Would you take a stake in a company that manufactured weapons? Do you support the exploitation of Third World countries? Almost certainly not. But fund managers are not so discerning. Their focus is on maximising returns, not on exercising their principles. As a result, many investors are inadvertently pouring money into businesses they would otherwise avoid.

An increasing number of funds, however, are taking an ethical stance, enabling investors to channel their money into companies they feel comfortable with. Different

ethical funds work to different criteria but fall broadly into two categories. Some will screen negatively: for example, refusing to invest in companies that sell arms, tobacco or alcohol, or deal with countries having oppressive regimes. Other funds discriminate positively by investing in companies that operate ecologically sound policies.

Ethical investment is the stock market's fastest growing sector and the Ethical Investment Research Service (Eiris) is hoping to boost growth further this week by publishing research demonstrating that ethical funds have lower total average risk than those funds not ethically screened.

Karen Eldridge, head of client services at Eiris, said the study overturns the myth that ethical funds are more risky than standard investment funds. The volatility of ethical funds in the UK growth sector over the past five years hit 10.4 per cent, against 10.9 per cent in non-ethical funds. This may prompt more people to consider the ethical option, she said.

While the report shows that average returns on ethical funds are "marginally lower" than non-ethical funds, there are exceptions. In the UK growth sector, Friends Provident's Stewardship fund and TSB's Environmental Investor have had better returns over the fund's life than the average in the sector, which demonstrates that it is possible to get good financial performance within an ethical framework.

Ms Eldridge added that the largest five ethical funds evaluated in the report outperformed 49 per cent of funds in their sectors in terms of return. Almost two thirds of the big five ethical funds had a lower risk profile than standard funds in their sectors.

Eiris concluded that the balance of risk and return offered by ethical funds "does not look materially different from that offered by the non-ethically screened funds".

Michael Owen, managing director of Plan Invest Group, an independent financial adviser, said that - as with all financial decisions - investors should consider their options carefully before jumping on the ethical investment bandwagon, since the conclusions drawn by Eiris are "a little too simplistic". He added: "It is quite a sweeping statement to say that ethical funds are lower risk than non-ethical funds. All companies are subject to the same market forces and commercial pressures."

The Eiris report itself demonstrates that both risk and performance of different ethical funds vary considerably.

In the UK growth sector, for example, while only 1 per cent of standard funds are rated as lower risk than the Abbey Ethical fund over a five-year period, a whopping 97 per cent of standard funds are deemed less risky than the Credit Suisse Fellowship fund. Performance is similarly diverse.

Mr Owen said that investors should focus instead on the fact that it is possible to reap good returns from an ethical investment and concentrate on picking a winner. He cited NPI, which he described as "possibly the best company in this field". He added: "They have a huge team looking at ethical investment, and if you are going to do this you cannot play at it. They have developed a social index of companies that they screen themselves."

A sum of £1,000 invested in NPI's Global Care growth fund over a five-year period would have grown to £1,790, assuming income was reinvested. On average, UK growth funds have grown £1,000 to £1,880 over five years.

Mr Owen also singled out Standard Life Ethical, a fund that was launched last year. "It is a much newer fund, but it has been putting in some reasonable numbers," he said.

If you had invested £1,000 in the fund a year ago, it would have grown to reach £1,130.

Credit Suisse Fellowship is another fund on the list - £1,000 invested five years ago would have grown to £1,923. Jupiter Ecology is another favourable performer - it has turned £1,000 to £1,766 over the past five years.

Conversely, there are ethical funds that investors should steer well clear of. Clerical Medical's Evergreen fund has boosted a £1,000 investment by a paltry £125 over the past five years.

William Sallitt, investment adviser at Carrington Investment Consultants, said that while he welcomed any increased publicity for ethical funds, "there still needs to be a wider choice of funds and a better education of what the funds actually stand for".

Mr Sallitt also picked out Credit Suisse Fellowship as one of the better-performing funds. And despite the fact that it is a small fund with just over £25 million invested, another fund he singled out was Lloyds TSB Environmental Investor, which has "performed very well". In addition to underscoring the viability of some existing ethical funds, the findings of the Eiris report are "all important" in the light of legislation to be implemented in July 2000 that will require trustees of all pension funds to disclose their policy on ethical investment. Ms Eldridge said that by demonstrating that ethical investment is a viable option in financial terms, the research should encourage trustees to develop ethical investment policies.

"We are seeing lots of interest - all the big actuary firms have given somebody responsibility for looking at ethical investment to bring them up to speed," she said. "Fund managers are also looking at it quite seriously as to how they can develop their funds."

Pension providers anxious about disclosing investment policy and now beginning to cast an eye over ethical funds should be encouraged by the fact that Eiris found that 37 per cent of people would like to see a small part of their pension fund invested in businesses set up to promote social or environmental causes, even if they get a lower return. Another 77 per cent said that their pension schemes should operate an ethical policy whenever they can do so without reducing financial returns. And 83 per cent said that pension providers should make their approach to ethical investment absolutely clear in their annual statements to scheme members.

Despite such encouraging statistics, Ms Eldridge conceded that those pushing ethical investment still have "a big, big nut to crack". The key problem remains a lack of awareness, she said, and added that it is up to IFAs to start asking the ethical question. "It is a question of people realising that where they invest their money is very important."

Eiris: 0845-606 0324 has a free list of IFAs that specialise in ethical investment.