Can Ethical Investors Save German Capitalism?

Greedy foreign investors and companies that would do anything to make a profit -- those are the "locusts" Social Democratic leader Franz Müntefering was talking about when he recently lambasted the state of German capitalism.

Were Müntefering to dig a little deeper though, he'd find that there is a good side to capitalism embraced by ethical investors who care about sustainability and social responsibility. Call them the ants.

Ethical funds, also known as socially responsible or "green" funds, offer investors with a conscience the ability to rest easy, safe in the knowledge that their money is not supporting companies involved in such areas as animal testing, nuclear energy, pornography, weapons, gambling and tobacco.

"There are different concepts on what constitutes an ethical company," said Paschen von Flotow, managing director of the Sustainable Business Institute at the European Business School. "One is positive screening, where fund managers try to find the companies within one sector that are 'better' than others, and the other way is to do negative screening, whereby you eliminate companies you don't want for various environmental or ethical reasons."

Although ethical funds remain a niche product, they represent an investment sector that is booming in Europe, and especially in the German-speaking world, where there are currently around 120 different funds available.

"The number of ethical funds is increasing today compared to the conventional market, where we see a decrease in the number of funds," said von Flotow.

Awareness lacking

Since 1998, demand for ethical funds has caused the total investment volume to balloon from around 300 million euros to a current volume of over 6.5 billion euros. Still, despite their success, ethical funds make up just 0.5 percent of the total market in investment funds. While optimists might say this leaves plenty of room for growth, it's also an indication of a lack of awareness both among the public, as well as professionals working in the financial sector.

"The problem is that the financial advisors of banks whose job it is to sell funds often don’t have much time to spend with clients, so they typically focus on those funds which they think are easy to explain," von Flotow said. "Sometimes the advisors don’t even know whether their bank even offers ethical funds."

Another problem has strictly to do with image. Ethical funds are often considered to be less profitable than conventional funds, even among people who are interested in making socially and environmentally responsible decisions. In reality, ethical funds have been performing solidly on the German market.

Someone who invested 10,000 euros in leading ethical fund "Ökovision" in 2003, for example, would now be able to cash in their shares for roughly 12,800 euros. The same amount invested in a comparable conventional fund with leading German mutual fund manager DWS would have yielded 12,050 euros over the same period.

In addition to pure mutual funds, there are also ethical pension funds that invest in state securities. Omitted from these portfolios are governments that own atomic weapons, use the death penalty, or have refused to sign the Kyoto treaty on climate change -- meaning the United States, Japan, Britain and France all fail to make the grade.

Increased transparency

A common factor with all ethical investments is an increased level of transparency for the investor.

In the past, Germans investing in pension funds, for example, were in the dark about what the funds' yields were supporting. Now, thanks to new legislation approved by the German parliament earlier this month, pension funds are obliged to report yearly on if and how they act ecologically and ethically with the funds at their disposal. "A milestone," according to Walter Kahlenborn, managing director of the German Sustainable Investment Forum.

"The new rules on transparency will have the effect of stimulating the market and promoting the social, ethical and ecological aspects of investment management," Kahlenborn said.

Similarly, companies wishing to be included in an ethical mutual fund also have comply with more rigorous Corporate Social Responsibility (CSR) reporting standards, answering questions about their social and environmental standards, both at home and in developing countries. The questions also go beyond product-related issues to include management issues such as company policy on diversity and equal opportunity.

An increase in consumers seeking to make informed investment choices could even rescue capitalism's blemished reputation in Germany, said Paschen von Flotow of the Sustainable Business Institute.

"Since we've had this debate about capitalism in Germany, there's been more discussion about responsible investment, and certainly for me, sustainable investment could be an important element of the further development of capitalism," von Flotow said.