With care, ethical investing can produce a bonus return, Penny Pryor writes.
Ethical investing used to be all about the "no" or what you couldn't invest in because it was bad for your health, the environment or had poor human rights practices. But during the past decade, and particularly since the global financial crisis, there has been a big shift in socially responsible investing, and now there is more emphasis on the positive impact of an investment.
You could, for example, invest in a company that has a good effect on the environment because of the products - such as solar panels - that it manufactures. You could also chose to invest in a social impact fund, or a social benefit bond, both products that use public funds to invest in programs that benefit society. Returns are based on how successful the programs are, for example, at preventing recidivism or restoring children previously in foster care.
Negative screening is still relevant, but it has become more of a macro practice, like the recent run of larger superannuation funds dropping tobacco companies from their investment holdings (see breakout). There are also niche investment opportunities, such as the equities fund-of-fund Third Link.
The good news is that as more investors and superannuates become engaged in what they invest in, and the potential impact that could have, there are more products available to them
Australian Ethical Investment was one of the first purely ethical fund managers, established in 1986. It's ridden all the ups and downs in this category, most recently the fall in favour of ethical investment during the global financial crisis.
Funds under management have grown from $100 million in 2000 to $750 million today.
General manager strategy and communications, Paul Smith, is encouraged by the range and breadth of product coming onto the ethical investment stage and changes in approach. "Certainly ethical investing was always about the negative screening and that still makes up the predominant [type]," he says.
"But one thing I think you're seeing a move towards is positive screening." This includes companies that have a positive influence on society, which may, or may not be, intentional, such as healthcare.
The Responsible Investment Association of Australia (RIAA) was set up as the Ethical Investment Association in 1999. Simon O'Connor is chief executive of RIAA. "I guess the really pleasing story, from the consumer sense of things, is there is more and more product out there," he says. Much is equity investments, as offered by Australian Ethical Investment, but options extend to fixed income, private equity and cash (also offered by Australian Ethical).
"It's responding to the really diverse set of values and interests of the retail investment market," O'Connor says. Funds under management in responsible investment in Australia (including all ethical and socially responsible funds, as well as the funds managed under ESG Integration that are rated as above average) rose by 30 per cent in 2012 to $152 billion or 16 per cent of total assets under management. The majority of that amount, or 89 per cent, was managed in ESG Integration, which was also up by
33 per cent over the year.
Australian ethical equity funds returned 21.45 per cent in 2012 on average (see breakout), while the Large Cap Australian Share fund average return was
18.14 per cent and the ASX 300 Accumulation Index returned
19.74 per cent.
The impact investment
In addition to corporate activism, where investors try to influence companies by voting against board proposals or remuneration plans, the emerging area of impact investing is becoming more popular.
The reason you may not have heard much about it, is not because there is no demand for investment in programs that make a social difference, merely that it is so new that supply is an issue.
This year the first social benefit bond was launched in Australia. This is a bond that receives government funding in order to support a program that meets a social need that also has the potential to save the government money. Three community programs were chosen by the NSW government to pilot these bonds.
For example, the UnitingCare Burnside Newpin Bond funds a program aimed at restoring children in foster care to their families. The NSW government pays the program an agreed amount, dependent on that program achieving performance targets. It also has external investors.
UnitingCare Burnside worked with Social Ventures Australia (SVA) in developing the investment.
If children are restored safely to their family the NSW government can save the approximately $37,000 it costs to raise a child in foster care a year, along with indirect savings. There were 17,200 children in out-of-home care in NSW as at June last year.
The social benefit bond has a high forecast return of 10 to 12 per cent annually to compensate for the risk in taking on an untested investment. SVA executive director, impact investing, Ian Learmonth, says the growth in this space is evidenced by the growth in his department, which after an initial appointment of just himself two years ago, now numbers five.
SVA also runs the social impact fund. This fund was promised $4 million from the Australian Government if that amount could be matched by private investments. It now has $8.65 million in funds under management and investments by the fund have been made in ventures such as low-cost health care centres and employment agencies for people with disabilities.
Paul Bide (see case study at left) has invested in both these investments and Learmonth reports there is a fair mix of investors across these kind of products, ranging from small investors with minimum investments of just $50,000 to larger institutional investors with millions of dollars to invest.
