The 'inconvenient truth' of climate change has kindled interest in green funds, writes Laura Slattery

An ethical consumer will separate their waste for recycling, buy organic produce and turn off the lights when they leave the room. But if they have a lump sum to invest, will they check whether the companies they're buying shares in aren't rampant polluters with a penchant for singlehandedly destroying rainforests and depleting entire oil fields in the pursuit of profit.

Probably not. The complexities of the investment world mean there are plenty of pension holders, equity Special Savings Incentive Account (SSIA) customers and other investors out there with the good conscience not to blow smoke rings in other people's faces or build their own private armoury but without the means or the know-how to avoid investing in arms manufacturers or Big Tobacco.

However, with the so-called "inconvenient truth" of climate change hitting more headlines than ever before, ethical investment funds are seeing a surge in interest from individual investors who simply aren't comfortable in financially supporting corporations that emit enough carbon dioxide to send Europe into another ice age in the length of time it takes to say "corporate social responsibility".

The "green pound" - or the "green euro" - has never been so important, according to Sophie Horsfall, who manages ethically screened funds for investment house F&C.

F&C's Irish arm, F&C Ireland, manages the Friends First's Stewardship Fund, which back in 1997 was the first ethical fund to be introduced to the Irish market. Its mission is to "offer investors the opportunity to make a positive contribution to society as well as investing for profit".

Since then, Hibernian has introduced a range of socially responsible investment (SRI) funds, while Dolmen Stockbrokers has launched the Green Effects fund.

In total, about half a dozen investment managers in Ireland are signed up to the British-based Ethical Investment Research Service, which analyses corporate behaviour on behalf of ethical fund managers, and also supplies information to the FTSE4Good index, which acts as a kind of benchmark for the ethical fund industry.

But the Irish market is still a few years behind Britain, where more than £6 billion is invested in about 80 separate ethical funds.

"In Ireland the interest in ethical funds has always been from religious and charitable groups, but individual investors are starting to catch on," says Horsfall. "People are seeing that they can match their choice of investment with their principles and get the same kind of performance that they would get from an unscreened fund."

Dolmen Stockbrokers, which now has €60 million in its Green Effects fund, already had several charities and religious orders on its client books. But the fund has a minimum investment requirement of just €5,000, and there are plenty of small investors putting in €5,000 or €10,000 into the pot, according to Richard Power, who manages the fund.

Although the criteria for ethical and SRI (Socially Responsible Investment) portfolios varies from fund to fund, almost all will exclude companies involved in activities such as nuclear energy, military equipment, tobacco and pornography.

"Historically, it has been all about excluding certain companies and sectors and using negative screens," says Horsfall, who manages F&C's Stewardship International fund.

But "positive screening", where the fund managers seek out well-run, environmentally friendly and community minded companies in sectors such as healthcare, food and education is now a crucial part of ethical funds. In other words, it's not just about weeding out the especially toxic companies.

"There is an engagement aspect as well. Companies might be excluded because they don't have sufficient labour standards in China - we could work with them on improving them."

Some funds take a "best in class" approach, investing in the best behaved companies in eco-hostile sectors like mining. "We don't invest in the mining sector at all," says Horsfall.

F&C also excludes financial stocks in order to avoid an indirect connection with unethical activities.

Of all the sectors that ethical funds do favour, there is one that is rapidly becoming crucial to the performance of the funds: alternative energy. "It is probably the strongest sector," says Power.

SolarWorld, one of Germany's largest solar energy companies, has been a good performer for Green Effects, he adds, while the fund has also been boosted by a strong holding in Vestas, one of the world's biggest manufacturers of wind turbines - a product much in demand as governments hunt for alternatives to the rapidly depleting and politically fractious oil and gas reserves.

"Alternative energy sources are getting a lot more coverage and a lot more airtime, especially with the way oil prices have been over the past year or two," notes Power.

But while climate change fears may prompt more interest in ethical funds, individual investors may well question if they have the ability to make a difference when billions of institutional and pension fund money flows into stocks and indices that care about nothing except the bottom line.

The National Pension Reserve Fund (NPRF), which will be used to meet the cost of State and public sector pensions in the future, has in the past provoked the censure of the Dáil Committee of Public Accounts for investing in the - often highly profitable - tobacco and armaments sectors.

The fund, which at €17.6 billion is one of the largest investment funds operating in Europe, has been in a tricky position: it is criticised for weak performance but hounded when it pursues investment opportunities that the fund managers - the National Treasury Management Agency - believe will give the highest returns. These include investing in private equity groups that embark on sometimes ruthless asset stripping of existing companies and buying the bonds of governments that may or may not engage in dubious foreign policy practices, depending on your political viewpoint.

Earlier this year, the NPRF pointed out that the returns from the tobacco industry have been 7 per cent higher than the average. But things are changing. In April, the NPRF joined a group of the world's largest institutional investment funds in signing the Principles for Responsible Investment, a group that came together at the invitation of UN general secretary Kofi Annan.

This means that the NPRF will bring environmental, social and governance (ESG) issues into its investment decision-making and ownership practices for the first time, on the basis that it is sustainable, well-managed companies that will give the best long-term returns in the years to come.

A spokesman for the NPRF says that it will shortly be putting out to tender the handling of its ESG issues. Rather than hiring a screening service per se, this will involve outsourcing its engagement with companies on their environmental, social and governance records.

As larger pension fund managers become more supportive of ethical funds, it helps dispel the myth that investing ethically will inevitably lead to underperformance or involve greater risks, says Horsfall.

"Trustees have a responsibility to get the best returns. While historically ethical funds may have underperformed, that is not the case in the past few years," she says. "There has been some very good growth stories, and I don't think you will see the same dragging of feet from pension funds, both internationally and in Ireland."

So for a small investor who doesn't want their lump sum to damage the planet, going green no longer means going alone.

Ethical investment options

• Wind power: Ethical funds have been investing heavily in wind-power companies such as Vestas with good reason. For many countries, including Ireland, wind power is now viewed as one of the only economic and viable ways to reduce dependence on fossil fuels such as oil, gas and coal. The sector is also helped by Government targets for the use of renewable energy.

• Forestry: Although it has yet to add any trees to its portfolio, Ireland's National Pension Reserve Fund has allocated 0.5 per cent of its total fund to investment in forestry, on the basis that purchasing land for afforestation is well-suited to long-term investments such as pensions.

Forestry also happens to be a highly green activity that is supported in the Republic by tax breaks.

• Telecommunications: Not all of the stocks held by ethical funds might seem obviously green.

The funds often include telecommunications companies such as Vodafone, which produce comparatively low levels of industrial waste and in theory also help reduce the need for carbon-emitting business travel.

• FTSE4 Good index: Launched in 2001, the index excludes companies operating in the tobacco, weapons and nuclear power station markets.

Some "negative screens" are being removed and replaced with stringent entry criteria, allowing companies that market breast milk substitutes and mine uranium to qualify for the index. At its last review, seven companies were deleted from the index for failing to meet environmental criteria, while toymaker Hasbro was removed for failing to meet supply chain labour standards.