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Six different approaches to ethical investing

In Business and Environment, Ethical Investing and Social Enterprise by LivingNowLeave a Comment

The use of money …to gain all you can, save all you can, then give all you can, but not at the expense of life, nor in any sinful trade and without hurting your neighbour…(John Wesley, 1760, the founder of the Methodist Church. Source UCA Funds Management 2006 annual report, page 9)

Concerns about the environment, the impact of climate change, and corporate malfeasance have put a spotlight on ethical investing. This article outlines the origins of and approaches towards ethical investing, defines ‘ethical’ in the context of the challenges humanity currently face in the 21st century, and then explores some of the features and idiosyncrasies of the ethical investment industry.

Ethical investing has its genesis with religious based organisations such as the Quakers in America who wanted to avoid investing in the ‘sin’ industries such as tobacco, alcohol, gambling and defence, which were in conflict with their member’s personal values and beliefs.

By eliminating certain industries from their pool of potential investments, these religious based investment funds were applying what is now commonly referred to as ‘negative’ screens. Negative screens typically screen out around 5% – 10% of all the possible investments in publicly listed companies.

In the last couple of decades ethical investing has become more sophisticated, and there is a diverse range of ethical investment products (offered by investment funds) in the market. Besides applying negative screens, some ethical funds now apply ‘positive’ screens. Positive screens are designed to identify the type of companies the ethical fund wants to invest in. Examples of positive screens might include companies involved in either renewable energy or public transport.

When an investment fund applies both negative and positive screens to its investment process, it could be screening out as much as 60 – 80% of all possible investments in publicly listed companies (and this is before financial screens are applied) . So it is a much more stringent criterion and leaves the investment fund with fewer potential investments.

Investment funds use different approaches to ethical investing.

Some of these are:

Pale green – Pale green fund managers normally only apply negative screens (i.e., financial screens are used to screen out any company that is financially ‘weak’) in their investment screening process. By applying negative screens, these funds will probably only screen out around 5% to 10% of all possible investments. This will allow them to invest in approximately 90% to 95% of all available listed companies on the market. Because a ‘pale green’ fund is only screening out a small portion of investment options, it still retains a large pool of potential investment alternatives.

Best of sector – Best of sector funds choose the most ethical company within a sector to invest in. For example, a ‘best of sector’ fund will invest in the most ethical bank, mining company, building materials company, insurance company, publishing company and so forth. ‘Best of sector’ funds will have an exposure to every sector in the market, even the mining and financial sectors, two of the largest sectors in the Australian stock market. By having an exposure to every sector in the market, these funds investment returns should move more or less in line with the overall market. For example, the Australian mining sector has been booming for the last couple of years due to high commodity prices. ‘Best of sector’ funds should have benefited by having some exposure to the mining sector. Whereas other types of ethical funds, which might exclude mining companies from their portfolios, may not have benefited directly from the boom in the mining sector.

Sustainable – Some funds are focused on the environment exclusively and invest in companies that are working to improve the environment and tackle climate change. These funds would probably invest in companies involved in renewable energy, and plantation timber.

Deep green – Deep green fund managers invest in the most ethical publicly listed companies. A Deep green fund would normally apply both negative and positive screens to its investment screening process. Deep green fund managers would typically be invested in companies involved in renewable energy, waste management, recycling, organic / natural foods, and public transport, etc.

Industry specific – Industry specific funds are funds that will invest in just one sector, for example the ‘water’ sector or the ‘renewable energy’ sector.

Shareholder activism – These funds invest in companies that are doing ‘bad’ things and then engage with management in an effort to change the company’s specific business practices. An example of this in Australia would be where an ethical fund invests in Gunns’ Ltd of Tasmania. Gunns’ is involved in the logging industry and an ethical fund might invest in the company so it can pass resolutions at shareholder meetings seeking to ban its logging of old growth forests.

Investing for the long haul

In the equity investment industry there tends to be a lot of focus on short run returns. But consider the following:

A. When a business decides to invest in a new plant, its investment horizon is normally at least seven to ten years. This includes the time required to identify and purchase suitable land for a factory; to commission a plant; to obtain various licenses and approvals from state and local governments; to hire and train a work force; and finally to start production. All of the foregoing is a very lengthy process indeed, and not something that can be achieved in one or two years. So when companies make investment decisions they are normally investing for the long run.

B. Today with compulsory superannuation in Australia, a great many people are investing for at least 50 years. For example, a person who begins to contribute money into a superannuation plan at age 25 and works until he/she is 55 years old, then lives in retirement until he/she is (say) 75 years old. In the future, some people will be managing super money into their 80’s, and perhaps into their 90’s.

If companies are investing for the long run, and investors have at least a 50-year investment time horizon, then investors should be focused on long run rates of return, when comparing the returns from different investment products and when making investment decisions.

For comprehensive tables to illustrate this point and to compare other interesting data, including rates of return by country and the real rate of return from 1900 to 2005 for USA, Australia and Germany, please go to www.livingnow.com.au.

Alphabetical listing of the major ethical fund managers in Australia

Fund
Inception
Years
Approx FuM*
AMP Alpha Fund 2001 7 $1.3 bill
Ausbil Dexia Ltd 2002 6 $80M
Australian Ethical Investment Ltd (5 trusts) 1989 19 640M
Christian Super 1984 24 475M
Hunter Hall Trusts (3 trusts) 1994 14 2 bill
Perpetual Wholesale Ethical SRI 2002 6 225M
SAM Sustainability Fund 2001 7 400M
Smallco Investment Fund 2000 8 220M
Suncorp Invest. Management (ethical trust) 2004 4 80M
Uniting Church Australia 1977 30 600M
Warakirri Charitable Australian Trusts 1993 15 400M
Westpac Australian Sustainable Share 2001 7 100M
* Funds under management
Source – “ Ethical Investor” July 2007 edition page 47 and Ethical Investment Association (EIA) website.

Useful sources of information

Ethical Investment Association (EIA) – this is a peak body for Australian ethical investors and fund managers. Its website has lots of interesting and useful information, including links to all the major ethical fund managers. Go to www.eia.org.au

 

Michael O’Brien holds a B. Comm (Hons) from the University of Melbourne and an MBA from Columbia University, New York. He has worked in the finance industry for 15 years, including 7 years in the ethical investment industry. Michael runs ethical investment seminars.

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