Growing concerns about global warming and other environmental issues are prompting more and more people to put their money into ethical investments. Ten years ago the amount that investors put into ethical funds was only £1.5 billion. But by 2007 the annual figure is estimated to have grown to more than £7 billion.

Ethical investment, also known as socially responsible investment (SRI), covers a multitude of different strategies. The main three are negative screening, positive screening and engagement.

Negative Screening

Funds that use negative screening, known as dark green funds, weed out companies that are involved in activities that the fund manager regards as unethical. Each fund group has a slightly different definition of what is unethical, but this typically includes gambling, tobacco, alcohol and arms manufacture. It could also cover pollution of the environment, bank lending to unsavoury regimes and testing of products on animals.

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Background

• The beginner's guide to emerging markets

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• How to buy shares

• How to invest ethically

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Positive screening

Funds that take this approach look for companies that are doing positive good, such as those engaged in recycling, alternative energy sources or water purification. So an ethical fund of this type might buy shares in a maker of wind turbines or solar panels.

Engagement

These funds take a stake in companies and then use that stake as a lever to press for changes in the way that the company operates. This could mean persuading oil and mining companies to take greater care about the environmental impact of their operations or pressing companies to offer better treatment of their workers.

Jupiter is one of the fund groups that specialise in engagement and has a whole department devoted to the practice. F&C also has a large team involved in engagement and some of its funds operate what may seem a rather confusing combination of negative screening and engagement.

Impact on performance

One of the objections to investing in ethical funds with a screening process is that this results in ethical fund managers having a smaller pool of stocks from which to fish.

In the case of a dark green fund, such as F&C Stewardship Income, the manager is left with about half the stocks in the FTSE all-share index to choose from.

Some experts reckon that, over a long period of time, this restriction is bound to be a real drag on potential performance.

However, the F&C fund has performed very well in recent years, showing that a talented manager’s stockpicking skills can sometimes overcome the handicap of having a narrower range from which to select.

Sometimes the ethical restraints actually work in the manager’s favour. For example, the exclusion of gambling stocks from ethical portfolios meant that ethical funds were largely shielded from the debacle that overtook online betting stocks in 2006.

In contrast, the ban on tobacco stocks has hurt ethical managers because tobacco has proved one of the best-performing sectors over the past five years.

How to pick an ethical fund

Investors could approach one of the small number of independent financial advisers (IFAs) that specialise in ethical investment. IFA Promotion will offer help with finding a suitable IFA.

Alternatively, investors could go to the Ethical Investment Research Service (Eiris) or the UK Social Investment Forum (UKSIF) for more information about ethical investment.

Although building an individual portfolio of ethical shares is something that should normally be done only with the help of an adviser, investors may, as a matter of interest, wish to look at a company's ethical ratings on sites such as ethicalconsumer.org or check out a company's corporate social responsibility report, if it has one.

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Five ethical funds

Aegon Ethical Equity

F&C Stewardship Growth

Jupiter Environmental Income

L&G Ethical Trust

Norwich UK Ethical

Five websites

Ethical Investments

Ethical Investment association

C of E Investment Advisory Group

The Co-operative Bank

Charities' Ethical Investment