‘Green’ investing is increasingly popular. More than £7 billion is currently invested in green and ethical funds in the UK, up from £1.5 billion just ten years ago. Some new research by Co-Operative Investments found that 18% of investors plan to invest ethically this year.

There are lots of ways to ensure that your money is invested ethically. In the UK, you have the choice of over 90 green and ethical funds. Each takes a slightly different approach and it can be confusing when you are trying to match a specific fund to your own ethical preferences.

Here is our short guide to the different green, ethical and socially responsible investment options available.

Why go green?

Investors have different reasons for choosing ‘green’ investment options.

Some do it because of particularly strong feelings, wanting to ensure their money is not being used to fund such things as arms trading, tobacco, pornography or alcohol. Others want to make a positive contribution to the world, investing in themes including renewable energy.

Some investors opt for ‘green’ funds simply because they see the potential for higher returns. There might be something in this, for reasons we will explain later.

Approaches to investing

There are four main ways in which a fund manager can approach the management of an ethical or socially responsible investment fund. These are negative screening, integration, engagement or positive selection. Each should result in a very different outcome in terms of the types of investment considered and how the fund might fit with your own views of the world.

Negative screening is where ethical investing started. It involves the exclusion of companies from the pool of those under consideration because of the things they do. This might include the exclusion of companies in the armaments or tobacco industries. Funds that use negative screening are sometimes referred to as ‘dark green’ as their screening methods should ensure no companies involved in undesirable activities slip through the net.

Integration involves the use of specific criteria in the selection of desirable companies. This could involve the use of analytical tools to identify environmental, social and governance (ESG) factors.

Engagement is an approach used to improve a company’s performance in respect of these ESG factors. The commercial motivation behind this approach is to improve the profitability of the company, whilst ensuring alignment with the objectives of the fund.

Finally, positive selection is an approach used to identify those companies that already display strong and attractive traits in terms of corporate social responsibility practices or other ‘green’ matters.

Four different approaches to the selection of suitable investments within funds means the various green funds on offer can look very different.

What about performance?

Investing in line with your views on green, ethical or matters of social responsibility is clearly important. Ensuring that you invest in line with your attitude towards investment risk and meet your investment objectives is also important.

A common criticism of green funds is that they carry a higher level of risk than traditional investment funds. There could be some truth in that statement.

Green funds, and particularly those that use negative screening, typically have access to a smaller pool of potential investments. This used to drive green funds in the direction of smaller companies which are usually more risky from an investment perspective than their larger cap peers.

The counter argument is that a fund manager with a smaller range of companies from which to choose should be able to analyse and understand those investment options to a very high degree.

Over the medium term, certain investment sectors will outperform others. For example, when tobacco stocks do well most green funds will miss out. Of course the reverse can also occur.

Longer term, you might expect green funds to perform well because of the increased global concern about the themes of renewable energy and reducing carbon emissions.

How do I invest?

YourEthicalMoney.org is a consumer website created by Ethical Investment Research Services (ERiS). You can use this website to find out more about where your money is invested, search for green and ethical financial products, and find out how you can help make finance more sustainable

Another good place to start your research into specific green investment options is the UK Social Investment Forum (UKSIF).

By far the most comprehensive book we have read on this subject is An Investor’s Guide to Ethical & Socially Responsible Investment Funds. It is expensive (with a retail price of £55, available for £52.25 from Amazon) but is good value for any serious ethical or socially responsible investors.

If you need advice, you can find a suitable independent financial adviser using Unbiased.co.uk, the professional advice website. This online tool allows you to search for advisers who can assist with ethical investments.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. He thinks he is quite ‘green’ (recycles everything, walks rather than drives, etc) but these lifestyle choices have yet to filter down into his personal investment selections.

There are over 3,000 investment funds and more than 230 fund management groups based in the UK alone. These range from household names to little known boutiques offering specialist expertise in a niche investment area.

Assuming you are planning to do more than simply pick the top-performing fund from last year (a mistake many investors continue to make) there are five important questions you should ask before investing in a fund. Here they are.

1 – Where does this fund invest my money?

Different funds invest money in different areas. Some invest in a single asset class or investment sector. Others invest across a range of asset classes, so-called multi-asset funds.

By understanding where your money is being invested, you should be able to work out how much risk you are taking with your money and also how the fund you are considering fits in with your overall investment or pension portfolio.

A good guide to where a particular fund is investing is the IMA Sector in which it sits. The IMA (Investment Management Association) is the trade body for the UK asset management industry. They allocate every fund in the UK to a specific sector based on the objectives and holdings of that fund. Examples of these sectors include Sterling Corporate Bond and UK Equity Income.

