Paul Smith: ethical investment performs better than people think

By Tina Perinotto

25 July 2013 — According to one of the toughest ethical investors on the block, property isn’t too bad a place to put your money, especially offices. Australian Ethical Investment holds shares through managed funds in Investa, Lend Lease and Charter Hall.  A few others still have “hoops to jump through”. And dispelling just one of the myths: ethical funds tend to outperform the rest of the market. Why? The investors have to be the “smartest people in the room”, says AE’s Paul Smith. Tina Perinotto reports.

The power of money to change things is immense and most people have this power either directly, or indirectly through their superannuation funds.

Imagine you’re on the way home on the bus, and you’ve just read an article on some disgusting environmental vandalism or worsening arctic ice melt.

You feel queasy in the stomach as you think about what your kids’ lives will be like. You pull out your iPhone, switch on the “super” app and tap all of your retirement savings out of that offending managed fund and switch it into the one that’s 90 out of 100 on the ethical/responsible scale.

You check its performance and realise it’s been making more than all the other “dirty” unfiltered funds anyway, and feel a bit silly for not doing this financial housekeeping earlier.

You breathe deeply, give a little smile to the kid in the stroller, jammed up with her mum, against the night-time commuters.

According to Australian Ethical Investment, such a future is not that away. In fact, it’s just at the next bus stop, in metaphorical terms.

AE thinks it could well be possible to develop such an app to give retail investors a clear indication of how managed and super funds perform on the scale of saving the planet and being ethical about how they go about it.

This app could run hand in glove with new laws to come in next year from the Australian Securities and Investments Commission that require greater disclosure from wholesale investors about exactly which companies they are invested in.

But why has it taken until now for the people supplying the money to super funds and managed funds to know where their money is going?

The fund managers are taking generous fees for “looking after our money” and the advisers and other consultants attached to self-managed super funds do the same. And yet we’re not sure what they do with the money.

According to AE’s Paul Smith, general manager, strategy and communications, there is broad information available about categories of investment but it’s tailored to the wholesale fund managers and institutional investors – the so-called professionals.

Some of the fund managers are “rather vague about it [ESG integration] because they don’t want people to know the difference between environmental, social and corporate governance, and ethical investment,” Smith says.

Mmm, conveniently so, you might think.

For instance, ESG might sound good and Smith says there has been rapid take up of ESG integration into reporting in Australia, but the reasons are more to do with risk management than any higher order of ethics.

Of course, climate change and even sustainability have a serious financial risk implications. The Productivity Commission knows this and made that link clear earlier this year with its report, Barriers to Effective Climate Change Adaptation, which was covered in The Fifth Estate.

The report looked at the potentially serious implications of climate change on businesses and the economy as a whole, and urged resilience planning as an economic strategy.

See our story The Productivity Commission warns on climate change

According to Smith, an ESG fund might invest in a coal company because the company is trying to reduce its environmental impact, but an ethical company would invest in renewable energy.

So how do you find out whether the ESG fund is also ethical? Often the only way is to Google articles and do the research yourself, Smith says.

What do you sacrifice for your ethics?

But even with all the disclosure you could want, the questions are still highly complex. For instance, do you stop investing in Bangladesh or India, or stop buying clothes produced there because of poor work practices and unsafe buildings? What if thousands of people have no job and go hungry as a result?

Australian Ethical and corporate ESG analyst CAER recently asked the same question in relation to China, because of its poor human rights record and environmental standards.

According to the report avoiding China altogether could be a mistake.

Investors could be missing out on both a financial opportunity and the chance to support a country that is lifting its game in these areas of concern.

Avoidance could be an “overly simplistic” approach, the report said.

“The research shows that investors need to deeply analyse the available data, which reveals that many Chinese companies are ticking all of the ethical investor boxes,” the report said.

AE international equities portfolio manager Nathan Lim said you need a nuanced approach.

“As our supply-chains continue to globalise, investing in China is becoming less an issue of avoidance and more an opportunity”.

One opportunity for Australian companies could be to find ways to work with China to improve environmental, social and sustainability standards.

For instance, just one result of China’s growing middle class is an explosion of electric bikes, currently estimated at about 130 million.

Sometimes the equation is even more complex.

So what would AE invest in?

As for AE, “We don’t have any mining companies however we have looked at a few.” This is because not all mining is for materials that are bad for the environment. “But those that are mining for good things, such as some rare earths, are in The Congo and they’re not behaving themselves.”

So why do they perform better?

In many ways ethical investors have to be the “smartest people in the room because they have to dig deeper.”

Here’s one case: Tomra Group, based in Norway is, or was, a really cool company working in interesting areas of sustainability, Smith says. It still does things like makes machines people can pop their used bottles into to receive some money.

“It also produces sorting machines for recycling and has a process that uses water instead of chemicals to clean the skins of potatoes (yes that’s right, our potato chips are cleaned by chemicals).

“So it’s a really, really good company,” said Smith.

But last year Tomra bought a Belgian company that makes machines for sorting tobacco leaves.

AE asked if it was going to continue with the machines for tobacco or whether they would be used for other purposes. The answer: tobacco.

AE contacted other global investors in Tomra and none of them seemed to know what was going on.

“It shows the details that ethical investors go into.”

