University College London is the latest institution to overhaul its investment policies after a student campaign against its involvement with an arms company.
A committee of UCL's governing council is investigating whether the institution should move its investments into ethical trusts. UCL's provost, Malcolm Grant, said the university was "taking on board student concerns".
The move adds to anecdotal evidence that universities are increasingly agreeing ethical investment policies, or selling shares in arms companies, in order to improve their image in a competitive student market and better to appeal to alumni for donations.
Last year the University of St Andrews introduced such a policy. In Cambridge, New Hall and St Catharine's College both sold investments in companies that do business with the Sudanese Government, and Pembroke College sold arms company stocks after student pressure last year.
Professor Grant said UCL's ethical investment policy had previously forbidden only investment in tobacco firms but now the college was looking at a range of issues including arms and the environment. Students had been consulted as part of a report into ethical investments commissioned by UCL from alumnus Edwin Glasgow QC.
Professor Grant had discussed the issue with students after a 2006 report from Campaign Against Arms Trade showed that UCL had £1.5 million in arms shares at the time - the largest amount of any university that replied to the survey. The report also revealed that UK universities held more than £15 million of shares in arms companies.
"I want to satisfy committee and council that, while we are getting a good return on investment, we are not making the world a worse place," Professor Grant said.
Minutes of a UCL council meeting also warned that there could be "financial consequences" if UCL damaged its reputation by investing in controversial firms.
However, Professor Grant said it would not be right to set out a policy forbidding research funding from arms companies.
"There is a fundamental question of academic freedom and the function of universities, which is the fearless pursuit of knowledge and how it can be applied to society. Universities that attempt to censor research are on very dangerous ground," he said.
Many technologies could be used for defence as well as attack, and some companies also make large numbers of products beneficial to the world as well as a small number of military components, he added.
UCL's move follows a sustained campaign of demonstrations and petitions by alumni and students to press the institution to set up an ethical investment policy and sell its shares in Cobham, maker of components for Hellfire missiles used in Iraq and Afghanistan.
Mischa Foxell, socially responsible investment officer at Cambridge University Students' Union, said increased ethical awareness is based on the fact that universities "are aware that students will be potential donors a few years down the line".
There were protests on several campuses on February as part of a national day of action to press universities to invest ethically.