in Asian

markets.

Next, within this research the attempt is made to combine the research on the financial

performance of the ethical funds with the analysis of the management fees. The goal is to

take a look at the ethical investments from viewpoint of the individual investors, who put

money in the funds. Individuals choose between investing in the ethical and non-ethical

funds, and as it is discussed above, on the first place they consider the returns and the costs

of the investment opportunities in the different funds. Therefore the simultaneous analysis

of the management fee and the financial performance of ethical and non-ethical funds

helps to investigate the pros and the contras of investing ethically.

Finally, the more contemporary data were collected. The data on the historical prices of the

mutual funds’ shares was collected for the period of 33 months, from January 2006 to Sep-

tember 2008. This time horizon was chosen for the several reasons. First of all some funds

in the sample were launched recently, so for many funds there is no information on the his-

torical price before the year 20063. Second, the most recent data on the performance was

excluded from the research due to the possible effect of the global financial crisis of 2008-

2009 on the funds’ share prices. It is well known that ethical funds avoid investing in some

industries which were highly damaged by the crisis (like oil and gas, natural resources).

However it was noticed that some ethical funds in the sample invest heavily into financial

sector and money market. Hence, to avoid the possible discrepancy of the results due to

the influence of the financial crisis the data was collected for the period before the crisis

had an impact on the share price. The sharp decrease in the price of the mutual funds

shares for all the funds in the sample is noticed after the September 2008. Thus latest share

prices collected are on the 1st of September, 2008.

1.7 Scope and DelimitationsThe scope of this thesis is to analyse the performance of the Unit Trusts and OEICs in the

United Kingdom for the period from January 2006 to September 2008. The study is limited

to the group of the funds which profiles are published on the Trustnet the Financial Ex-

3 Some funds in the sample were launched after the research start date, for these funds the annualized returns

were calculated from the launch data. It should not influence the benchmark analysis, since it does not ef-fect the risk-adjusted measures. The same approach is used by Mallin et al., 1995, and Kreander et al., 2005.

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press Company website database. The Trustnet database contains information about the

2410 Unit Trusts and OEIC in the United Kingdom. Obviously the study sample suffers

from the survivorship bias, but since it affects both the ethical and non-ethical funds it

should not affect the comparative analysis.

Another limitation which is worth to be mentioned is that the ethical status of the certain

fund is difficult to define. It is hard to assess which fund can be considered ethical and

which can be considered non-ethical. Mostly the funds characterize themselves as been fo-

cused on the socially responsible investments, which is not easy to verify. Moreover con-

ventional funds generally do not state in their profiles that they are non-ethical and it is

hard to investigate if they consider the social issues in their investment strategies or not.

Thus it is hard to create the sample of purely ethical funds or purely non-ethical funds to

conduct the comparative analysis. To reduce the impact of this limitation the ethical rank-

ing is used and the main holdings of the funds in the samples are analysed.

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2 Background and Literature ReviewThe phenomenon of the ethical funds is analysed in the academic literature from different

viewpoints and different perspectives. Some studies focus on individual investors who put

money in the ethical mutual funds and analyse the reasons behind this investment decision.

Others are interested in the investment approach of the ethical funds and their objectives

or analyse the profile of the companies included in the holdings of the ethical funds. Some,

like this study, are interested in the financial performance of the ethical funds in compari-

son with the conventional funds. The SRI is a complex phenomenon that involves many

individuals and institutions. In this chapter the attempt is made to look at the different as-

pects of the ethical investments and to analyse the different viewpoints and reasons behind

SRI. However on the first place this thesis research concerns the financial performance and

the management fees of the ethical and non-ethical funds. The background discussed in

this chapter serves the main purpose of this research and explains the previous studies on

the ethical funds from the perspective of financial performance. The emphasis is made on

the determinants of the performance and the approaches to the performance analysis.

To structure the studies reviewed in this chapter and to highlight the most important topics

of this research, the simplified scheme of the investing into the ethical funds is cre-

ated(Figure 1). The main purpose of this scheme is to provide some illustration of how this

chapter is organised. The ethical funds are discussed from viewpoints of three main parties

involved in the SRI through the funds: individual investors, firms and ethical funds them-

selves. Individual investors make a decision about putting money into the certain fund, af-

ter that the fund makes a decision about purchasing the shares of the certain companies.

The scheme shows which aspects influence the investment decisions at each stage, and on

which side these aspects occur. Finally, these investment decisions result in the certain

portfolio the ethical mutual fund holds and determine the financial performance of the

fund.

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Figure 1 The SRI through the ethical funds

Source: Made by the author

The chapter is organised using the scheme on the Figure 1, the various aspects of the ethi-

cal investments are analysed and at the end of the chapter all of them converge to the ques-

tion about the financial performance of the ethical funds. First two parts of this chapter

look at the socially responsible investments from outside the ethical funds and discuss the

external factors which influence the financial performance of the ethical funds. First part is

devoted to the studies on the individual investors and the second part analyses the social

responsibility of the firms. In the last part the ethical funds are discussed directly and the

internal factors of the funds’ financial performance are analysed.

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2.1 Profile of the ethical investorsThe growth of the SRI in the world indicates that the demand for SRI from the individual

investors has increased in the last decade. This part includes the profile of the ethical inves-

tors and discusses the determinants of the investment decision. In general the surveys dis-

cussed in this chapter show that ethical investors are demographically different from the

conventional investors. However they as well reveal that ethical and conventional investors

are more similar in their incentives, than it might be expected, since both put the financial

reward on the first place when making an investment decision.

Several studies show that socially responsible investors are generally younger, better edu-

cated and have a lower income than conventional investors (Rosen and Sandier, 1991,

McLachlan and Gardner, 2004). Research conducted by KPMG (2000) suggests that 80%

of 25-39 year olds as compared to 72% of 40-59 year old would consider investing ethically

(cited in McLachlan and Gardner, 2004). Rosen and Sandier documented that 60% of the

ethical inventors had graduate degrees, but currently earned 15% less than the conventional

mutual fund investors, possibly because they were in earlier stages in their careers. As well

it was noticed that ethical investors are more likely to be female than conventional inves-

tors.

The ethical investment research literature traditionally suggests three reasons for people in-

vest in socially responsible funds: for superior financial returns; for non-wealth returns; to

contribute to social change (Beal et al., 2005). The review of the literature on the ethical in-

vestments, conducted by Beal et al.(2005) concludes that ethical investors are motivated by

a combination of financial returns and non-wealth factors. The ethical investors are inter-

ested in all three of proposed objectives, however the social change factor is the least im-

portant in the decision to invest in SRI funds. In contrast, the financial return remains the

main important factor for most of the investors, when making the decision to put money

in the ethical fund. There is a number of studies which support this hypothesis. The results

of the Sparkes’s study (1998) are reviewed in the Introduction chapter. Similarly, the survey

conducted by McLachlan and Gardner (2004) using the sample of 55 conventional and 54

ethical investors showed no evidence that financial returns are more important for conven-

tional investors than for socially responsible investors.

The studies on the ethical investments conclude that ethical investors seek to align their

personal values with the investment objectives, and contribute to the society. Ethical inves-

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tors believe that SRI funds produce at least the same returns as the conventional funds and

at the same time ensure the high CSR standards in the companies they invest in.

However it is often mentioned in the studies on the SRI that ethical funds are rather make

people to feel better about themselves, than actually change the society. Investing in the

SRI funds does not affect the environment or businesses directly, but makes people believe

that eventually SRI will make a change (Beal et al., 2005). Therefore there is a strong as-

sumption that labeling themselves as ‘ethical’ mutual funds seek to attract the new type of

investors, and SRI is nothing more than a new marketing strategy. Some researches which

support this hypothesis are revealed in the last part of this chapter.

2.2 Corporate Social Responsibility The theory on the corporate social responsibility is analysed in this part. Traditionally CSR

is assumed to be the main source of the financial performance of the ethical funds. The

screening of the firms according to the socially responsible criteria performed by the ethical

funds involves that the ethical funds intend to invest in the companies with high quality of

CSR. Some analysts note that SRI and CSR are basically the same concept that business

should generate the wealth for society. CSR takes a look from the viewpoint of the firms,

while SRI looks from the viewpoint of investors, including mutual funds. Thus the per-

formance of the ethical funds is believed to be dependent on the relationship between cor-

porate social responsibility and corporate financial performance at the scale of the individ-

ual firm (Mill, 2006). Explicitly, if there is a difference in the performance between the so-

cial responsible and conventional firms, there should be a difference in the performance

between the ethical and conventional funds.

There are several reasons why analysts assume that CSR can increase the value of the com-

pany. Bird et al.(2007), mention such factors as; (1) activities that result in an immediate

cost saving, which increase the profitability and therefore the company’s market values, like

becoming more energy efficient, (2) Other activities that bring reputational benefits (good-

will) to the company which increase both profitability and market valuation, (3) Other ac-

tivities that dissuade future action by government and other regulatory bodies which might

impose significant costs on the company. Another value increasing sources of the CSR is

proposed by Yellen (1984), this study suggests that CSR creates the intrinsic motivation for

the employees, that improves productivity at the same costs. These motives make managers

to improve the corporate social responsibility and anticipate the increase in the market

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value. As it might be expected there is as well an opposite opinion on the link between the

CSR and the market value of the firm. Some analysts claim that there are many other im-

portant events influence the financial performance of the firm, so CSR cannot have an ob-

servable influence on the market value (Ullman, 1985). Other say that improving CSR is as-

sociated with the high expenditures which put the company at a comparative disadvantage

and effects negative its market value (Aupperle et al., 1985)

There are different theories on the relationship between CSR and the market value of the

company. However it is important to take into consideration the results of the empirical re-

search. One of the common ways to analyse the effect of the CSR on the market value is to

check for the abnormal returns when company engages in the SR activities. One of the

common indicators of company applying the CSR principles is inclusion of the company in

one of the CSR indices. The most commonly used indices are Dow Jones Sustainability

World Index, Domini 400 Social Indices, FTSE4Good Indices. They track the perfor-

mance of the CSR world leading companies. There is empirical evidence that companies

inclusion (exclusion) from the Domini 400 Social Index, leads to the abnormal positive

(negative) returns (Becchetti et al., 2007). However the negative effect turned out to be

much stronger than positive effect. Some other empirical tests show that the effect of the

CSR activities on the firms’ performance is significant only in the short time horizon. Lo-

pez et al.(2007), using the Dow Jones Sustainability World Index, showed that there is no

significant difference in the revenues of the firms included in the index and not included in

the index during the 7 years period.

