Putting the ethics into investment

Ethics and investment have not always been natural bed partners. Money has been, and continues to be, made from companies engaged in businesses some perceive as unethical. Companies that manufacture tobacco, booze and weapons. Those that employ children in developing countries or pay a pittance to workers who make shoes that sell for $200. Others that pollute the environment, expose workers to danger, or contribute to climate change.

It’s all a matter of perspective. Some investors are prepared to tolerate some degree of social irresponsibility in exchange for a good return, while an increasing number of investors will eschew those companies that operate in a sector or manner contrary to their beliefs, along with the funds that invest in them.

What’s in a name?

First there were ethical funds, most of which use negative screens for stock selection – i.e. excluded companies as dictated by an investment mandate.

There was always some difference in the degree of ethics applied; while some funds would have a blanket ban on investment in companies in specific sectors or with stated business attributes, others would take a less hard-line approach and limit exposure to such companies. A common example were resource stocks that mined uranium – some ethical funds would have no exposure, others might cap the exposure.

Next came the acronym ESG – investors increasingly consider Environmental, Social and Governance factors when selecting stocks. Investors using ESG factors generally use a positive screen to actively seek companies that have desirable ESG attributes, or which are actively working to improve in these areas. Common ESG issues are as follows:

Hot on the heels of ESG came SRI, or Socially Responsible Investment; a little more broadly defined, it could be argued that socially responsible investment embodies both ‘ethical’ and ESG investment. SRI approaches may use both negative and positive screening of sectors and companies. Rewarding good corporate citizens is an important motivation of SRI investors; after all, there generally needs to be a financial motivation for businesses to operate in a socially responsible manner.

Socially responsible investment goes mainstream

The Responsible Investment Association Australasia (RIAA) is the peak industry body for ethical investment and represents responsible investors across Australia and New Zealand. Its 170+ members, which include super funds, investment managers and asset consultants, manage more than $1 trillion assets under management – that’s nearly the size of Australia’s super pool.

The adoption of socially responsible and ESG metrics into company analysis by mainstream fund managers has grown over the past decade. Fund manager activism is on the rise. Increasingly, fund managers see the integration of these metrics as a source of alpha, or above benchmark return, to their investors.

And it’s paying off: Australian Ethical (AE) reported a 34% increase in the number of members in its super fund at 30 June 2017. AE invests in ‘good investments in areas such as clean energy, health care, sustainable products, recycling and innovative technology’, among others. AE avoids companies involved in coal, coal seam mining, native forest logging, weapons, harmful products or human rights abuses – to name just a few.

This is a global trend – the United Nations Principles for Responsible Investing (UNPRI), launched in 2006, reflect the view that ESG issues can affect the performance of investment portfolios and believes investment managers must give ESG factors appropriate consideration if they are to fulfil their fiduciary duty.

Signatories are divided into three categories:

 

Number globally

Number Australia

Asset owners

359

35

Investment managers

1,224

83

Service providers

230

12

Source: www.unpri.org at 28 September 2017

Does ethical mean lower returns?

The perception of lower returns has somewhat dampened the growth of this sector; however, the trend seems to have reversed. Companies that are seen to do the wrong thing often (but not always) experience some degree of backlash by investors and, of course, the media.

A governance issue fresh in the collective Australian mind is CBA’s recent alleged failure to comply with its AML/CTF obligations – on more than 53,000 occasions! Although it has clawed its way back to the number one Australian company (by market cap) it did slip a rung; on 1 August 2017, its share price was $84.54. Just over a month later, it had tumbled over $10 to $73.24 (8 September). If each individual breach is treated separately, the ensuing fines could further impact the bank’s share price and even the raison d'être for many investors, its dividend. The scandal has prompted changes at board level and will see CEO Ian Narev depart a little earlier than planned.

The RIAA’s Responsible Investment Benchmark Report 2017 published this analysis that shows over the medium to longer term, SRI funds tend to outperform their mainstream counterparts. Of course, each may vary enormously and as with any investment, it’s incumbent on you to do some research!

graph.pngSource: RIAA Responsible Investment Benchmark Report 2017 (Australia)

Past performance is not a reliable indicator of future returns

 

Impact investing and other new trends

Aside from picking your own stocks or an ethical fund, there are other ways to invest and appease your social conscience:

  1. Given the proliferation of Exchange Traded Funds, a sustainably focused ETF is a no brainer. BetaShares launched its Global Sustainable Leaders ETF (ETHI) in January this year; it provides exposure to 100 large global stocks (ex -Australia) that are climate change leaders, and which are not materially engaged in activities deemed inconsistent with responsible investment considerations. According to BetaShares, ETHI is resonating particularly well with millennials.
  1. Green bonds are those created to fund projects with a positive environmental or climate benefit. Several banks have arranged green bonds in the Australian market, and Australian corporates have launched green bonds into the European and US markets. Demand has been strong, driven by investment managers with mandates supporting clean investment. According to Bloomberg, issuance of green bonds is set to reach a record breaking US$134.9 billion by the end of 2017.
  1. Impact investing tends to focus on a single asset class, or sometimes, a single asset. It might support agriculture engaging clean and green practices, affordable housing, renewable energy or a community project. There are few domestic examples, although DomaCom is supporting several – including the clean energy development Biohub– using its fractional investment platform. Several smaller projects have got off the ground via peer to peer lending and crowd funding.
  1. Balance Impact aims to take ethical investing mainstream. Through its online portal, investors can create a personalised ethical investment portfolio, tailored to their risk profile and financial objectives. It offers ethical model portfolios and managed account service, and utilises a mix of ethical ETFs and managed funds.

It’s likely that a year from now, a blog on this topic will contain a plethora of emerging trends in socially responsible investments. Once again, fintech has blown open the door to innovative fund-raising approaches and opportunities. Raising money from like-minded, environmentally and socially aware folk to invest in a range of socially responsible projects will become simpler and common place – and the good corporate citizens will reap the rewards.


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