Before 18 March 2007, if you'd thought of ethical investments, Dutch pension funds might have come to mind as paragons of virtue. They were the first among institutional investors to consider the subject. They were prepared to test the theory that ethical investment portfolios would perform better, even though ethical considerations would limit the choice of funds to invest in. They started model portfolios, test portfolios, encouraged research and were founding members of corporate governance organisations.

After 18 March, the public image of Dutch pension funds in the field was diametrically opposed. They were shown as robotic, greedy monsters without a conscience. When confronted with the facts, their principal reaction seemed to be that the profits are good and there are no rules against unethical investments.

What happened on 18 March? Dutch television journalists had used a report on investing behaviour to investigate US equity portfolios of the largest pension funds. It gave them the opportunity to see part of pension fund investments; the part that is reportable to the US authorities and published on the internet.

The journalists came up with a list of seven questionable enterprises. They sent the list to the pension funds and applied for interviews on how the pension funds were using their voting rights in these companies. They persisted in this deception for a while, then switched to ethical investing, the subject they were really interested in.

Their report was devastating. Through suggestive editing, leaders of the pension fund industry were effectively visually linked with cluster bombs, land mines, child labour and grossly polluting enterprises. The report made a deep impression. The pension funds' reaction was a promise to do better and to publish more information on investments, but the damage had been done.

While I think the TV journalist's tactics were irresponsible and sensationalist, there is no doubt that on a strategic level they have a serious point that merits consideration and improvement. Pension funds had long and loudly claimed the moral high ground and were shown to be negligent in part of their investment portfolio. The image and the facts were at odds.

Some of the companies the journalists focused on should at least have been identified as highly questionable beforehand, either because they produce arms such as land mines, or because they are an image risk, such as being unfriendly to trade unions. However, the issue is far too complicated for a medium like television.

There can be no doubt that the extremes of the arms industry can be immoral and socially unacceptable. Nevertheless, the arms industry is to a large extent integrated in the economy. Boeing is the largest arms producer in the world, yet, less than half of Boeing's production is equipment for armed forces. Should pension funds boycott Boeing as an important part of the arms industry or embrace it because its arms production is not a major part of its activities. Are you supporting the arms industry by flying in a Boeing plane? Or should you insist on flying in Boeing aircraft because you want to support its space research?

Over half of the hardware sold by British Telecom is for the armed forces. Should pension funds draw the consequences or should they argue that telephones don't kill? Are you voting for war by being a British Telecom client or should you support an innovative and creative industry? There is no answer that will make everybody happy.

Another problem is defining arms. A fast boat is a recreational vehicle, the same boat with a reinforced deck is a navy patrol boat. A medium-sized passenger aircraft with a slightly larger door is suitable for airborne troops. Bedouins use army boots and military food rations in the Sahara and uniform trousers and jackets are for sale in inner city fashion shops. Radar posts, anti-aircraft guns and ‘Goalkeeper' style missile defence guns cannot be used for attack, they can only preserve life in danger.

Furthermore, arms do not have a monopoly on being bad for you. Goods such as tobacco, alcohol, motorcycles, confectionary and soft drinks are all perfectly legal, but serious and recognised threats to public health. Should pension funds avoid supporting the producers? Should you? If you think some in this list are worth boycotting but others are not, who decides what is acceptable?

What if some people start wondering if it is ethical to invest in say the Austrian federal state of Carinthia because its people have been electing far right populist nationalists like Jörg Haider? Is it relevant to the discussion that pope Gregory V also came from Carinthia?

All these issues do not add up to "let's ignore the problem". They do put the question into perspective, though: if the government or the international community have expressed clearly which goods or regions are not acceptable, it behoves pension funds and other investors to draw the consequences.


f the clients of a pension fund have strong and collective aversions to certain goods, that should weigh heavily on pension funds' investment behaviour. It is not up to television journalists to select issues at will and hold investors up to their standards. It is not up to "ethical investment" market players to make self-serving comments on how this would not have happened if they had had a larger market share.

The episode is now best used to draw some lessons. Here are some I would suggest:

❑ Pension funds (and other institutional investors) should consider image risk in their investment portfolios.

❑ There is no excuse for doing nothing. While the level of expected extra returns differs widely in studies and research, practically all research concludes that ethical investing does not affect returns negatively. If returns are not affected, image risk dictates that portfolios should be made "ethical".

❑ Pension funds should engage in a dialogue with stakeholders in order to map their product aversions. I think it is very important to communicate the cost of exclusions in terms of return and risks in a clear and understandable way, without trying to influence decisions. It's their pension, after all.

❑ Rather than using bureaucratic rules or inflexible codes, pension funds should use principles, common sense and flexibility to decide which enterprises not to invest in. Here too, I think transparency is vital. Explain your decisions, positive and negative, to the public.

❑ Murphy's law applies. Individual investments and investment managers (internal and external) should be checked at random on ethical considerations from time to time.

❑ You cannot be partly ethical. You are, or you are not. Do not crow about your achievements until they cover a whole asset class and make sure you communicate precisely and repeatedly which asset classes are not covered and why. Do not present research as achievement but as research.

❑ Maintain a consistent media policy and make sure everyone understands that they are subject to the policy. Avoid journalists known for sensationalist behaviour. There are plenty of good journalists out there, so there's no reason to deal with the black sheep. Avoid discussing complicated problems on a shallow medium like television. Do not avoid serious inquiries but meet them with openness and willingness to correct mistakes.

While the fuss has been painful, it is possible to turn the consequences into something positive. Participants are now showing an interest in pension funds and their investments. Let's engage them in a dialogue, not with some bland circular letter, but with an invitation to participate in the funds' thinking. Even the most conservative portfolio manager now realises that ethical investing is no longer just an option. Let us use the momentum. There are watchdogs out there who'll help in identifying doubtful enterprises and business practices. Let us listen to them.

Peter Kraneveld is an international pension expert