2.3 Ethical fundsThis part addresses the ethical mutual funds directly and explains the investment approach

of the ethical funds and other determinants of their financial performance. First, the studies

on the mutual funds reviewed, since the financial performance of the ethical funds is ana-

lysed in this thesis research using the conventional approach to the analysis of the mutual

funds’ performance. Than it explains how the ethical funds are different in their investment

strategies from the rest of the mutual funds, and what does the SRI approach implies. Fi-

nally the effect of the SRI on the financial performance of the ethical funds is discussed

and the results of the previous studies in this area are reviewed. Also some criticism of the

SRI approach as being used solely for the marketing purpose is presented in this part.

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2.3.1 Mutual funds

The object of this research is the sample of the mutual funds in UK. Thus there are some

background studies on the mutual funds which are important for this thesis. First of all the

most common approach to the benchmark analysis of the financial performance of the

mutual funds is using the risk-adjusted measures. The reason behind this approach is to

make the funds comparable with each other and the benchmark. This method is used for

example by Sharpe (1966) and Jensen (1968).

It is generally accepted to take into consideration both the expected risk and return of the

portfolio when analysing its financial performance. The higher return of the investment

normally implies higher risk associated with this investment. The task of the investor is to

select among the different portfolios the one that he considers the most desirable, based on

his particular feelings regarding expected risk and return (Sharpe, 1966). Therefore there is

a need for approach which allows to compare the portfolios characterised by the different

expected returns and risks. To make the portfolios comparable the risk-adjusted measures

were proposed by several analysts. There are different measures of the risk-adjusted per-

formance, however they all express the same concept. The idea behind the risk-adjusted

method is to bring all the analysed portfolios to the certain level of risk (to the benchmark

level) and to investigate which portfolio shows the best expected returns at this level of

risk. Namely it makes the different combinations of the risk and return comparable with

each other, by showing how the return of the portfolio would change if the risk of this

portfolio was adjusted to the certain level. There is a number of the risk-adjusted measures

proposed by the different analysts. In this study the Modigliani and Modigliani (M2) meas-

ure is used, the M2 approach is discussed in the Method and Data chapter.

Another question which is considered in this research is the influence of the various factors

on the financial performance of the mutual funds. The most commonly considered factors

are the size, the age and the management fee. There are some studies which show that the

small funds on average perform better than the big funds. Gallagher et al.(1998) analyse so

called small funds effect on the sample of 46 mutual funds and conclude that small funds

show higher returns than bigger funds. However this effect disappear when the funds are

compared using the risk-adjusted measures. In the Kreander et al.(2005) research it was

shown that the size of the fund is not related to the performance as well as the age of the

fund, while the management fee is argued to have a significant effect on the performance.

15

The influence of the size and the age on the performance is taken into consideration within

this thesis research, and for this reason the matched sample approach is used to avoid the

influence of the certain characteristics on the performance of the ethical funds.

Regarding the management fee charged by the funds there is some evidence that the fee is

related to the financial performance. However the results of the studies on the determi-

nants of the financial performance of the mutual funds are inconclusive about whether this

relationship is negative or positive. In Kreander et al.(2005), the regression analysis per-

formed using the sample of the mutual funds in UK showed that the fee coefficient is posi-

tive and significant. While Grinblatt and Titman (1994) documented a significant negative

relationship between fee and the Jensen measure for US mutual funds. This thesis seeks to

obtain more evidence on the relationship between the management fee and the financial

performance in the mutual funds.

2.3.2 Socially Responsible Investments

This part explains what does the SRI approach implies, how the ethical funds are different

in their investment strategies from the rest of the mutual funds and what are the ethical cri-

teria they apply.

Ethical investments have a long history. In the 18th century under the influence of the

Catholic Church many individuals refused to do business with the firms involved in the

slave trade, alcohol or gambling (Schwartz, 2003). The ethical issues historically were taken

into consideration by many groups and communities, like Jewish community or Quakers

community. But the peak growth of the ethical investments was noticed after the 1980.

There are several factors boost the growth of the ethical investments. Among others there

are such important factors as growth of the business ethics and the corporate responsibility

movements, the growing evidence that ethical funds produce the sufficient returns, growth

of advertising of the ethical funds, growth of sustainability indices and other (Schwartz,

2003).

It is argued in many papers what type of funds can be considered ethical and what are the

ethical criteria. Some of the analysts argue that ethical criteria are individually established in

every certain company and depend on the corporate policy and the ethical codes (Cowton,

1999). As well there are various guidelines and documents which help funds to adopt the

SRI principles. Most of the ethical funds use two approaches, negative and positive, when

screening the companies included in their portfolio (EIRIS, 2008). The negative approach

16

implies that funds avoid investing into the non-socially responsible companies (Schwartz,

2003). For instance ethical funds avoid investing in the tobacco, gambling, and alcohol in-

dustries, into the companies which exploit the animal testing and violate the human rights.

The positive approach implies that ethical funds tend to invest in the companies with good

corporate governance, which promote the environmentally friendly behaviour, protect hu-

man rights, et cetera. There are different acts and documents which provide the guidelines

for the ethical funds. Since this research focuses on the mutual funds in UK it is worth to

mention that most ethical funds in UK choose their criteria from the list of the 300 criteria

provided by the Ethical Investment Research Service (Mackenzie, 1998).

There are several reasons why the certain industries might be considered unethical by the

mutual funds. Some of them, like alcohol and tobacco are considered both addictive and

dangerous (some of the analysts include unhealthy restaurants and food producers to this

category as well) (Schwartz, 2003). However some of the industries which are often ex-

cluded from the ethical funds portfolios are questioned as been unethical. For example

gambling harms people, brining financial problems and even suicides, but even though

some analysts argue that it is similar to the investing in the stock markets, since people vol-

untary engaged in it and aware about the possibility of losing money (Schwartz, 2003).

Some of the funds avoid the certain gas and oil companies, since many of them imply the

environmental pollution4 and are not considered to be sustainable due to the decreasing of

oil and gas resources.

Generally ethical funds screen the companies and look for these, which consider the social

responsible objectives. It is argued that companies and funds behave socially responsible,

not because they concerned about social issues, but rather to stay competitive on the mar-

ket. Promoting racism or destroying the nature, companies become less attractive for the

customers and are threatened to get penalties from the government. For this reason it is ar-

gued that ethical behavior does not mean that the company step towards social responsibil-

ity in a positive sense (Hellsten and Mallin, 2006). It is argued in the Beal et al.(2005) study

that screening firms according to the socially responsible criteria allows ethical funds to

create a new market niche, rather than anticipate the positive changes in the society. There-

fore labeling themselves as ethical is often considered a new marketing technique of the

mutual funds.

4 For example Enron or Chevron had to pay pollution charges

17

However this thesis research is focused on the financial performance of the ethical funds,

rather than on its social impact. This study seeks to investigate the effect of the social

screening on the financial returns. The relationship between SRI and positive changes in

the business and environment can be suggested as a topic for the further research.

For the purpose of this research these funds were included in the ethical sample which use

any type of the ethical criteria, regardless if everyone agrees that this criteria is truly ethical

or not. However most of these funds are quite famous and appear in the several ethical

rankings. Thus the assumption is made that these funds can be used as the good represen-

tatives of the society of the socially responsible institutional investors.

2.3.3 Financial performance of ethical funds

The main question of this study is the financial performance of ethical funds. Thus, the

background on the effect of the SRI approach on the performance of the mutual funds is

reviewed in this chapter.

There are several approaches to the analysis of the SRI effect on the financial performance

of the funds were found in the research literature. The obvious one is to analyse the per-

formance of the funds that switch from the conventional investment objectives to SRI ob-

jectives, and to investigate if there is a significant changes in the financial performance of

the fund after the SRI principles are introduced. The risk-adjusted performance of the 4

UK funds, that switch to SRI, is analysed by Mill (2006). This study concludes that there is

a positive effect of the SRI approach on the financial performance of the mutual funds oc-

curs over a 4 years period from adoption of SRI. This evidence support the hypothesis that

the SRI fund perform better than conventional funds.

However the comparative analysis of the ethical and non-ethical funds do not prove the

significant difference in the financial performance. Mallin et al.(1995) examine the perfor-

mance of the UK ethical mutual funds and compare it with the performance of the non-

ethical funds using the Sharpe, Jensen and Treynor measures. They conclude that there is

no significant difference in the performance between two samples. Late Kreander et al.

(2005) perform the similar test using the same measures and additional regression analysis,

on the sample of the ethical and non-ethical funds from the different countries. This test

did not show the significant difference in the performance of the ethical and non-ethical

funds as well.

18

One of the reasons for choosing this topic for the thesis research is the disproportion be-

tween the big amount of the theoretical predictions of the positive effect of the SRI on the

financial performance of mutual funds and little empirical evidence which would confirm

this hypothesis. As well there are some expectations that there is in fact no obvious differ-

ence in financial performance between ethical and non-ethical funds, since most of the

empirical results do not indicate any. Therefore the additional analysis of the management

fee charged by the funds is conducted, to check if ethical and non-ethical funds are differ-

ent in the compensation they ask for their services.