But whether you extract yourself from this company or not is all about your tolerance level.

For instance, what about buying clothes from companies that use sweat shops in Bangladesh. Or child labour in Africa. Take the work away and those people might starve.

Some people have zero tolerance regardless of the consequences. “Some are willing to sacrifice a few people and a few animals for the greater good.”

“People who want to invest ethically need to compare what they are willing to give up.”

Is there an alternative?

Nearly always there is a better way, Smith says. Such as supporting community grants, empowerment and micro finance for enterprises that can change the way things are.

AE invests 10 per cent of its profits  into such efforts. But it’s not always possible to do so or to do it sufficiently well to stop someone going hungry or worse.

Smith says the decision “comes down to how authentic is the behaviour?”

It’s why initiatives or movements such as conscious capitalism are positive things.

You might not want to invest in a company that does well in some selected sphere but also makes weapons and nuclear power plants.

But then not all weapons are bad if they are to be used for responsible defence.

“That’s why we allow ourselves to invest in government bonds [because it’s likely our government will use weapons for defence rather than aggression].

What about other corporates.

The banks are interesting. ANZ still invests in a lot of coal. And so does the Commonwealth Bank, Smith says, so AE does not invest in those shares.

Best performer on sustainability is Westpac and AE invests in Westpac because of its record.

“They do still lend to coal but they have the lowest level [one per cent or so to coal and resources]. But the way we judge them is they have the highest proportion of positive lending to businesses and they lend to positive businesses.

So why keep the lowly one per cent?

“Can you imagine the uproar if they pulled back from mining? All those job losses, would be the cry.”

The other good news is that the property sector isn’t too bad a place to be, according to AE, especially offices.

“We tend to think of the office sector as ethically benign,” Smith says.

AE has commitment in Investa, Lend Lease and Charter Hall – “mostly office funds”, he says.

A few property companies still need to “jump through some hoops, but we see city office space as a broad positive”.

But AE actively excludes retail and manufacturing property.

“We take a view that with most manufacturing it’s hard to know what is manufactured there.

“We’re fairly strict.”

In previous times even offices were excluded unless AE knew who the tenant was and approved of them.

In retail, the highest green property rating will not hold sway. “It’s a case of what the retail is being used for. Our view is that if it’s unsustainable consumption it’s not good. We’re still pretty strict.”

So GPT is out then. However other ethical funds are fine with green-rated retail property.

Size of fund

AE is one of the smallest funds around. Its total size is $700 million, but it’s growing fast – 15 per cent on last year, when it was $600 million and 10 per cent growth in investors.

Some would-be investors whose super is award-linked, such as teachers, would like to invest in AE (teachers are more highly motivated by ethical investments, Smith says) but are precluded by strict control of the funds they can chose.

However a recent softening of restrictions by the Western Australian government resulted in a recent influx of new members, Smith says.

One attraction was the 25 per cent return last year shown by one small company’s fund (And yes, any retail investor can get a slice of that action).

A rule change to enable more choice will be one element to open the gates to growth in the ethical sector. Others are disclosure and ethical performance indicators.

Right now a small mountain of paper work precludes people from easily switching their super funds.

But the technology is moving along nicely and soon we could have well encrypted protection for our savings, better disclosure and performance indicators that will finally put the unethical, unsocial and unsustainable investment funds on full alert.

And won’t that be fun?

The Responsible Investment Association

One good source of information is The Responsible Investment Association.

A look at the investment managers certified under the RIA’s Responsible Investment Certification Program reveals a small handful.

In the retail area there is:

  • Australian Ethical Investment (Also in wholesale)
  • Cromwell Property Group
  • Hunter Hall Investment Management

In the retail and wholesale are there is:

  • AMP Capital Investors
  • BT Investment Management
  • Dalton Nicol Reid
  • Foresters Community Finance
  • Investa Funds Management
  • Perennial Growth Management
  • Perpetual Investments
  • UCA Funds Management

In the wholesale only area there is:

  • Ausbil Dexia Ltd

Here is some data on the ethical investment landscape:

Funds under management

As at 31 December 2012, funds under management in responsible investment portfolios in Australia totalled $152 billion or 16 per cent of total assets under management – including all ethical and socially responsible funds, as well as the funds managed under ESG integration that are rated as above average (In 2011 it was 13 per cent of total assets under management).

Returns
Core responsible investment funds are delivering better returns than both the benchmark and the average of all mainstream funds in all but one category across time periods (1, 3, 5 and 10 years) in three major investment categories – Australian equities, international equities and multi-sector growth funds.

Five-year returns post-GFC has been stronger in all responsible fund categories compared with the benchmark and average mainstream funds.

ESG integration in Australia has proven to be the dominant method of responsible investment, representing 89 per cent of the overall market total ($135 billion) having experienced 33 per cent growth between 2011 and 2012.

Ethical and socially responsible investment funds grew only a modest 4.2 per cent during 2012 from $14.6 billion to $15.2 billion despite some of the strongest performance of funds in many years, typified by the best performing Australian equities fund in 2012 being an ethical fund.

New Zealand is also a very strong responsible investment story this year, with funds in New Zealand managed responsibly totalling NZ$22.6 billion, a growth of 17 per cent – a massive 38 per cent of total assets under management across the country.