Key points
- More people are investing in ways that factor in environmental, social and governance factors.
- Core responsible Australian equities investment funds outperformed the ASX 300 index and the large-cap Australian equity fund average over 1, 3, 5 and 10 years.
- When looking for an ESG fund, focus on those that have established records.
The Australian National University’s decision this month to sell its fossil-fuel investments sparked an outcry. Although tiny, the $16 million divestment elevated the stakes in ethical investing and brought environmental considerations in investment decisions to the fore.
The move also raises questions about whether a stringent approach to responsible investing sacrifices long-term returns – a critical issue for a growing number of retail investors who want to invest with their conscience, rather than only their wallet.
Responsible investment is an umbrella term to describe an investment process that factors in environmental, social, governance (ESG) or ethical considerations into decisions. Ethical investment funds are a subset of this evolving investment category.
Interest in core responsible investing is rising. Assets under management in ethical, socially responsible, community finance and sustainability-themed companies grew 51% to more than $25 billion in the year to December, 2013, according to the 2014 Responsible Investment Benchmark Report from the Responsible Investment Association Australasia (RIAA).
Growth in responsible investing is being driven by superannuation funds. They are focusing more on ESG factors in investment decisions, which in turn is forcing fund managers to consider ESG in company assessment and valuations, and forcing investment banks to produce detailed ESG assessments in their broking research.
Long-term outperformance
Core responsible Australian equities investment funds outperformed the ASX 300 index and the large-cap Australian equity fund average over 1, 3, 5 and 10 years, RIAA found. It said: “Core responsible investments outperforming the average fund returns in all categories over 5 and 10 years is a further demonstration of the sustainability of responsible investments, both in their returns and also the impact they deliver.”
Care is needed with these results. Core responsible investing covers a reasonably broad group of funds. It includes those that screen investments, focus on sustainability-themed investing, impact/community investing, and corporate engagement and shareholder actions. Nevertheless, this “category” provides useful insight for investors who want to invest in responsible companies, without excluding too much of the investment universe.
As an aside, a strict ethical-investing approach that excluded banks (that lend to fossil fuel companies) and resource companies, would wipe out about 60% of the S&P/ASX 200 index. Add to that Woolworths and Wesfarmers, which own poker machines through their hotel investments, and not much of the index is left, by market capitalisation.
Three steps to invest ethically
First, decide on the level of “responsible investing” and trade-offs you are prepared to accept. Investors who want to own companies that have good ESG credentials should focus on broad responsible investment funds. Those who seek more detailed ESG screening should focus on the smaller group of core responsible investment funds. Specialist ethical funds are a good option for investors with a narrower definition.
Second, choose a managed fund rather than build a portfolio of direct investments. The two main advantages of funds – diversification and professional managers – are vital in responsible investing. Such funds screen companies for their ESG credentials and give investors exposure to a basket of stocks that fit the bill. This is especially valuable in ethical managed funds.
Investing directly in small-cap companies that have excellent environmental credentials can be hazardous. The Australian CleanTech Index, which measures 65 clean-technology companies, returned minus 19.5% over three years to July 2014.
The CleanTech index outperformed the S&P/ASX200 index and Small Ordinaries index in FY14. But its long-term performance is a reminder of the dangers in investing in speculative emerging-technology companies, and why a basket investment approach to spread risk is important.
Finally, choose investment funds that have an established record – preferably more than five years – and a long-term commitment to socially responsible investing. Understand their definition of responsible investing, for it can vary across funds, and assess management expertise, fees, long-term performance and the investment strategy, as you would any fund.
Funds that fit the bill
The Switzer Super Report analysed 47 socially responsible funds Morningstar covers. Most are small: the median funds under management was only $39 million. But a few funds stood out.
The Perpetual Wholesale Ethical SRI was the largest fund with $795 million in net assets. It had the best performance over 10 years to September 30, 2014, with an almost 13% annualised gain. Other Perpetual SRI funds performed well over five years.
The Australian Ethical Smaller Companies fund also warrants consideration. It had $274 million in net assets and an annualised 10-year return of almost 10%.
The AMP Capital Sustainable Share Fund and the BT Wholesale Australian Sustainable Share Fun returned almost 8% annually over 10 years.
Double-digit returns that are broadly in line with the Australian sharemarket’s return over 10 years show that ethical investing need not sacrifice investment performance.
Australian shares returned 9.2% annually (on a before tax, after-fees basis) over 10 years, according to the 2014 Long-Term Investing Report from the Australian Securities Exchange and Russell Investments.
Consistent long-term outperformance by funds with a narrow ethical investing mandate is harder to find, given a smaller investment universe in Australia compared with US and European exchanges.
But achieving a similar return to the market, by investing only in responsible companies, will appeal to those who want to invest with their conscience and wallet.
– Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at October 29, 2014.
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.