19

3 Method and Data

3.1 MethodTo answer the research questions the performance of the group of ethical funds was com-

pared with the performance of the group of non-ethical funds using the matched pair

analysis5. To evaluate the risk-adjusted performance the Modigliani and Modigliani (M2)

measure was chosen. The matched pair analysis is used in several other studies, that ana-

lyse the performance of ethical funds. This thesis research is based on the approach sug-

gested by Mallin et al. (1995), and later used by Kreander et al.(2005) to compare the risk-

adjusted performance of ethical and non-ethical funds. The idea is to create two samples,

one consists of the ethical funds and another consists of the non-ethical funds. The sam-

ples are matched in a way that for every fund in the ethical sample there is a similar fund in

the non-ethical sample. Funds can be matched on the basis of size, date when the fund is

launched, investment universe or others. The reason behind the method is to make the

samples comparable to eliminate the effect of specific characteristics on the performance

of the ethical funds (Mallin et al., 1995). The characteristics considered in the previous

studies are size and age. Many investors believe that there is a difference in performance

between large and small mutual funds (Gallagher, 1988). As well, it is noticed that most of

the ethical funds are relatively small. Thus to avoid the size effect, the funds in non-ethical

sample should be matched in size to these in the ethical sample. Concerning the age of the

fund it is obvious that non-ethical funds have a longer history than the ethical funds, which

is also believed to have an effect on the performance.

Following the approach suggested in the previous studies, two samples of the mutual

funds, ‘ethical’ and ‘non-ethical’6, are created. The funds were matched on the basis of size,

launch date, sector (or investment universe) and index. The data on the funds historical

monthly share price was collected for the 33 months period and the historical monthly

rates of return were calculated using the following formula:

(1)

5 In some studies this type of analysis is also called matched samples analysis

6 In this study non-ethical fund and conventional fund are synonyms

20

Where is the return earned by the fund i in the month t; is the price of the share of

the fund i in the month t, is the price of the share in the month t-1.

The average monthly rates of return were multiplied by 12 in order to calculate the annual-

ised returns. Using the annualized returns for the funds and benchmarks the risk adjusted

performance, M2 measure was calculated. Finally the risk-adjusted performance of the

ethical funds was compared to the benchmark and the risk-adjusted performance of the

conventional funds.

As it is discussed in the introduction section another part of the research is to investigate

whether or not there is a difference in the annual management fees between ethical and

conventional funds. And if yes, whether or not the management fee is linked to the per-

formance. The data on the annual management fees and the initial charge were collected

for every fund. The regression model is used to analyse the relationship between the man-

agement fee, the performance and the ethical status of the fund.

3.1.1 Modigliani and Modigliani model

It is common to use the risk-adjusted measures to evaluate the performance of the mutual

funds. This approach is used in many previous researches including Sharpe (1966) and Jen-

sen (1968). There are several different measures of the risk-adjusted performance can be

used. As it is discussed above for this thesis research the Modigliani and Modigliani (M2)

measure is chosen. The reason for using the risk-adjusted measures is to make the per-

formance of the funds comparable with benchmark and each other. The main characteris-

tics of the mutual fund financial performance are the rate of return and the risk. The stan-

dard deviation of the rates of return is often used as the measure of the funds’ risk. The

higher rate of return is normally associated with higher risk. For this reason it is important

to make a decision if the expected returns from the certain investment are appropriate for

the level of risk related to this investment. The funds in the samples provide different re-

turns with the different level of the risk. Thus there are funds which give better returns but

might be more risky, and these which show smaller returns but are less risky. It is hard to

compare the funds according to the both criteria at the same time. Using the risk-adjusted

measure is a way to solve this problem. This measure shows what would be the rate of re-

21

turn of the certain fund if it provides the same risk as the benchmark. When all of the rates

of return are adjusted to the same level of the risk it is easier to compare and conclude

which fund is performing better. The M2 measure implies that the expected return on the

portfolio is adjusted to the same level of risk as the benchmark by borrowing at the risk-

free rate and investing in the portfolio (when need to increase the risk of the portfolio) or

selling the part of the portfolio and investing at the risk free rate (when need to decrease

the risk of the portfolio). Increasing the risk of the portfolio, by borrowing at the risk-free

rate, leads to the increase in the portfolio return (assuming that return on the portfolio is

higher than risk-free rate). Decreasing the risk of the portfolio by investing risk-free, leads

to the decrease in the portfolio return (assuming that return on the portfolio is higher than

risk-free rate).

The M2 measure can be calculated using the following formula:

(2)

Where is the risk-adjusted performance of the portfolio i; is the standard devia-

tion of the market portfolio; is the standard deviation of the portfolio i; is

the excess return of the fund i; is the annual risk-free rate of return.

The excess return is estimated using the formula below:

(3)

where is the return on the portfolio i; is the annual risk-free rate of return.

As the proxy of the market portfolio the benchmark indices are commonly used. The risk-

free rate of return is assumed to be the rate of return on the UK 1-year Treasury Bonds.

According to the market data at the bbc.co.uk, on the April 2009 it equals 4.75%. In this

case the choice of the risk-free rate do not affect the comparative analysis, the certain fund

will show the better RAP than another fund, regardless the value of .

3.1.2 Cross section regression

As it is mentioned before for the more comprehensive analysis of the difference be-

tween performance of ethical and non-ethical funds the cross-section regression model is

22

used. There are two main reasons why the regression model is suggested in addition to the

risk-adjusted performance analysis. First analyzing the risk-adjusted performance one might

only conclude that on average ethical funds outperform (underperform/have the same per-

formance) as the conventional funds. The regression analysis can show more specifically

the relationship between performance and fund’s decision to invest ethically. Therefore,

the regression analysis is assumed to be a good contribution to the study on the risk-

adjusted performance. Second, the regression model allows to analyze the determinants of

the financial performance. The emphasis is put on the relationship between the manage-

ment fee and the performance.

The following regression model is chosen:

(4)

Where is the risk-adjusted performance of the fund. is measured in the millions

of pounds sterling. is the number of months from the launch date. is the initial

charge for buying the share in the fund (in percentage). is the annual management fee

charged by the fund (in percentage). is the ethical status of the fund according to

the Ethical Investors UK Ranking. Finally is a random disturbance term.

The certain model is identical to the one in the Kreander et al.(2005) research. The only

difference is that in Kreander et al. only 2 values are assigned to the dummy vari-

able, 0 when the fund is ethical and 1 when it is non-ethical. In this research vari-

able will be the rank of the ethical fund according to the Ethical Investors UK Rating. The

rating approach and its application are discussed in more details below in the Data part.

Kreander et al.(2005) documented the positive relationship between performance and ,

while the coefficient turned out to be insignificant. Nevertheless the authors men-

tioned that the results were different from these obtained by other analysts. Collecting the

data for the thesis research it was noticed that the initial load varies more significantly from

fund to fund than the annual management fee. For 46 funds out of 58 in the sample the

annual management fee is equal to 1.5%. Thus it is assumed that the higher performance

might be reflected not in the higher management fee, but rather in the higher initial load.

Therefore despite the results from the previous studies the coefficient is expected to

be insignificant, while the coefficient is expected to be positive and significant. Since

23

this thesis is primarily focused on the relationship between performance, SRI and the man-

agement fee, the coefficients and are discussed very little. However it is

expected that these coefficients are insignificant. These results were obtained by Kreander

et al. (2005) and there are no changes in the model which would allow to anticipate differ-

ent results.

3.2 Data

3.2.1 Samples

For the purpose of this research the two samples consist of the Unit Trusts and OEICs

were created, one for the matched pair analysis of the risk-adjusted performance and an-

other one for the cross-section regression model (Tables 1 and 2, Appendix). The samples

consist almost of the same funds, however the latter one is smaller, due to the absence of

the data on the Ethical Ranking for some of the funds. The exclusion of the funds from

the sample is discussed in more details in the last part of this chapter.

The funds were selected from the Trustnet Financial Express Company database. This da-

tabase contains the information on the 2410 Unit Trusts and OEICs. For the purpose of

the research the 58 funds (29 ethical and 29 non-ethical) were selected for the analysis of

the risk-adjusted performance, and 54 funds (both ethical and non-ethical) were selected

for the cross-section regression. The selection process was conducted following the 3 steps:

1) Selection of the ethical funds;

2) Selection of the matched non-ethical funds;

3) Selection of the funds for the regression analysis.

The simplified scheme of the data gathering procedure is presented on the Figure 2

24

Figure 2 The data gathering procedure

Source: Made by the author

The selection process is described further in this chapter. First the gathering of data for

the risk-adjusted performance analysis is discussed, later the collection of the data for the

cross-section regression analysis is illustrated.

The historical prices of the funds’ shares and of the indices’ performance were collected

from the Market Data sections at the Bloomberg, Google Finance websites. The share

prices were collected for the first trading day of each month, measured in the UK pence.

3.2.2 Data gathering

Out of 2410 Unit Trusts and OEICs in the Trustnet Financial Express Company database

58 are focused on the Ethical/Sustainable investments. Among these only 32 were invest-

ing in equity, and provide all the information relevant to this research. After data collection

3 funds were dropped, 2 of them because there were no information on the area of invest-

ments and 1 because the comparable non-ethical fund was not found (Step 1, Figure 2).

Using the same database the other 2352 Unit Trusts and OEICs with focuses another than

Ethical/Sustainable investments were screened to match the sample of the ethical funds.

After the screening process described below, another sample of 29 conventional funds was

created (Step 2, Figure 2).

As it is discussed in the Method part, for the purpose of this research the funds are

matched on the basis of size, age, sector and index. All the information about these charac-

25

teristics is obtained from the Trustnet Financial Express Company website. The size of the

funds is measured in the million pounds sterling on the March 20097. As the age the num-

ber of the months from the launch date is used. The sector is defined according to the

Trustnet classification, and mainly referred to the investment universe the certain fund is

operating in. The sample includes the funds from the following sectors: Global Growth,

Europe Excluding UK, Europe Including UK, Asia Pacific Excluding Japan, UK Equity

Income, UK Growth & Income, Active Management, UK All Companies. Respectively

these funds are using the following indices to create the portfolios: FTSE World Index,

MSCI The World Index, FTSE World Europe EX UK Index, FTSE World Europe Index,

MSCI Ac Asia Pacific ex Japan Index, FTSE All Share, FTSE-350 Index, FTSE-100. These

indices are used as the benchmarks for the risk-adjusted performance analysis.

