It's not a dirty rotten fund ...

But lots of people want to put their money in. Melanie Bien on the rise of ethical investing

Although investment funds have suffered this year, both in terms of performance and in the amount of money attracted from investors, ethical funds have continued to grow in popularity.

"This is the year that ethical investment has become part of the mainstream," says Jean-Paul Maytum at Co-operative Insurance (CIS). "With the advent of SRI [Socially Responsible Investment], companies are realising that, particularly in a downward market, investors will vote with their feet if they do not agree with what they are up to."

While the dismal performance of the stock market has concerned investors, their ethical values have not wavered. And even though ethical funds haven't set the world alight this year – the best performing, the Aegon UK Socially Responsible Income fund, has grown 0.83 per cent over the past 12 months – some of them have still outperformed the FTSE 100. All the top 10 best-performing ethical and ecological unit trusts, as ranked by Standard & Poor's, have beaten the FTSE 100, which is down 18.3 per cent over the same period.

Since the first ethical fund – Friends Provident Stewardship – was launched in 1984, the market has expanded dramatically. There is now just under £4bn invested ethically in more than 50 funds.

There has been more pronounced growth in ethical investing in the past year, partly as a result of new launches such as Norwich Union's Sustainable Future UK Growth, European Growth and Global Growth funds. The introduction in June of the FTSE4Good Index has also helped raise awareness, though controversial stocks such as oil giant BP are listed on it.

The terrorist attacks of 11 September also led to a rise in the number of enquiries to ethical fund managers, as investors are keen to avoid anything that could be connected with terrorism or arms sales. CIS enjoyed an 8.2 per cent increase in the number of individual savings account (ISA) investors in its environmental funds between August and November, compared with the previous year.

"There has definitely been an increase in ethical investment," says Toby Belsom, analyst at Morley Fund Management, which manages Norwich Union's Sustainable Future funds. "Retail investors are developing an increasing awareness of social and environmental issues."

Interest in ethical investment really took off last year when legis-lation gave people the right to know whether their company pension scheme was committed to investing in a socially responsible way. As a result, many pension fund providers have adopted social policies across some, or all, of their funds.

The increased popularity of ethical funds is also being fuelled by a change in the previously strict approach to green investing. Not so long ago, ethical investment meant strictly avoiding any companies involved in activities of which you disapproved – for example, arms, tobacco and nuclear power. Dark-green, purist funds, which include Jupiter Ecology, Friends Provident Stewardship and NPI Global Care, offer investors the chance to do this.

But lighter-green funds socially engage with a company, trying to influence it to change its practices from the inside. Performance is not necessarily sacrificed to conscience, as was often the case with pure ethical investments. With SRI, funds tend not to put principles before returns.

The growth of SRI means the new range of funds is less strict than the dark-green variety. But, on the whole, ethical investors are still happy to put their money in them. This is because they regard investing in a firm that has some questionable practices as a positive move: it is only from "inside" that many things can be changed. Instead of taking part in demonstrations, these new protesters are using their power as shareholders to persuade companies to change their ways.

And investors are also happy because such schemes are more di- versified. SRI funds are regarded with less suspicion than dark-green ones because investors, quite rightly, argue that a wider-ranging fund means less volatility and therefore better returns.