When you look up the fact sheet for a fund, it should be very clear about where the fund invests. This usually forms part of the objective statement for the fund. It might cover a much wider range of investment types or areas than the fund manager will typically use, which means they are able to invest there but might not always do so. Increasingly fund managers want the flexibility to move money around depending on market or economic conditions. Depending on how much control you want over where your money is actually invested, this might be a positive or a negative factor.

2 – What are the charges?

Never invest in a fund until you understand exactly what you are paying and who you are paying for the privilege. Investment funds typically come with two different charges – an initial charge and an annual management charge, the AMC.

The initial charge is the up front cost of investing in a fund. It can range from 2-6% and often includes an element of commission for the adviser recommending the fund. If you are investing without advice (on an ‘execution only’ basis) then you should ensure the initial charge is heavily discounted.

A form of initial charge is the bid/offer spread. This is the difference between the buying and selling price of units, and can be as much as 5%. This is one to watch out for, particularly on funds where there is no explicit initial charge or the initial charge has been discounted for some reason.

The annual management charge (AMC) is the amount deducted from the value of your investment each year and paid to the fund management group for managing your money.

Once again, this charge can often include an element of commission for the adviser or salesman selling you the fund, so look for a discount if you are investing directly. AMCs vary from 0.3% to 2.5% per year, and once they reach around 1.5% typically pay around 0.5% out as commission; sometimes more, sometimes less.

A more accurate measure of how much you are actually paying each year for fund management is the Total Expense Ratio (TER). This includes the cost of other expenses paid for by the fund, in addition to the AMC. Funds are not obliged to publish this figure, and not all choose to do so, but where they do it should give you a better idea of the real cost of the fund.

Some funds have a performance-related fee in addition to the AMC. This concept came from the world of hedge fund management and it not yet very common for mainstream investment funds. A typical performance-related fee might be 20% of the fund gain above a set benchmark. I’m personally not a big fan of these, particularly where the benchmark used is modest, but also because they might encourage fund managers to take greater risks with your money. They also tend not to penalise fund managers for failure; they still get paid the AMC if the fund performs poorly.

Another cost to look for is an exit charge. These are more common on institutional share classes where there is no entry cost to invest in the fund but a fee is charged when you leave.

3 – How consistent has the performance been?

Past performance is not usually a very good measure of how well a fund might perform in the future. The risk warning you will always see when investing about past performance not being a good guide to the future is there for a good reason. In fact, there is well documented academic research that shows a fund which performed well in one year is likely to do poorly the following year. Investors who chase performance are usually on to a losing strategy.

A much better measure of a fund is consistency of performance.

If a fund manager has been posting similar results, relevant to the sector, for three, five or ten years then there is a chance they will be able to repeat this consistency in the future. Of course it is not guaranteed that they will continue to do well, but a fund manager who has delivered consistent performs in the past has at least demonstrated their ability.

4 – How large is this fund?

Size isn’t everything, but when you are selecting suitable investment funds, size is one factor you might want to consider.

Investment funds vary in size from the very small (maybe only a few million) to the gigantic (several billion pounds of assets under management). Filtering out the extremes of fund size can make real sense.

If an investment fund is small this should tell you one of two things. Firstly, it has not managed to attract much money from other investors. Are other investors avoiding the fund for a good reason or is it really the best kept secret in the world of investment management?

Secondly, will the fund management group keep the fund open for the long term? Small investment funds tend to be those that get ditched by fund management groups or at least merged with others to create bigger funds.

Big funds, which have attracted many investors, face other problems. Once an investment fund gets to a certain size (say, £1bn) the fund manager might start facing some difficulties.

A really big investment fund can be more challenging to manage as investing the money in the best ideas can move individual share prices. As a result, the fund manager might not be able to invest the fund assets exactly as they might like. Getting large amounts of money out of investments that have gone wrong could be equally as challenging.

5 – Who is managing my money?

This is not always as clear as it seems. A key distinction is between a fund run by a fund manager and one run by a whole team at the fund management group. Both ’star manager’ and team-based approaches to managing funds have their attractions, but it is important you know who is ultimately responsible for making the decisions about where your money is invested.

Knowing who is managing your money should allow you to look at their background in more detail. If they have a relatively short track record at the helm of their current fund (say, less than five years) then you should take a look at the experience of their previous fund. You can even look at fund manager (rather than fund) performance on the Citywire website.

Some funds are promoted by one fund management group but the actual management of the money is outsourced to another group or manager. This is more common when the fund is investing in overseas equities, where local management of the money can really pay dividends. What this approach might mean is a household name promoting the fund but a tiny boutique actually managing the investments on a day-to-day basis.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.