To match the ethical funds in the sample the attempt to satisfy all the 4 criteria was made.

However, if the sector and the index can be matched completely, that is not the case with

the size and the age of the fund. It is almost impossible to find two funds with exactly the

same size and the same launch date. Thus one of the factors had to be chosen as the prior

in the selection process. In this study the size of the fund is considered to be more impor-

tant than the age, since it is assumed that the small fund effect is more important than the

age of the fund. Thus the selection process was conducted in the following way. First of all

for the certain ethical fund from the Trustnet database were selected all conventional funds

operating in the same sector. Than the attempt was made to match all the three remains

criteria: index, size and age. For most of the funds there was no match which would be the

best according to the all three criteria. Therefore the criteria were ranked according to the

importance for the research purpose. The most important was considered the index, than

the size of the fund and the least was the age of the fund. Thus first of all it was important

to match the funds according to the size and the index they track. After the funds were

screened to find these which match the size and the index criteria, the fund with the closest

launch date was selected. This procedure is illustrated on the Figure 3.

7 The exact day varies from fund to fund, but it was verified that there is no significant changes in size for the

estimation period. The significant change was considered the change in size more than 5%. In this case the latest information on the size of the fund was used.

26

Figure 3 The selection of the non-ethical funds

Source: Made by the author

In the created samples all the fund pairs are the best matches according to at least three out

of four criteria. The priorities are given to the Sector, Index and Size criteria.

One more issue is taking into consideration while screening the funds. As it is discussed in

the Introduction chapter one of the key limitations to this study is to verify if the certain

fund is ethical or non-ethical. While the ethical funds specify in their profiles that they fo-

cus on the ethical/sustainable investments, the conventional funds not always provide in-

formation to which extent they are concerned about the ethical issues. Thus some of the

conventional funds might as well screen the companies included in their portfolios and

avoid investing in the same industries as the ethical funds. For this reason, the main hold-

ings in the portfolios of the funds were analysed as well to verify if the fund can be classi-

fied as non-ethical. The priority was given to the funds which invest in non-ethical and

non-sustainable industries like tobacco, gambling, oil and gas and others.

3.2.3 Data for the cross-section model and Ethical Rating

The data on the launch date, size, initial load, management fee and ethical status of the

funds was collected to carry out the regression analysis. It is possible to access the funds

profiles from the Trustnet website, which provide the data on the launch date, size, initial

load and a management fee for all of the funds in the database. However there were no in-

formation about the ethical status, namely ethical ranting of the funds on this website.

Therefore some other source was used to obtain the information about Ethical Rating. Af-

ter collecting the data for the cross-section regression analysis 4 ethical funds were ex-

27

cluded from the study sample, because there were no information on the Ethical Rating

(Step 3, Figure 2). It resulted in the total sample for the regression analysis of 54 funds.

To define the variable in the regression model the Ethical Rating from the Ethical

Investors company, the first finuncial adviser company that specialized on the ethical in-

vestment advice was used(Ethical Investors). As well the information on the ethical status

of the certain funds was verified using the EIRIS Ethical Fund Directory. EIRIS Ethical

Fund Directory provide the profiles of the ethical funds in UK and explains the SRI ap-

proach, used in every fund and the ethical issues each fund is particularly concerned about.

Since the both sources report similar information about the ethical policy of the funds in-

cluded in the sample, the proposed Etrhical Ranting is assumed to be credible and appro-

priate for the research.

The ethical rating is available on the Ethical Fund Directory at the Ethical Investors web-

site. Only ethical and sustainable funds from UK are included in the rating. The funds are

rated in three areas Animals, Environment and Social. The animals’ issues are focused on

the animal testing. The environmental issues include the exclusion of companies based on

negative impacts; investing in companies that are taking positive steps to manage their im-

pacts and others. The social category covers issues arising from company activities that im-

pact on people, or society at large. Each fund is rated in these three areas as better as or

worse than average, comparing to the rest of the funds. Thus each fund can be evaluated as

Below Average, Average, Plus or Double Plus in every category. For the sake of the regres-

sion analysis this ranking system is simplified and transformed to the numerical form. So

the ranking system was given a numerical equivalent in each category (Table 1). The idea is

to distinguish the ethical funds in the sample from each other and from the non-ethical

funds. Therefore each fund is given the value from 0 to 12, based on the rating. The 0 val-

ue is given to the non-ethical funds, which are not included in the Ethical Rating. The value

12 is given to the funds which are estimated as Double Plus in all three categories Social,

Animals and Environmental. For the sake of simplicity all the categories are assumed to

have the same weights in the rating. Therefore the Below Average estimate in any category

gives the fund 1 point. So if the fund gets the Below Average estimation for all three cate-

gories it will sum up to the total rating equal 3. Respectively the Average estimate gives the

fund 2 points. So if the fund gets the Average estimation for all three categories it sums up

to the total rating equal 6. Following the same approach the Plus estimate gives the fund 3

points and the Double Plus estimate gives the fund 4 points. The points received in each

28

category sum up and result in the total value given to the fund for the sake of the regres-

sion analysis.

29

Table 1 The Ethical Rating

The position of the fund in the rating

The ethical areas

Animals Environment Social

Not in the rating

(non-ethical)

0 0 0

Below Average 1 1 1

Average 2 2 2

Plus 3 3 3

Double Plus 4 4 4

Source: Ethical Fund Directory and the author’s calculations.

For example if the fund receives Average in the Environmental and the Social categories

and Below Average in the Animal category, it’s total rating is 2+2+1=5.

All funds in the sample are evaluated according to this system and the obtained results are

used for the regression analysis. The outcome is shown in the Table 2 in the Appendix.

30

4 Empirical Results and Analysis

4.1 Characteristics of the data sampleIt is discussed in the Method and Data chapter that funds in the sample are operating in

the different sectors. The distribution of the funds among these sectors is illustrated on the

Figure 4 below:

Figure 4 The distribution of the funds in the sample among the sectors

Source: Trustnet Financial Express Company database

For the purpose of this research two matched samples of the ethical and non-ethical funds

were created. All the pairs of the matched funds are from the same sector and using the

same index. As well all the funds are matched very closely according to the size criterion

(Table 2). In the sample of the ethical funds the size of the largest fund is 406 million

pounds and the smallest is 0.8 million pounds, the average size of the ethical fund in the

sample is 86.78 million pounds. For the sample of non-ethical funds the size of the largest

fund is 384.5 million pounds and the smallest is 1.5 million pounds, the average size of the

fund in the sample is 84.99 million pounds.

31

Table 2 The size of the funds in the sample

Ethical Funds Non-Ethical Funds

Largest fund 406 million pounds 384.5 million pounds

Smallest fund 0. 8 million pounds 1.5 million pounds

Average size 86.78 million pounds 84.99 million pounds

Source: Trustnet a Financial Express Company database

The average size difference between two matched ethical and non-ethical funds is 7.68 mil-

lions, which is only 8.8% of the average size of the ethical funds in the sample As well 19

pairs have a difference in size less than 7.68 million and 10 more than 7.68 million.

The average age of the ethical funds in the sample is 134 months, and of the non-ethical

funds 144 months. The average difference in the age between two matched funds is 43

months, which is quite a lot. In the data gathering section it is discussed why the age crite-

rion was given the low priority in the selection process. That is why not every fund pair in

the sample consists of the best matched according to this criteria.

It is mentioned in the Data gathering part that in addition the main holdings of the conven-

tional funds were analysed in order to verify if the fund can be classified as non-ethical. It

was noticed that tobacco companies are often appear among the 5 largest holdings of the

funds. In the collected sample 12 of the funds have the tobacco companies among the

largest holdings. These funds are listed in the Table 3 together with the tobacco companies

they invest in.

32

Table 3. The funds which have the tobacco companies among the 5 largest holdings and the tobacco companies they invest in.

NAME Tobacco Company

1 SVM UK Alpha ITG

2 Invesco Perp Childrens ITG, BAT

3 BlackRock Global Equity ITG, BAT

4 GLG UK Growth BAT

5 JPM UK Focus ITG, BAT

6 Legg Mason UK Equity BAT

7 Aviva Inv Blue Chip Tracking BAT

8 Trojan Income ITG, BAT

9 Allianz RCM Global Equity PMInt

10 Baillie Giff British 350 BAT

11 MFM Slater Pension ITG

12 Cler Med FTSE 100 Tracker BAT

(Imperial Tobacco Group (ITG), British-American Tobacco (BAT), Phillip-Morris International (PMInt))

Source: Trustnet a Financial Express Company database

All of these funds invest more than 3% of the assets in each of the tobacco company.

Most of the funds in the both ethical and non-ethical samples charge the annual manage-

ment fees equal to 1.5%. The initial loads for most of the funds, both ethical and non-

ethical, are equal 5%. The distribution of the annual management fees and the front loads

in the both samples is illustrated in the Figures 5 and 6 below.

Figure 5 Annual Management Fees.

ETHICAL FUNDS NON-ETHICAL FUNDS

Horizontal axis: Management Fee in percentage. Vertical axis: Number of the funds

Source: Trustnet Financial Express Company database

33

Figure 6 Front Loads.

ETHICAL FUNDS NON-ETHICAL FUNDS

Horizontal axis: Front Load in percentage. Vertical axis: Number of the funds

Source: Trustnet Financial Express Company database

As it can be seen on the Figures 5 and 6 the ethical funds charge slightly higher manage-

ment fees than non-ethical funds, but generally have slightly lower front loads. The differ-

ence in the management fees among the funds is analyzed further in this chapter.

4.2 Results of the matched pair analysisThis part describes the results of the data analysis. The first part discusses the financial per-

formance of the funds in the sample. The analysis of the performance includes the com-

parison of the average annualised returns of the ethical funds with the average annualised

returns of the non-ethical funds and the benchmarks. Further the annualised returns of the

funds and the benchmarks are compared to each other using the risk-adjusted measures. In

the second part the results of the analysis of the annual management fees are provided.