Australian Ethical has also just invested in a social benefit bond in its balanced fund, where it is part of its fixed income asset allocation. Currently investors need to be wholesale as defined by the Corporations Act i.e. annual income of $250,000 over the previous two years or "net assets" in excess of $2.5 million, but Learmonth says they are working on an option that would be available to retail investors.
In addition to the traditional and the expanding social impact space, there are other niche opportunities available to the investor wanting to make money and contribute to the greater good. Third Link Growth Fund is an Australian equities fund-of-fund that donates all service fees to charity. That means all fund managers, custodians, and administration platforms, donate the fees they would normally charge, which are distributed to a number of not-for-profit organisations.
Chris Cuffe is the founder and portfolio manager of the fund and is well aware that it is something that only he could probably do. Not only because of the unique approach to investing, but also because it needed to be run by somebody who had a profile.
Cuffe became famous, or infamous, for receiving a large payment when he left Colonial First State in January 2003. "I hated [the profile] for years. It took me a lot of years to recover from the bashing in 2003. I sort of reached a point where I realised I can't change what happened. I thought I'll use my profile for the good," Cuffe says.
"A lot of doors were opened for me all over the place." And he says, he's never been refused when he has made a request to a service provider to be part of Third Link.
The fund was established in 2008 and just reached $2 million in total donations and $60 million in total funds under management.
The performance is better than reasonable too, thanks to Cuffe's avoidance of benchmark huggers in his approach to manager selection. For the five years to the end September the fund returned
10.4 per cent a year, which was
3.6 percentage points above the index.
Watch John Collett and Penny Pryor discuss changes in ethical investing at theage.com.au/money
Community investment a no-brainer
Paul Bide is ex Macquarie. He left the investment bank in late 2009, after 25 years in financial markets, wanting to put some of his business and finance expertise to philanthropic use. He is an investor in the Newpin Social Benefit Bond and the SVA Social Impact Fund.
"I do not see social impact investing being inherently more risky than investments made purely for financial gain," he says.
"In fact, given the social benefits built into socially impacting investments, all other things equal, I think social impact investing is a better risk-reward trade-off, because it invests in the community we all live and hopefully prosper in."
Regardless of the jargon, which can be confusing, all investments are successful, or not, because of the underlying activity and structure funded by the investment. "Social finance or impact investing is not the same as philanthropic investing or donating. The motivation for a social impact investment is both social and commercial. It's up to investors how they want to balance those motivations - but a rational investor starts out expecting a positive return in both."
This kind of investment is important to Bide because he believes social enterprises provide a healthy addition to the way social services can be delivered to the community.
"There are people out there in the social space that aren't being funded and that's a shame." Bide doesn't see impact investing as a replacement for funds that offer a traditional ethical investment product.
"[It's] just another type of investment product for investors targeting a social or ethical return in addition to a financial return. It is in the class of investments that allow investors to choose investments on the basis of their values. It is good to have that choice out there."
Super funds stub out tobacco firms
Last year the $36 billion First State Super was one of the first major superannuation funds to drop tobacco investments from its portfolios, partly prompted by the urging of doctor members, after Health Super merged with the fund. But First State Super members had been pushing for the divestment as well.
The $89 billion Future Fund followed in February. Its tobacco investments were estimated to total $222 million. Other funds to dump tobacco companies include HESTA, SunSuper, Christian Super, UniSuper, Local Government Super and the construction and building industry super fund, Cbus. Announcing its decision in early September, Cbus said it believed there was no safe level of use of tobacco products.
"Cbus is of the view that the current targeting by tobacco companies of young people in developing countries is not a sustainable business model and opens Cbus to investment and reputation risk," the release said.
The second reason was the health impact of tobacco products on members, with 6.6 per cent of life insurance claims from Cbus a result of lung cancer. Echoing the sentiment of many funds which have dumped tobacco producers, Cbus' environmental, social and governance investment manager, Louise Davidson, said although it was unusual for the fund to drop investments in a particular sector, as its preference was to influence companies, the decision was made because corporate activism would not work with tobacco. Producing the harmful product was the companies' entire reason for being and it would therefore be impossible to persuade them to stop.