Is ethical investment as good for your wallet as it is for your soul?

If you could earn a solid return, with lower risk, while only investing in ethical investments, you would probably do it. Socially Responsible Investment (SRI) funds offer the ethical part. But do they really offer the same return?

Many investors say they'd prefer to invest in responsible funds, but when it comes to the crunch, their top priority is the level of return.

Research comparing traditional funds with SRI funds has not exactly been conclusive. But comparing the performance of any two funds is inherently difficult due to the number of variables. And of course past performance is no guarantee of what will happen in the future. But according to Roger Wildeboer Schut of the Aegon Asset Management's Responsible Investment team, "Looking at the available academic research, the consensus is that SRI doesn't seem to hurt performance, and there may even be a slightly positive effect on returns."

To test this hypothesis further, TKP Investments, part of Aegon Asset Management, carried out a simulation exercise on the recently launched TKP Investments MM World Equity Index SRI Fund. The simulation mimicked the investment scenario between 2007 and 2015 and showed that this socially responsible fund would have performed just as well as its regular parent index.

Perhaps more interesting is that the result was achieved with a lower degree of volatility and risk. SRI has the potential to protect investors from future shocks in the financial markets, a valuable proposition given current uncertain economic times.

Which companies deliver the best SRI payoff?

Finding companies who genuinely offer socially responsible investment opportunities is typically one of the main challenges for SRI fund managers. In the past, the composition of funds tended to be highly western-centric, but Aegon Asset Management is addressing this imbalance as SRI disclosure standards improve around the world.

Ryan Smith, Head of Environmental, Social and Governance (ESG) research at Kames Capital - part of Aegon Asset Management in the UK - says more Asian companies are being added to its Global Sustainable Equity Fund. This reflects the fact that some of the most exciting sustainability solution providers are active in that part of the world. "We are firm believers that investing in emerging markets is the right approach as many of the greatest sustainability challenges are faced in these regions," Ryan Smith says.

One potential conundrum facing fund managers is the size of firm to invest in. While large corporations tend to have dedicated departments that track social-responsibility indicators, small and medium sized firms can sometimes fly under the radar. For this reason, Aegon Asset Management's local brands try to identify opportunities in smaller enterprises that may not have provided the markets with full details of their efforts yet.

Companies with a sustainable advantage

Based on tailor-made SRI methodology for its Federis ISR EURO fund, Aegon's French joint-venture partner La Banque Postale Asset Management (LBPAM) has invested in a number of smaller companies, including Koninklijke Wessanen, a Dutch food company that produces healthy and sustainable products, and Gamesa, a Spanish developer and constructor of wind turbines.

"If you simply look at the ESG indicators you would say that larger companies perform better, but we think often this is because they simply have larger departments to track all kinds of ESG indicators and report on them. Smaller companies sometimes don't perform worse, they're just not disclosing it," says LBPAM's SRI analyst Paul Merle.

For its part, Kames Capital has invested in Mohawk Industries Inc., an American carpet and flooring company that has integrated sustainability into its operational practices by investing heavily ($500mln) in plastic bottle recycling facilities (Mohawk is the largest recycler of plastic bottles in the US). Ryan Smith comments: "We think Mohawk is a great example of a company where sustainability has provided it with competitive advantages."

The future of ethical opportunities

Aegon Asset Management's fund managers involved with SRI funds are enthusiastic about the future market opportunities of ethical investing, as economies of scale are expected to help reduce fund-administration costs. "It is still early days and it is hard work, but in the end we know that the impact will be huge – and that is very rewarding," concludes Wildeboer Schut of Aegon Asset Management's Responsible Investment team.