4.2.1 Financial performance

The data on the historical share prices was collected for the period from January 2006 to

September 2008 for each fund. The reasons for choosing this time horizon are discussed in

the Introduction chapter. Normally each fund in the sample offers several classes of shares

(most common are A-shares and B-shares). The main difference between these classes is in

the way of pricing sales loads. For the purpose of the research the A-shares were chosen as

a proxy for the fund performance. The A-shares imply that fund charges the front load for

buying the share in their portfolio. For some of the funds there is as well an opportunity of

not paying the front load but paying the back load instead, when selling the share in the

fund (B-shares), or paying a higher ongoing fee in the form of 12B-1 fee (C-shares) et cete-

34

ra. It is common for the funds to offer several classes of the shares. There is a number of

reasons for choosing the A-shares as a proxy for the performance. First, all of the funds in

the sample offer the A-shares, which is not the case with the other classes of the shares (B-

shares, C-shares et cetera). Second, one part of the research is to analyse the relation be-

tween the performance and the front load. Thus within this study it is reasonable to meas-

ure the performance using the price of the A-shares. Finally all the classes of the shares of-

fered by the fund represent the performance of the same fund (so based on the same port-

folio) and their historical prices and rates of return are almost perfectly correlated8. There-

fore it is adequate to choose only one of the share classes as a proxy for the fund’s per-

formance.

The historical prices of the A-shares for all the funds in the sample were collected and an-

nualized returns calculated. The results of the calculations are presented in the Table 4 in

the Appendix.

In the study sample the average annualized rate of return of the ethical funds is 2.52% with

the average standard deviation equal 4.21%. For the non-ethical funds the average annual-

ized rate of return is 2.73% with the average standard deviation equal 4.05%. Thus non-

ethical funds seem to perform slightly better and been less risky. However, the results are

very close to each other, and for such a small sample the difference in the returns might be

considered insignificant. The matched pair analysis shows that in the 14 pairs the ethical

funds outperform the matched non-ethical funds and in the other 15 pairs the non-ethical

funds outperform the matched ethical funds. The hypothesis of the significant difference in

the performance between ethical and non-ethical funds is examined in more details using

the risk-adjusted measures and cross-section regression.

The annualized returns for the benchmark indices are calculated as well and documented in

the Table 5 in the Appendix. However there were no free available data for the two of the

benchmark indices: FTSE World Index and FTSE World Europe EX UK Index. These in-

dices are assumed to be the benchmarks for the funds operating in the Global Growth and

Europe excluding UK sectors. To solve this problem it was decided to use the MSCI The

World Index as a bench mark for all the companies operating in the Global Growth Sector

and FTSE World Europe Index for the Europe excluding UK sector.

8 Calculated by the author using the study sample.

35

The analysis of the annualized returns showed that 40 funds in the sample (21 ethical funds

and 19 non-ethical funds) outperform the benchmark index.

The risk-adjusted measures of the performance are calculated using the formula (2). The

risk-free rate is assumed to be equal 4.75 %( the return on the 1-year UK Treasury bonds).

The output of the calculations of the risk-adjusted performance measures and the excess

returns are provided in the Table 7 in the Appendix. It is noticed that 19 of the funds in

the sample (10 ethical and 9 non-ethical) show negative excess returns. The comparison of

the fund’s performance on the risk-adjusted basis show that ethical funds perform better

than non-ethical funds. Average RAP for the ethical funds equals 3.29%, while for the non-

ethical funds average RAP equals 2.76%. The summary of the empirical results are pro-

vided in the Table 4 below.

Table 4 Summary of the empirical results

ETHICAL FUNDS NON-ETHICAL FUNDS

Average Annualized returns 2.52% (Average StDev 4.21%) 2.73% (Average StDev 4.05%)

Average Risk-Adjusted Performance 3.29% (Average StDev 3.56 %) 2.76% ( Average StDev 3.56 %)

Overperforme the benchmark index (# of the funds)

21 19

Underperforme the benchmark Index (# of the funds)

8 10

Overperforme the risk-free bonds (# of the funds)

19 20

Underperforme the risk-free bonds (# of the funds)

10 9

Performe better than the matched-pair fund (# of the funds)

14 15

Source: Author’s calculations

The results from the risk-adjusted analysis contradict with these obtained from the analysis

of the annualized rates of returns. It is explained above that annualized non-adjusted re-

turns are almost the same for the two groups of the funds (Table 4). However the risk-

adjusted returns are higher for the group of ethical funds in comparison with non-ethical

funds. The results from the risk-adjusted analysis might mean that when the funds in the

matched pairs are adjusted to the same level of risk the ethical funds perform better than

non-ethical funds. However, there is one issue should be taken into consideration when in-

terpret the M2 measure. The M2 measure brings the risk of the funds to the same level as

36

the benchmark. So it decreases the standard deviations and the returns of the fund when

the standard deviation of the fund is higher than the standard deviation of the market in-

dex, and increases the standard deviation and the returns in the opposite case. That is true

only assuming that fund shows positive excess returns. However in the case when fund

shows negative excess returns and high standard deviation, the M2 measure reduces the

standard deviation and at the same time increases the returns of the fund (since it substi-

tutes the part of the portfolio with the risk-free asset, which provides better performance

and lower risks than the fund). Thus in this case M2 measure cannot be adequate for com-

paring the fund’s performance, since it makes the fund’s performance look better than it

actually is. M2 measure simply substitute the poor performing high risky fund portfolio,

with the better performing non-risky asset. This has a bigger effect on the funds with the

higher standard deviations, since for these funds the leverage factor (σm/σi in formula (2))

is smaller and therefore the weight of the risk-free asset (rf in the formula (2)) in the M2

measure is higher. There is a number of the funds in the sample (ethical and non-ethical)

show negative excess returns, and the ethical funds in the sample on average show higher

standard deviations than non-ethical funds. Thus the M2 measures of the performance of

the ethical funds is more biased towards the risk-free asset. That is why the results of the

risk-adjusted analysis might be misleading. The t-statistics was used to verify if the differ-

ence in the average values of M2 for the ethical and non-ethical funds is significant. The

probability of the t-statistics is equal 0.48 which implies that the null-hypothesis cannot be

rejected and the difference is not significant.

When the problem with the M2 measure was recognised the addition calculations of the

Sharpe measure were made to verify the results obtained using the M2 measure. Sharpe

measure is an alternative risk-adjusted measure, however it does not have the same prob-

lem as M2 measure when calculated for the funds which show negative excess returns. The

Sharpe measure was calculated using the following formula (Kreander et al.2005):

(5)

37

where is the return on the portfolio i; is the annual risk-free rate of re-

turn; is the standard deviation of the portfolio i. The outcome of the calcula-

tions is presented in the Table 8 in the Appendix. The average Sharpe value for the ethical

funds of -0.4531 is higher than the value of -0.5461for the non-ethical funds. However the

probability of the t-statistics of 0.66 shows that the difference in the Sharpe measures is not

significant.

The results from calculation of the Sharpe measure and M2 measure correspond with each

other. Based on these calculations and t-tests the conclusion is made that there is no evi-

dence of the significant difference in the financial performance between ethical and non-

ethical funds.

To verify these results and further investigate the relationship between the funds’ ethical

status and its performance the cross-section regression analysis was carried out.

4.2.2 Management fee

The average management fee for the sample of the ethical funds is 1.48% and for the sam-

ple of the non-ethical funds is 1.34%. The average front load for the sample of the ethical

funds for the 4.16% and for the sample of non-ethical funds is 4.19%. Thus the fee is

higher among the ethical funds and the load is higher among the non-ethical funds. There-

fore it is not quite clear who charges more for their services. However if the investor plans

on keeping the money in the fund for several years, investing in the ethical fund would be

more expensive. The difference in the annual fee is more than 10 %. Thus it can be con-

cluded that ethical funds on average charge more than non-ethical funds. It is discussed in

the previous part that there is no obvious evidence that ethical funds perform better than

non-ethical funds. The relationship between performance and the annual fee is analyzed in

more details using the cross-section model.

38

4.3 Results of the regression analysisThe OLS estimates of the coefficients in the equation (4) are calculated using the EViews

software. The results of the calculations are presented in the Table 5, below.

Table 5 The output of the OLS regression #1.

Dependent Variable: ADJRETURN

Included observations: 54

Variable Coefficient Prob. t-Statistics

AGE -4.07E-05 0.6383

ETHIC 0.000796 0.5545

FEE -0.026929 0.4429

LOAD 0.004714 0.3161

SIZE 0.000107 0.1602

C 0.043235 0.2943

R-squared 0.073791Source: Author’s calculations

The output of the regression model shows that all of the coefficients are turned out to be

insignificant due to the t-statistics at the 5% level of significance. The analysis of the re-

siduals showed that residuals are normally distributed and there is no heteroskedasticity. As

well it is reasonable to assume that some of the variables are highly correlated with each

other and therefore the model might be misspecified. The correlation matrix is provided in

the Table 6 below.

Table 6 Correlation Matrix

FEE LOAD SIZE ADJRETURN AGE ETHIC

FEE 1,000 0,618 0,104 0,026 -0,066 0,324

LOAD 0,618 1,000 0,093 0,113 0,167 0,092

SIZE 0,104 0,093 1,000 0,224 0,594 0,220

ADJRETURN 0,026 0,113 0,224 1,000 0,119 0,102

AGE -0,066 0,167 0,594 0,119 1,000 0,143

ETHIC 0,324 0,092 0,220 0,102 0,143 1,000

Source: Author’s calculations

As it might be expected the load and the management fee are highly correlated as well as

the size and the age of the fund. To check for the multicolleniarity the adjusted returns

39

were regressed on each of the predictor variables separately. However the coefficients still

remained insignificant. Thus there is no evidence of the misspecification in the model due

to the high correlation between the predictor variables.

