Paul Todd describes Nest’s approach to ethical investing

Ethical investing has always been contentious. What are ethics? Whose ethics count?

In a globalised financial system, how can you really be sure what you’re investing in? And if you are being ‘ethical’, how can you possibly make any money out of it?

These are legitimate, if difficult, questions. But this should not mean that institutional investors avoid answering them or opt-out of offering ethical choices altogether.

The UK ethical consumer market was worth £54 billion in 2013, more than triple the size it was just over a decade ago. Consumer demand for ethical products has continued to grow, even during the recession.

This trend may not have yet translated into a significant take-up of ethical pension funds. But that doesn’t mean the demand isn’t there.

Low take-up is more likely a symptom of a wider issue – mainly the fairly commonplace misconception many people have about what happens to their money when it’s in a pension.

Most don’t realise it’s invested at all, and if they did, the concept of investing is still quite far removed from their day-to-day interactions with shops and businesses.

As automatic enrolment brings millions more people into pension saving and their pots begin to build up, we expect engagement in where that money is going to rise as well.

So while this may be a slow burn, evidence from the consumer market suggests there is nowhere for interest in ethical pension funds to go but up.

Before establishing the NEST investment strategy and fund choice structure, we spent a lot of time researching and learning about our future members.

What we found is that members want a degree of choice over what happens to their money. There is also a clear desire for many to be able to invest according to ethical or religious beliefs.

But too much choice is debilitating and disempowering, leaving savers simply overwhelmed and less likely to make any choices at all.

Offering NEST members access to ethical investments is therefore important, but forcing members to choose between numerous different ethical options is likely to be counter to what they need and want.

That’s why we offer a single ethical option which we’ve designed carefully to take account of the ethical concerns of our target market as well as their attitudes to risk and volatility.

Our Ethical Fund, which is structured in the same way as our default target date funds, is the only ethical fund option in the UK that has both a dynamic multi-asset allocation and a three-phase risk lifecycle.

We believe this gives members a similar degree of sophistication and opportunity to grow their money as they would get in our default fund, while ensuring ethical considerations are front and centre.

So what are those ethical considerations?

Interestingly, the research we’ve undertaken indicates that people are not as concerned about traditional ethical no-go areas like alcohol or gambling. The main things people we asked were concerned about were social in nature and often global in scope.

Labour rights in the UK, human rights abuses, child and forced labour, corrupt regimes and, to a lesser extent, environmental and ecological damage.

Excluding companies on the basis of bad practice in any of these areas is an obvious pre-requisite for our Ethical Fund. But equally important is positively reinforcing good behaviour through proactive investments and engagement.

Property, for example, is one area where shareholders can help drive greater environmental sustainability, improve communities and tackle social problems.

NEST’s Ethical Fund has around 20 per cent allocated to UK property through the green star rated Legal and General Investment Management (LGIM) Managed Property Fund, which has won a number of awards for its focus on integrating sustainability across their direct real estate portfolio.

So as Good Money Week brings ethical investing into focus, we believe it is time for there to be greater unity of purpose. More and more consumers want ethical and sustainable goods and it’s likely that demand for ethical pension funds will follow.

With automatic enrolment there is now a huge new market of pension savers who can be given this choice. The challenge for all providers is to develop products that are simple, effective and do not compromise on value.

Paul Todd is head of investment policy for NEST.