The decision last week by AMP Capital, Australia’s second largest fund manager with $130bn under management, to dump nearly $600 million worth of investments in big tobacco, cluster munitions and landmines after overhauling its ethical guidelines, has reignited the debate about ethical investing. Can you invest “responsibly” and be rewarded, or at least, not be penalised for choosing investments that meet various ethical criteria?
Well, according to the Responsible Investment Association of Australia, you can. In fact, they argue that core responsible investment funds have outperformed large cap Australian share funds over most time periods.
As ethical questions are by nature open to interpretation, this article looks at how the industry is defining “responsible investing”, the performance of core responsible funds, and some investment options, either through managed funds or exchange traded funds.
Responsible investing
Responsible investment is an umbrella term used to describe an investment process that factors in environmental, social, governance (ESG) or ethical considerations into decisions.
As of 31 December 2015, responsible investment made up $633.2 billion assets under management, which is around 47% of all professionally held assets in Australia.
Core responsible investment is a subset of this broader category, and applies at least one of these responsible investment strategies:
- Screening of investments – negative, positive or norms-based;
- Sustainability themed investments;
- Impact or community investment; or
- Corporate advocacy and shareholder action.
Core responsible funds had $51.5bn in funds at 31 December 2015, a 62% increase on the year before.
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The two largest categories of core responsible investing in Australia are sustainability themed and screening. Sustainability themed funds invest in assets that specifically relate to sustainability themes, such as clean energy, green technology, sustainable agriculture and forestry, green property or water technology. This area is growing rapidly.
The second category is screening. Screening can be negative, for example, exclude companies involved in alcohol, tobacco, weapons, pornography, gambling, etc.; positive, where companies are assessed against their industry peers on ESG grounds and only those with superior ESG performance are selected; or norms-based, where companies must meet minimum standards of business practice which are usually defined by the United Nations.
Performance
As the table below shows, according to the Responsible Investment Association of Australia, core responsible investment Australian equities funds outperformed both the ASX 300 and the average large cap Australian equities fund across the one-, three-, five- and 10-year periods to 31 December 2015.
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While these figures are prima facie pretty impressive, a little bit of care is needed with these results, as it is not clear whether the core responsible funds are applying screening and the degree of screening, or a sustainability theme (and which one).
Further, a strict ethical investing approach might want to exclude companies involved in gambling (which might wipe out Woolworths and Wesfarmers because of their ownership of hotels and poker machines), the mining or production of fossil fuels and those companies that lend to fossil fuel companies, such as our major banks. This would exclude almost 60% of the S&P/ASX 200 index by market capitalisation.
Some funds to consider
The largest asset managers of core responsible investments are shown in the table below.
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Looking at some of the specific funds, Australian Ethical stands out for its name, but also because it boasts an impressive performance record. Its flagship Australian Shares Fund aims to provide long-term growth by focusing on Australian companies that meet The Australian Ethical Charter, a charter developed by it. This charter addresses environmental and social considerations, and has both positive and negative screeners. Typically, the companies are smaller, and stocks are selected for growth rather than income.
The management fee for the retail fund is high at 2.5% p.a., but investors accessing the wholesale fund via a platform or through mFunds will only pay 0.95% pa (minimum $25,000 for the wholesale fund).
Australian Ethical Aust Shares -returns to 28 February, 2017
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Hunter Hall applies an ethical investment policy to all the funds it manages. The Hunter Hall Australian Value Trust (AVT) is invested in an ethically screened portfolio of domestic small cap companies.
It applies a negative screening process that excludes companies involved in:
- the manufacture or sale of weapons and weapons components;
- tobacco manufacture;
- gambling outlets or systems;
- intensive animal farming;
- animal testing for cosmetics;
- activities that give rise to human rights violations;
- unremediated destruction of the environment;
- uranium mining and nuclear reactors;
- fossil fuel exploration, production, refining, storage and transportation.
The management fee is 1.0%, plus a performance fee of 15% of the excess return over the Small Ordinaries index plus 1%.
Hunter Hall Australian Value Trust-returns to 28 February, 2017
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AMP Capital Sustainable Share Fund is one of the largest responsible funds at $940m. It uses an active, bottom up approach that systematically integrates environmental, social and governance factors with financial measures to gain insights into a company’s growth and risk elements.
The management fee is 1.45% for the retail (off-platform) version, or 0.98% for the platform version. The fund uses the S&P/ASX 200 as its benchmark, and performance is shown in the table below.
AMP Capital Sustainable Share Fund – returns to 28 February, 2017
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An alternative to managed funds is exchange traded funds. Unfortunately, there is not a well-developed ESG index in Australia. UBS has worked with MSCI to create the MSCI Australia ex Tobacco ex Controversial Weapons Index, and then developed an ETF to track this. The UBS IQ MSCI Australian Ethical ETF trades on the ASX under stock code UBA. The ETF is relatively new, so performance is hard to assess, but in the year to 28 February, the index returned 23.8% and the ETF 23.7% (the S&P/ASX 200 return was 22.1%).
For investors looking for exposure to global ESG leaders, Betashares has an ETF called the Betashares Global Sustainability Leaders ETF (ASX Code: ETHI). This ETF tracks the NASDAQ Future Global Sustainability Leaders, which is comprised of 100 large cap stocks from developed countries that are ‘climate leaders’ and passed certain ESG eligibility screens.
Conclusion
Although the term “feel good investing” is somewhat patronising, the evidence suggests that you can invest responsibly and enjoy sound financial returns. The obvious starting point is to work out what is important to you, and compare that very carefully to the ESG charter or sustainability theme of the particular fund. There is huge variability in the approaches taken.
And while excluding a small number of industries or companies that a fund will not invest in shouldn’t be a problem, the more exclusions that are applied, the more risk that the fund will not deliver market performance. It might turn out that it will outperform the market, or underperform the market – only time will tell – but what you can be sure of is that it won’t perform with the market.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.