To make sure that there is no relationship between the performance and the ethical status

of the fund one more regression was run. Among the ethical funds these were selected

which ethical ranking is higher than average (according to the all 3 criteria). There were 13

ethical funds like that. Their performance was compared to the performance of matched

non-ethical funds. The average annualized returns for the group of 13 best in ethical rank-

ing funds were slightly better than of the 13 matched non-ethical funds 4.72% and 4.19%

respectively.

However the regression analysis showed that the difference in the performance is not sig-

nificant on the 5% level.

The results of the OLS regression are in the Table 7.

Table 7 The output of the OLS regression #2.

Dependent Variable: ADJRETURN

Included observations: 26

Variable Coefficient Prob. t-Statistics

ETHIC 0.002990 0.8397

FEE -0.006344 0.8849

LOAD 0.003426 0.5865

SIZE 5.68E-05 0.4626

AGE -0.000227 0.0354

C 0.070321 0.1506

R-squared 0.218710Source: Author’s calculations

According to the t-statistics all of the coefficients except for the Age coefficient turned out

to be insignificant on the 5% level. The Age coefficient turned out to be negative and sig-

nificant, which indicates that younger funds perform better than older funds. It is different

from the results obtained by Kreander et al.2005. However only 26 observations were

used for this regression, therefore the results cannot be considered credible. As well in the

Kreander et al. research the authors showed that the management fee is positive and signif-

icant, while in both regressions run within this research the Fee coefficient turned out to be

insignificant.

40

41

4.4 Analysis of the resultsThe two main questions of this research are formulated in the Introduction chapter. The

first question is concerned the financial performance of the ethical and non-ethical funds.

And the second question is related to the difference in the management fee charged by the

funds.

As it is explained in the Empirical Results and Analysis chapter the average annualized re-

turns for two groups of the funds turned out to be very close to each other, thus it can be

concluded that there is no significant difference in the performance of the ethical and non-

ethical funds. The results of the regression analysis also confirm that ethical status of the

fund does not affect the financial performance. As well the financial performance of the

ethical funds turned out to be more volatile than the performance of the non-ethical funds.

However the analysis of the risk-adjusted performance shows that on the risk-adjusted ba-

sis ethical funds perform better than conventional funds. Nevertheless the credibility of the

results obtained using the M2 measure was questioned, due to the fact that many funds in

the sample show negative excess returns. So the fact that M2-measure is high for the ethical

funds than for conventional funds might be explained in two ways:

1. Ethical funds in fact would perform better than non-ethical funds if the both

groups of the funds were exposed to the same level of risk;

2. There are more ethical funds which underperform the risk-free asset. Therefore

most of the ethical funds could significantly improve the performance by simply

investing in the risk-free bonds.

To verify if the results obtained using M2 measure are significant the alternative Sharpe

measure was calculated and the t-test was performed for the both the M2 measure and the

Sharpe measure. The results from these calculations indicate that the difference in the val-

ues of the risk-adjusted measures between two analysed samples is not significant. The re-

gression analysis also does not prove that ethical funds perform any better than non-ethical

funds. As well the results from both the analysis of the annualised returns and the analysis

42

of the risk-adjusted performance show that in the sample 14 ethical funds outperform the

matched non-ethical funds, and 15 non-ethical funds outperform matched ethical funds.

Hence it is not clear which group of the funds perform better and the conclusion can be

made that there is not enough evidence on significant difference in performance between

two groups of the funds.

Regarding the second question of this research, the average management fee turned out to

be higher for the group of ethical funds than for the group of non-ethical funds. Most of

the ethical funds in the sample charge the annual management fee equal to 1.5% (only 1

fund charges lower fee, and 1 fund charges higher fee). While the non-ethical funds show

more variety. Among non-ethical funds in the sample 9 charge the fee lower than 1.5% and

1 fund charges a higher fee. As well the average difference in the fee charged by two

groups of funds is quite high, 0.14%. Which means, assuming the average fee 1.5%, that

ethical funds charge approximately 10% more than non-ethical funds.

These results show that putting money in the ethical funds is more expensive for the inves-

tors. The reason is probably that the investment approach of the ethical funds is associated

with the higher costs. Ethical funds perform the screening of the companies according to

the social responsible criteria. It means that they collect not only financial information

about the firms, as the conventional funds, but as well an information about corporate so-

cial responsibility. Therefore it is reasonable to assume that ethical funds spend more on

screening the companies than the non-ethical funds. The results of this research show that

the management fee charged by the funds in the examined sample is not related to the fi-

nancial performance of the funds. Which means that ethical funds do not provide higher

returns for charging higher fees. However these results as well indicate that excluding the

companies with poor quality of CSR from the portfolio, ethical funds do not sacrifice their

financial performance. The ethical funds in the sample provide about the same returns as

the conventional funds, which undermine the hypothesis of the negative effect of social

screening on the performance.

43

5 Conclusion

The analysis of the financial performance of the 29 ethical and 29 non-ethical UK mutual

funds shows that there is no evidence that ethical funds have significantly different finan-

cial performance from non-ethical funds. Analysis of the average annualised returns show

that non-ethical funds perform slightly better and are less risky than ethical funds. In con-

trast to these results, the risk-adjusted performance of the ethical funds turned out to be

better than risk-adjusted performances of the non-ethical funds. However the results of the

risk-adjusted analysis might be biased due to the big number of the poorly performing

funds in the ethical samples and higher volatility of the returns provided by the ethical

funds. In addition more ethical funds, than non-ethical funds underperform the risk-free

asset in the collected sample. Thus, the study concludes that ethical funds provide about

the same returns as conventional funds.

The analysis of the management fees charged by the funds show that ethical funds on aver-

age charge higher management fees than non-ethical funds. The difference in the fee is

around 0.14%. For instance if investor keeps money in the fund for 5 years he will pay 7%

more for working with ethical funds, than for working with non-ethical funds. In this case

investing in the ethical funds implies paying more for managing the assets but not receiving

significantly higher returns. However it is discussed in the Introduction chapter, that ethical

funds provide different service than conventional funds. Ethical funds spend more re-

sources on screening the companies included in their portfolio. They are looking not only

for high returns but as well for sustainability and high standards of corporate social respon-

sibility. Therefore in return for paying more for investing in the ethical funds investors get

an opportunity to align their moral values with the investment goals. In general it can be

said that since there is an evidence of the growing number of socially responsible funds,

there is a number of investors who are willing to pay premium for investing ethically.

44

6 Suggestions for the further researchThis study analyses the link between SRI approach and financial performance of the mu-

tual funds. It concludes that ethical funds on average produce about the same returns as

conventional funds, and SRI does not have a significant effect on the performance. How-

ever it was noticed that ethical funds charge higher management fees than conventional

funds. Therefore making an investment decision socially responsible investors are looking

for the trade-off between their desire to invest ethically and the costs of the investments.

The following suggestions for the further research emerge after the analysis of the thesis

results:

To develop this study it might be interesting to analyse the reasons behind the

higher management fees charged by the ethical funds. It can be useful to take a

look at the costs associated with the investment approach of the ethical funds and

investigate if the costs are higher or lower than in the conventional funds.

As well, it might be valuable to carry out the similar to this research for the longer

time horizon to test the hypothesis of the ethical funds being more sustainable than

conventional funds and perform better in the long time horizon.

Next, the analysis of the performance of the 13 best in ethical rating funds show

that average annualized returns of these funds are higher than average returns in

the whole sample (4.72% against 2.52%, pages 33 and 36). No conclusions are

made based on this fact since this research has not shown any evidence of the link

between the performance and the ethical status of the fund. However it is noticed

that 13 non-ethical funds which match the sample of the leading ethical funds as

well show higher returns than average in the sample (4.19% against 2.73%, pages

33 and 36). Therefore it might be assumed that these two groups of funds share

some common characteristics, like size or age. Thus it might be interesting to ana-

lyse the relationship between the ethical status of the fund and other characteristics

of the mutual funds.

Finally, the analysis of the background literature revealed that a number of analysts

doubt that SRI are beneficial for the society and can produce a significant positive

45

change in the environment and business. Therefore some analysts believe that ethi-

cal funds apply SRI principles solely for the purpose of marketing. The changes of

the investment objectives and new marketing strategies of the mutual funds can be

a topic for the further research.

46

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48

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49

Appendix Table 1 The matched samples of the Unit Trusts and OEICs from the United Kingdom

NAME

Size (million pounds)

Age (months) NAME

Size (million pounds) Age (months)

ETHICAL NON-ETHICAL

1Aberdeen Ethical World 141.8 119 Jupiter Global Managed 181 134

2

Aberdeen Responsible UK Equity 11.4 35 SVM UK Alpha 9.4 43

3AEGON Ethical Equity 158.7 240 Invesco Perp Childrens 140.3 252

4

Aviva Inv Sustainable Future AbsoluteGrowth 39.8 98

New Star Global Strateg-ic Capital 40.6 261

5

Aviva Inv Sustainable Future European Growth 111.2 98

JPM Europe Dynamic Ex UK 99.3 55

6

Aviva Inv Sustainable Future Global Growth 106.4 98 BlackRock Global Equity 125.3 111

7Aviva Inv Sustainable Future UK Growth 90.1 98 GLG UK Growth 86.6 133

8AXA Ethical Distribution 38 5 JPM UK Focus 40.4 37

9 CS Fellowship 41.1 273 Legg Mason UK Equity 40.2 162

10Ecclesiastical Amity UK 37.9 133

Aviva Inv Blue Chip Tracking 37.1 146

11F&C Stewardship Growth 406 298 Artemis Capital 384.5 268

12F&C Stewardship Income 221.4 270 BlackRock UK Income 198.8 301

13F&C Stewardship International 195.3 258 Artemis Global Growth 206 226

14First State Asia Pacif-ic Sustainability 54 40 New Star Pacific Growth 49.6 179

