According to the latest figures from the UK Investment Management Association, net sales of ethical funds have reached their highest level since the fourth quarter of 2007, but investors would be wise not to become too overenthusiastic about these products just yet, warns AWD Chase de Vere.

As reported elsewhere by WealthBriefing today, in the last quarter net sales of ethical funds reached £98 million (about $154 million), steeply up from £37 million in the first quarter and a stark contrast to the second quarter of last year, when sales were negative £8 million. Meanwhile, funds under management in ethical vehicles reached £5.6 billion in the three months to end June, a rise of 22 per cent year-over-year from £4.6 billion in Q2 2009.

But while these gains would certainly seem to sound a positive note for ethical investments, Patrick Connolly, head of communications at AWD Chase de Vere, is sceptical about this sector’s ability to continue to grow and indeed whether ethical funds represent a good investment prospect at all.

While the financial crisis loomed large and large financial institutions teetered on the verge of collapse, public opinion was naturally focused on issues such as corporate financial responsibility. But concern over social responsibility, ethics and governance has arguably been gathering for a much longer period, giving rise to predictions that ethical investing would be the next “big thing”. Not so, says Connolly, believing that “interest in ethical funds and ethical financial advice has not taken off as many people have predicted over the years and is showing no real signs of doing so.”

The reasons for this are manifold according to Connolly, the first being that investors’ over-riding concerns are maximising returns and effectively managing risk. “Investing ethically can have a negative impact on both of these,” he said.

In Connolly’s view, the ethical sector presents investors with a limited range of investment opportunities and restricts access to some assets classes; ethical portfolios also tend to be more volatile than their more traditional counterparts he believes. Moreover, “the best managers don’t tend to manage ethical funds, putting these funds at a disadvantage regarding potential performance,” Connolly said.

Another concern highlighted by Connolly is that investment companies can adopt very different criteria as to what is or isn’t an ethical investment, making it hard for investors to construct a portfolio which is completely aligned with their personal values – meaning that any risk/return disadvantages may not even be compensated for by ethical considerations.

Advocates of ethical investing would of course strenuously defend the sector against such criticism, and indeed over recent years there has been an erosion of the widely-held assumption that ethical investing entails reduced returns - many in fact argue that companies with good SRI records tend to be among the most profitable long term. Ethical investing is however a relatively young part of the industry and the debate over its efficacy looks sure to rumble on in the absence of more hard data on its performance over the long term.