Ethical investing thriving, but remains a minefield

It’s an embarrassing and messy situation, with Australia’s Westpac, ANZ and AMP among several KiwiSaver partners linked to investments in companies making antipersonnel mines, cluster bombs, nuclear reactors and other weapons via a fund run by US-based investment giant Vanguard.

The public backlash has been enormous and most of KiwiSaver’s service providers have announced they are offloading their weapons exposures.

On the surface, it would seem that ethical investing strategies by big corporations still have a long way to go. But investors committed to responsible investing practices, and committed to excluding investments in funds and companies that don’t tick all the boxes in terms of sustainability, protecting the environment and the rights of people and animals, shouldn’t be too disillusioned.

In reality, despite a few isolated incidents and inconvenient truths, the options and safeguards around ethical investing are now better than ever. As well as a wide range of specialist ethical funds providing full transparency to investors in terms of their investment methodology and company holdings, more and more Australian managed funds are offering ethical choices.

“Even if you’re agnostic about the benefits of environmental, social and corporate governance investments, the products available are very useful in getting people engaged in their investing,” says Jonathan Ramsay, director of portfolio construction and consulting company InvestSense.

The firm recently created two funds to cater to retail product providers. Its Dark Green Opportunities Fund has no direct or indirect exposure to fossil fuels, uranium, defence industries, extractive industries, gaming, alcohol or tobacco stocks. Its Light Green fund relaxes those constraints and only needs to avoid direct exposure to those sectors.

Is investing ethically a better investment option?

According to the Responsible Investing Association Australasia, more than $630 billion of funds, almost half of Australia’s total investments, are now being invested responsibly.

RIAA’s annual benchmark report, released in July, found that a significant step-up in consumer demand had resulted in billions of dollars shifting from mainstream to responsible funds.

“In observing the significant and consistent growth in responsible investment, we can say without a doubt that this isn’t just a passing trend, but an evolution of the entire sector that is now being driven strongly by consumer demand and engagement with where they invest and bank their life savings,” says chief executive Simon O’Connor.

In fact, a ­comparison of the ASX 200 against a “strong ESG portfolio” created by InvestSense shows the ethical portfolio beating the ASX 200 on a consistent basis over the last decade. O’Connor says investors who have “embraced the evolution have reaped the rewards”, with responsible investment outperforming and returning greater benefits than their mainstream peers over the last one, three, five and 10 years.

“Every year we see more Australians opening their eyes to the opportunities to invest ethically and responsibly. You can invest with confidence, aligning your money with your morals, and it’s not just a ‘well-intentioned’ philanthropic approach, it is generating great returns for savvy investors.”

Australian Ethical’s head of ethical research, Stuart Palmer, says that for investors, the “ethical dimension” needs to be focused on where a fund is investing as well as the returns.

Ramsay says one of the key factors for investors with good ethical intentions to consider is their entry price, with “quality stocks” (with dependable earnings and low leverage) and stocks that are good quality from an ESG perspective having rallied strongly in the post-GFC environment.

“Many of them do appear to be getting quite expensive. We firmly believe that in the world of investments, nothing should be done at any price,” he says.

“With ethical investing, as with all investing, care must be taken not to overpay.”

Five things the ethical investor should do

Without clear rules and regulations, investors have to make their own minds up about what constitutes ethical investing. Yet common investment principles must still be applied.

1. Define your boundaries

There are no regulated definitions about ethical investing, and an industry that may be considered unethical to some may be perfectly acceptable to others. For example, is a rail company unethical if it has a contract to transport iron ore? A sensible approach is to rule out specific industries and then consider other holdings on a case-by-case basis.

2. The screening process

Positive and negative screens are key in the ethical investing process. Positive screening involves looking for companies that are actively involved in areas or activities aimed at protecting the environment, for example, or who are focused on medical breakthroughs. Negative screens are used to filter out companies involved in harmful areas, such as mining, oil production, tobacco or old-growth forest logging.

3. Not all funds are the same

The number of funds being tagged as ethical is ballooning, but some are more ethical in their approaches than others. Transparency is key. A recent Bloomberg study found a number of so-called ethical investing funds in the US had holdings in oil and tobacco stocks.

4. Consider building your own portfolio

For self-directed investors, including self-managed super fund trustees, it’s relatively easy to build a custom ethical investments portfolio based on your ethical objectives. Diversification is key, as being exposed to only a handful of companies in certain sectors carries higher risk and the potential for lower returns.

5. Keep value investing principles in mind

Don’t overpay to follow a specific company or ethical quality objective. It’s still important from an investment perspective to focus on value — ethical stocks can be overpriced or underpriced at any time in the market.