15 Halifax Ethical 60.4 183Rathbone Global Opportunities 51.2 95

16Henderson Global Care Growth 129.9 224

Scot Wid Global Select Growth 129.1 278

17Henderson Global Care UK Income 59 167 Trojan Income 50 55

50

18Henderson Indus-tries of the Future 56.8 171

Allianz RCM Global Equity 33 170

19 Insight Evergreen 33 230 Cavendish Worldwide 29.5 177

20 Jupiter Ecology 256 132Aviva Inv International Index Tracking 258.4 218

21

Jupiter Environmental Income 33 113 Neptune UK Equity 32.8 109

22 L&G Ethical 98.9 117 Baillie Giff British 350 96.2 132

23Marks & Spencer Ethical 11.5 26 MFM Slater Pension 12.8 49

24 Old Mutual Ethical 8.6 133Cler Med FTSE 100 Tracker 8.1 121

25Stan Life Inv Euro-pean Ethical Equity 27 20

Invesco Perp European Equity Income 30.9 16

26Stan Life Inv UK Ethi-cal Trust 66 134 Gartmore UK Tracker 71 146

27 SWIP Global SRI 5.8 81CF GHC MultiManager Global Equity 4.1 77

28SWIP Pan European SRI Equity 17.1 83 Newton Pan European 17.2 122

29 SVM All Europe SRI 0.8 30CF Lord Abbett European Growth 1.5 111

AVERAGE 86.78966 134.7241 AVERAGE 84.99655 144.2759

Source: Trustnet a Financial Express Company Website database

51

Table 2 Ethical Rating

NAME Ethical Rating

1 Aberdeen Ethical World 9

2 Aberdeen Responsible UK Equity 3

3 AEGON Ethical Equity 8

4 Aviva Inv Sustainable Future Absolute Growth 9

5 Aviva Inv Sustainable Future European Growth 9

6 Aviva Inv Sustainable Future Global Growth 9

7 Aviva Inv Sustainable Future UK Growth 9

8 AXA Ethical Distribution 7

9 CS Fellowship 5

10 Ecclesiastical Amity UK 4

11 F&C Stewardship Growth 11

12 F&C Stewardship Income 11

13 F&C Stewardship International 11

14 First State Asia Pacific Sustainability 4

16 Henderson Global Care Growth 12

17 Henderson Global Care UK Income 10

18 Henderson Industries of the Future 9

19 Insight Evergreen 10

20 Jupiter Ecology 9

21 Jupiter Environmental Income 8

22 L&G Ethical 5

23 Marks & Spencer Ethical 4

24 Old Mutual Ethical 7

25 Stan Life Inv European Ethical Equity 7

26 Stan Life Inv UK Ethical Trust 7

Source: Ethical Investors, Ethical Fund Directory and author’s calculations

52

Table 3 Front Load and Management Fees

NAMEFront Load Fee

Front Load Fee

ETHICAL NON-ETHICAL

1 Aberdeen Ethical World 4.25 1.5 Jupiter Global Managed 5.25 1.5

2Aberdeen Responsible UK Equity 4.25 1.5 SVM UK Alpha 5.25 1.5

3 AEGON Ethical Equity 5.5 1.5 Invesco Perp Childrens 5 1.5

4Aviva Inv Sustainable Future Absolute Growth 4 1.5

New Star Global Strategic Capital 5 1.25

5Aviva Inv Sustainable Future European Growth 4 1.5 JPM Europe Dynamic Ex UK 5.5 1.5

6Aviva Inv Sustainable Future Global Growth 4 1.5 BlackRock Global Equity 5 1.5

7Aviva Inv Sustainable Future UK Growth 4 1.5 GLG UK Growth 5.25 1.5

8 AXA Ethical Distribution 5 1.5 JPM UK Focus 4.25 1.5

9 CS Fellowship 5.25 1.5 Legg Mason UK Equity 4.25 1.5

10 Ecclesiastical Amity UK 5 1.5 Aviva Inv Blue Chip Tracking 0 0.93

11 F&C Stewardship Growth 5 1.5 Artemis Capital 5 1.5

12 F&C Stewardship Income 5 1.5 BlackRock UK Income 5 1.5

13F&C Stewardship International 5 1.5 Artemis Global Growth 5.25 1.5

14First State Asia Pacific Sustai-nability 4 1.55 New Star Pacific Growth 5 1.25

15 Halifax Ethical 0 1.5Rathbone Global Opportunities 5.5 1.5

16Henderson Global Care Growth 4.5 1.5

Scot Wid Global Select Growth 5 1.5

17Henderson Global Care UK Income 4.5 1.5 Trojan Income 0 1

18Henderson Industries of the Future 5 1.5 Allianz RCM Global Equity 4 1

19 Insight Evergreen 4 1.5 Cavendish Worldwide 5 0.75

20 Jupiter Ecology 5 1.5Aviva Inv International Index Tracking 0 0.9

21Jupiter Environmental Income 5.25 1.5 Neptune UK Equity 4.25 1.6

53

22 L&G Ethical 0 1 Baillie Giff British 350 5 1.5

23 Marks & Spencer Ethical 1 1.5 MFM Slater Pension 5.25 1.5

24 Old Mutual Ethical 4 1.5 Cler Med FTSE 100 Tracker 3.5 0.75

25Stan Life Inv European Ethical Equity 4 1.5

Invesco Perp European Equity Income 5 1.5

26 Stan Life Inv UK Ethical Trust 4 1.5 Gartmore UK Tracker 0 1

27 SWIP Global SRI 5 1.5CF GHC MultiManager Global Equity 5 1.5

28SWIP Pan European SRI Equity 5 1.5 Newton Pan European 4 1.5

29 SVM All Europe SRI 5.25 1.5CF Lord Abbett European Growth 5 1.5

AVERAGE 4.163 1.485 4.190 1.342

Source: Trustnet a Financial Express Company Website database

Table 4 Annualized Rates of Returns and Standard Deviations

NAMEAnnualized

returns StDev NAMEAnnualized

returns StDev

ETHICAL NON-ETHICAL

1 Aberdeen Ethical World 5.30% 3.64% Jupiter Global Managed 8.14% 3.72%

2Aberdeen Responsible UK Equity -2.57% 4.79% SVM UK Alpha -1.01% 4.44%

3 AEGON Ethical Equity 7.14% 3.70% Invesco Perp Childrens 3.93% 3.44%

4Aviva Inv Sustainable Future Absolute Growth 3.54% 4.04%

New Star Global StrategicCapital -0.56% 4.24%

5Aviva Inv Sustainable Future European Growth 10.64% 3.73%

JPM Europe Dynamic Ex UK 12.35% 4.20%

6Aviva Inv Sustainable Future Global Growth 4.22% 4.26% BlackRock Global Equity 6.42% 4.23%

7Aviva Inv Sustainable Future UK Growth 4.18% 5.32% GLG UK Growth -4.78% 4.02%

8 AXA Ethical Distribution -3.37% 4.82% JPM UK Focus -1.55% 4.10%

9 CS Fellowship 0.93% 3.36% Legg Mason UK Equity -1.96% 3.57%

10 Ecclesiastical Amity UK -0.57% 3.82%Aviva Inv Blue Chip Track-ing 0.34% 3.23%

11 F&C Stewardship Growth 0.03% 4.13% Artemis Capital -0.88% 3.92%

54

Sources: Bloomberg.com, Google Finance UK

12 F&C Stewardship Income 1.02% 3.52% BlackRock UK Income 3.27% 4.03%

13F&C Stewardship International 2.80% 4.16% Artemis Global Growth 8.95% 4.93%

14First State Asia Pacific Sustai-nability 13.26% 4.13% New Star Pacific Growth 6.67% 5.59%

15 Halifax Ethical 5.06% 4.40%Rathbone Global Opportunities 8.57% 4.67%

16Henderson Global Care Growth 7.69% 4.48%

Scot Wid Global Select Growth 4.17% 3.74%

17Henderson Global Care UK Income -2.25% 4.04% Trojan Income 4.66% 2.64%

18Henderson Industries of the Future 8.09% 4.09% Allianz RCM Global Equity 5.87% 3.59%

