A matter of principles
UCA Funds management chief executive Graeme Rough examines the evolution of ethical investment into its contemporary guise
While there is a long tradition of ethical investing dating back many centuries, it could be argued that modern-day ethical investing started to come into its own during the 1980s. The catalyst for its growth is widely seen as community and investors’ concerns regarding questionable corporate behaviour at one level and concerns regarding abuses of human rights at a higher, trans-national level.
Gradually, throughout the 1980s and 1990s, ethical investing grew in its sophistication. More and more investment product offerings were developed with the aim of (mostly) excluding from their investment mandates morally objectionable activities such as weapons manufacturing.
As the ethical funds’ performance were not materially different from those of non-ethical funds (and in many cases outperformed them), the correlation between superior risk management and investment alpha was seen as a positive product differentiator. Indeed, the historical misconception of ethical investing being code for underperformance has been debunked.
Over time, ethical investing spawned other new investment models that bore a more than passing resemblance to their ethical investment forebears. New descriptors such as Socially Responsible Investment (SRI), Cause Related Investing and Sustainable Investing gradually found their way into the investment jargon.
As mentioned earlier, many see the longer term outperformance of ethical or responsible investment funds as not surprising given the attention ethical investment managers pay to corporations’ conduct and risks in relation to environmental, social and corporate governance (ESG) activities. Indeed, the often long-tail nature of investing (in growth assets in particular) suggests that today’s risk may well become tomorrow’s liability. It is this philosophy that was behind the time-honoured “stewardship” ethical investment approach of many religious organisations where one is seen merely as a custodian of assets for future generations.
The greater acceptance today of the importance of ethical research to guide future performance is reflected in the majority of Australian Industry Superannuation Funds (ISF) adopting some form of “responsible investing” framework. Ninety percent of ISF’s are now signatories to the United Nations Principles of Responsible Investment (UNPRI). This commits them to seeking greater ethical research and performance analysis from the investment managers they engage.
Similarly, Australia’s peak association for organisations and individuals working in responsible investment, Responsible Investing Association of Australasia (RIAA) has reported a consistent growth in certifications in “responsible Investment” by fund managers, financial advisers and dealer groups.
This growth in awareness notwithstanding, there is a continual need to improve the amount and depth of information available to make ethical comparisons of companies. To address this imbalance, the Commonwealth Government recently helped fund the establishment of a Responsible Investing Academy, run under the auspices of the Responsible Investing Association of Australasia.
As these initiatives develop, ethical investing information and advice will form an increasing part of investment research by researchers, advisors and fund managers as well as individual investors.
Ethical investment managers also display a genuine willingness to engage with companies about their ethical conduct. Not only might they seek to exclude companies from their portfolios based on their unethical activities, but engage companies that are reducing their unethical conduct and risk exposures. They can also engage more meaningfully with companies without having to resort to “compliance check lists” to indicate where the risks may lie.
In the current ethical investment landscape in Australia there are a number of different types of ethical funds covering different asset classes.
For example, some funds exclude activities considered by their clients as morally objectionable, such as armaments, gambling and pornography. They may not, however, be restricted to fixed criteria in selecting their investment options.
These funds tend to have developed earliest, in response to the lack of mainstream ethical investment options for their original stakeholder group. Since their inception they have broadened their investment base and are subsequently being made available to the broader investment community and individuals. Some examples of this include the endowment management and investment arms of high net worth families as well as the financial management divisions of certain industry based professions.
Other funds may apply specific ethical screening methods, which use one or more explicit criteria to exclude (or include) companies. These funds, usually a form of individually managed account, tend to have been developed as additional investment choices by major financial houses and institutions. They apply set criteria dictated by the investor, which instruct which companies are in or out of the portfolio.
Another ethical investment technique employed is the “best in sector” screening method, which is a most commonly used approach in developing a diversified fund which seeks to only include the “ethical outperformers” in each asset class or category. This method does not necessarily apply positive of negative filters to certain industries but instead seeks companies, which by dent of ESG metrics, are considered relatively more ethical than their peers. An example may be an investment in the most environmentally responsible companies in the mining sector, an industry many investors wish to avoid.
These funds can and do use the weight of their institutional investments to participate in engagement on ethical issues, often identified and promoted by the core ethical funds.
A more recent initiative has been the development of themed ethical funds, which invest according to certain “themed” criteria, such as for a positive contribution to the environment or micro-financing designed to provide capital to individual entrepreneurs in developing economies.
A large number of environmentally associated funds have emerged from investment houses over the past few years, seeking to capture the increased investor interest and topical concerns such as environmental warning and carbon emissions. While these may be represented as one component of a diversified fund, these funds are often devoted to one theme.
Self-Managed Ethical Portfolio
A self-managed ethical portfolio could include investment in any of the above types of funds. It may be difficult for individuals to find and interpret a full suite of ethical investment analytics and comparisons between companies. The advantage of a self-managed ethical portfolio is individuals can naturally set their own ethical criteria, and can be guided by the increasing disclosure and transparency that companies provide. It should be noted though that corporate ethical communication, such as those found in annual reports, are often presented in the best marketing light and can be difficult to interpret. In such instances it may be instructive for investors to apply their own proprietary-designed hyperbole filters when undertaking research.
There are a range of resources for further investigating ethical investing and should assist in providing a pathway for individual investors to find advisors or conduct further research.
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Want to know more?
Responsible Investing Association of Australasia (RIAA)
RIAA provides a list of Responsible Investment Certified Financial Advisers and Dealer Groups
Responsible Investment Academy of Australia (RIA)
RIA provides responsible investing information and education pathways.
ESG Research Australia
United Nations Principals for Responsible Investment
The United Nations Environment Programme Finance Initiative
United Nations Global Compact
The Equator Principles
Global Reporting Initiative
The Carbon Disclosure Project
Coalition for Environmentally Responsible Economics
Investor Group on Climate Change (IGCC) Australia/New Zealand
OECD Multinational enterprises guidelines and signatories