19 Insight Evergreen 3.96% 4.09% Cavendish Worldwide 3.16% 3.85%

20 Jupiter Ecology 12.12% 3.70%Aviva Inv International Index Tracking 3.72% 3.95%

21Jupiter Environmental Income 3.78% 3.90% Neptune UK Equity 5.72% 3.85%

22 L&G Ethical 0.07% 3.93% Baillie Giff British 350 -0.63% 3.33%

23 Marks & Spencer Ethical -7.25% 4.81% MFM Slater Pension -9.95% 3.32%

24 Old Mutual Ethical -4.41% 4.36% Cler Med FTSE 100 Tracker 2.20% 3.70%

25Stan Life Inv European Ethical Equity -12.92% 6.77%

Invesco Perp European Equity Income -0.67% 6.89%

26 Stan Life Inv UK Ethical Trust 3.37% 3.81% Gartmore UK Tracker 1.99% 3.66%

27 SWIP Global SRI -0.36% 3.98%CF GHC MultiManager Global Equity 2.54% 3.74%

28SWIP Pan European SRI Equity 4.77% 3.88% Newton Pan European 8.48% 4.07%

29 SVM All Europe SRI 4.94% 4.53%CF Lord Abbett European Growth 0.05% 4.82%

AVERAGE 2.52% 4.21% AVERAGE 2.73% 4.05%

55

Table 5 Benchmark Returns

Benchmark Index

Average

monthly return Annualized StDev

FTSE All Share 0.02% 0.26% 3.64%

MSCI THE WORLD INDEX 0.23% 2.77% 3.03%

MSCI AC ASIA PACIFIC ex JAPAN 0.82% 9.82% 5.77%

FTSE-350 Index -0.10% -1.24% 3.40%

FTSE-100 -0.42% -5.03% 4.07%

FTSE World Europe Index -0.18% -2.15% 4.11%

Source: Bloomberg.com

Table 6 Funds returns compared to the benchmark returns

ETHICAL

Benchmark Return -Fund Return NON-ETHICAL

Benchmark Return - Fund Return Benchmark

1 Aberdeen Ethical World -2.53% Jupiter Global Managed -5.4%MSCI THE WORLD INDEX

2Aberdeen Responsible UK Equity 2.83% SVM UK Alpha 1.3% FTSE All Share

3 AEGON Ethical Equity -6.88% Invesco Perp Childrens -3.7% FTSE All Share

4

Aviva Inv Sustainable Future Absolute Growth -0.77%

New Star Global Strategic Capital 3.3%

MSCI THE WORLD INDEX

5

Aviva Inv Sustainable Future European Growth -12.79%

JPM Europe Dynamic Ex UK -14.5%

FTSE World Europe Index

6Aviva Inv Sustainable Future Global Growth -1.45% BlackRock Global Equity -3.6%

MSCI THE WORLD INDEX

7Aviva Inv Sustainable Future UK Growth -3.92% GLG UK Growth 5.0% FTSE All Share

8 AXA Ethical Distribution 3.63% JPM UK Focus 1.8% FTSE All Share

9 CS Fellowship -0.67% Legg Mason UK Equity 2.2% FTSE All Shares

10 Ecclesiastical Amity UK 0.83%Aviva Inv Blue Chip Track-

-0.1% FTSE All Share

56

ing

11F&C Stewardship Growth 0.23% Artemis Capital 1.1% FTSE All Share

12F&C Stewardship Income -0.76% BlackRock UK Income -3.0% FTSE All Share

13F&C Stewardship International -0.03% Artemis Global Growth -6.2%

MSCI THE WORLD INDEX

14First State Asia Pacific Sustainability -3.44% New Star Pacific Growth 3.1%

MSCI AC ASIA PACIFIC ex JAPAN

15 Halifax Ethical -2.29%Rathbone Global Opportunities -5.8%

MSCI THE WORLD INDEX

16Henderson Global Care Growth -4.92%

Scot Wid Global Select Growth -1.4%

MSCI THE WORLD INDEX

17Henderson Global Care UK Income 2.51% Trojan Income -4.4% FTSE All Share

18Henderson Industries of the Future -5.32% Allianz RCM Global Equity -3.1%

MSCI THE WORLD INDEX

19 Insight Evergreen -1.19% Cavendish Worldwide -0.4%MSCI THE WORLD INDEX

20 Jupiter Ecology -9.35%Aviva Inv International Index Tracking -0.9%

MSCI THE WORLD INDEX

21Jupiter Environmental Income -3.52% Neptune UK Equity -5.5% FTSE All Share

22 L&G Ethical -1.31% Baillie Giff British 350 -0.6% FTSE-350 Index

23Marks & Spencer Ethical 6.01% MFM Slater Pension 8.7% FTSE-350 Index

24 Old Mutual Ethical -0.62%Cler Med FTSE 100 Tracker -7.2% FTSE-100

25Stan Life Inv European Ethical Equity 10.77%

Invesco Perp European Equity Income -1.5%

FTSE World Europe Index

26Stan Life Inv UK Ethical Trust -8.40% Gartmore UK Tracker -7.0% FTSE-100

27 SWIP Global SRI 3.13%CF GHC MultiManager Global Equity 0.2%

MSCI THE WORLD INDEX

28SWIP Pan European SRI Equity -6.91% Newton Pan European -10.6%

FTSE World Europe Index

29 SVM All Europe SRI -7.09%CF Lord Abbett European Growth -2.2%

FTSE World Europe Index

NUMBER OF THE FUNDS OUTPERFORME THE INDEX 21

NUMBER OF THE FUNDS OUTPERFORME THE INDEX 19

Sources: Bloomberg.com and author’s calculations

57

Table 7 Excess Returns and Risk-Adjusted Performance (M2 measure)

Risk-free rate4.75%

NAMEExcess

Returns RAP NAMEExcess

Returns RAP

ETHICAL NON-ETHICAL

1 Aberdeen Ethical World 0.55% 5.21% Jupiter Global Managed 3.39% 7.52%

2Aberdeen Responsible UK Equity -7.32% -0.81% SVM UK Alpha -5.76% 0.02%

3 AEGON Ethical Equity 2.39% 7.10% Invesco Perp Childrens -0.82% 3.88%

4Aviva Inv Sustainable Fu-ture Absolute Growth -1.21% 3.85%

New Star Global Stra-tegic Capital -5.31% 0.95%

5Aviva Inv Sustainable Future European Growth 5.89% 11.24%

JPM Europe Dynamic Ex UK 7.60% 12.18%

6Aviva Inv Sustainable Fu-ture Global Growth -0.53% 4.37% BlackRock Global Equity 1.67% 5.95%

7Aviva Inv Sustainable Fu-ture UK Growth -0.57% 4.36% GLG UK Growth -9.53% -3.87%

8 AXA Ethical Distribution -8.12% -1.38% JPM UK Focus -6.30% -0.85%

9 CS Fellowship -3.82% 0.61% Legg Mason UK Equity -6.71% -2.09%

10 Ecclesiastical Amity UK -5.32% -0.32%Aviva Inv Blue Chip Tracking -4.41% -0.23%

11 F&C Stewardship Growth -4.72% 0.58% Artemis Capital -5.63% -0.49%

12 F&C Stewardship Income -3.73% 0.89% BlackRock UK Income -1.48% 3.42%

13F&C Stewardship International -1.95% 3.33% Artemis Global Growth 4.20% 7.33%

14First State Asia Pacific Sus-tainability 8.51% 16.66%

New Star Pacific Growth 1.92% 6.73%

15 Halifax Ethical 0.31% 4.75%Rathbone Global Opportunities 3.82% 4.75%

16Henderson Global Care Growth 2.94% 6.74%

Scot Wid Global Select Growth -0.58% 4.28%

17Henderson Global Care UK Income -7.00% -1.55% Trojan Income -0.09% 4.63%

18Henderson Industries of the Future 3.34% 7.22%

Allianz RCM Global Equity 1.12% 5.70%

19 Insight Evergreen -0.79% 4.17% Cavendish Worldwide -1.59% 3.50%

20 Jupiter Ecology 7.37% 10.78%Aviva Inv International Index Tracking -1.03% 3.96%

21Jupiter Environmental

-0.97% 3.84% Neptune UK Equity 0.97% 5.66%

58

Income

22 L&G Ethical -4.68% 0.70% Baillie Giff British 350 -5.38% -0.75%

23 Marks & Spencer Ethical -12.00% -3.73% MFM Slater Pension -14.70% -10.29%

24 Old Mutual Ethical -9.16% -3.81%Cler Med FTSE 100 Tracker -2.55% 1.95%

25Stan Life Inv European Ethical Equity -17.67% -3.16%

Invesco Perp European Equity Income -5.42% 2.37%

26Stan Life Inv UK Ethical Trust -1.38% 3.27% Gartmore UK Tracker -2.76% 1.68%

27 SWIP Global SRI -5.11% 0.86%CF GHC MultiManager Global Equity -2.21% 2.96%

28SWIP Pan European SRI Equity 0.02% 4.77% Newton Pan European 3.73% 8.52%

29 SVM All Europe SRI 0.19% 4.92%CF Lord Abbett Euro-pean Growth -4.70% 0.75%

AVERAGE -2.23% 3.29% AVERAGE -2.02% 2.76%

Sources: Bloomberg.com and author’s calculations

Table 8 Sharpe measure

ETHICAL Sharpe measure NON-ETHICAL Sharpe measure

1 Aberdeen Ethical World 0.1502 Jupiter Global Managed 0.9128

2Aberdeen Responsible UK Equity -1.5262 SVM UK Alpha -1.2985

3 AEGON Ethical Equity 0.6455 Invesco Perp Childrens -0.2379

4Aviva Inv Sustainable Future Absolute Growth -0.2985 New Star Global Strategic Capital -1.2527

5Aviva Inv Sustainable Future European Growth 1.5802 JPM Europe Dynamic Ex UK 1.8107

6Aviva Inv Sustainable Future Global Growth -0.1240 BlackRock Global Equity 0.3949

7Aviva Inv Sustainable Future UK Growth -0.1064 GLG UK Growth -2.3679

8 AXA Ethical Distribution -1.6839 JPM UK Focus -1.5379

9 CS Fellowship -1.1364 Legg Mason UK Equity -1.8794

10 Ecclesiastical Amity UK -1.3930 Aviva Inv Blue Chip Tracking -1.3679

11 F&C Stewardship Growth -1.1443 Artemis Capital -1.4387

12 F&C Stewardship Income -1.0597 BlackRock UK Income -0.3663

13 F&C Stewardship International -0.4686 Artemis Global Growth 0.8521

14First State Asia Pacific Sustai-

2.0637 New Star Pacific Growth 0.3435

59

nability

15 Halifax Ethical 0.0701 Rathbone Global Opportunities 0.8174

16Henderson Global Care Growth 0.6563 Scot Wid Global Select Growth -0.1563

17Henderson Global Care UK In-come -1.7314 Trojan Income -0.0339

18Henderson Industries of the Future 0.8168 Allianz RCM Global Equity 0.3123

19 Insight Evergreen -0.1926 Cavendish Worldwide -0.4136

20 Jupiter Ecology 1.9893Aviva Inv International Index Tracking -0.2620

21 Jupiter Environmental Income -0.2489 Neptune UK Equity 0.2507

22 L&G Ethical -1.1913 Baillie Giff British 350 -1.6174

23 Marks & Spencer Ethical -2.4952 MFM Slater Pension -4.4234

24 Old Mutual Ethical -2.1020 Cler Med FTSE 100 Tracker -0.6890

25Stan Life Inv European Ethical Equity -2.6106

Invesco Perp European Equity Income -0.7863

26 Stan Life Inv UK Ethical Trust -0.3631 Gartmore UK Tracker -0.7537

27 SWIP Global SRI -1.2824CF GHC MultiManager Global Equity -0.5916

28 SWIP Pan European SRI Equity 0.0045 Newton Pan European 0.9171

29 SVM All Europe SRI 0.0417CF Lord Abbett European Growth -0.9753

AVERAGE -0.4531 AVERAGE -0.5461

Sources: Bloomberg.com and author’s calculations