Investing from the Heart

If you think the world of ethical investing is any less competitive, deceptive and occasionally treacherous than mainstream investing, think again.

Unfortunately, despite continuing demand from Australian investors for ethical investments, this whole sub-category of investment markets has been blighted by cynical branding, patchy reporting and '” worst of all '” a lack of agreement over just what defines “ethical” when it comes to investing.

But first the good news. After many years of debate in the Australian market, new research released earlier this month by Associate Professor John Evans from the school of banking and finance at the University of NSW has gone a long way towards answering a key question for most investors: Does investing in ethical funds or companies mean you won't make as much money as if you acted freely of ethical considerations? The answer is no.

Nor will you get any richer through ethical investing than by pursuing other investments, Evans found. The long-term effect of ethical investing is neutral.

Of course there are some qualifications to his conclusion. The research covered only five years, 1998 to 2003, which is not a long time in the realms of academic research.

Evans also based his research on the performance of 90 “global” stocks so the research is highly relevant, though not specific to the ASX. .

He says the outstanding message from the research is that ethical investing is cost-neutral, provided investors have a sensible asset allocation strategy that reflects conventional industry settings. (In Making Money, the investment book written by Alan Kohler and the Eureka Report team, a “conventional” asset allocation for long-term investors had 35% Australian shares, 25% international shares, 25% fixed interest, 10% property and 5% cash.)

As Evans explained to the Institute of Actuaries in Sydney: "Investors can use ethical filters (criteria such as excluding uranium or gambling activities) to select securities without an expected performance cost, provided they also diversify by the normal factors such as value investing versus growth investing or big-cap investing versus small-cap investing.” Evans is not the first to come to these conclusions, researchers from Maastricht University in Belgium had similar findings back in 2001.

Evans concedes there may be temporary variations. "With the dominance of the mining sector especially in recent years, Australian ethical investors may be working at a disadvantage," he told Eureka Report.

To work with cohesive and comparable material, Evans worked with the definition supplied to him by Ethibel, a European equity researcher. However, he remains concerned at variable definitions of ethical investing.

Elusive terms

Despite the failing efforts of Australian-based ethical investment funds to present a united front, the definition of “ethical” remains a problem '”the terms ethical, sustainable and socially responsible are often seen as interchangeable

Industry analysts estimate the “ethical” sector has about $8 billion under management. Among the biggest funds are the Hunter Hall Global Ethical ($319 million) AMP Capital Investors Sustainable Future Australian Shares ($250 million) and Australian Ethical Balanced. Although these funds are significant, they remain small by wider industry standards.

In overseas markets, the term “ethical investment” is coming to mean something more precisely defined. In London, the FTSE4Good index '” a subset of the Financial Times Stock Exchange (FTSE, or “Footsie”) index '” includes companies that satisfy set ethical criteria. In the US, similar progress is being made with the Dow Jones Sustainability Group indices.

One of Australia's biggest property companies, Mirvac, recently became the first Australian company to be included on the FTSE4Good index. As a member of the index Mirvac will be monitored by the Footsie regulators; if it fails to match the continuing criteria it will be dropped from the index. Mirvac has won inclusion because of its efforts to match world-best practice sustainability criteria in air-conditioning, heating, refrigeration and other environmental factors in property management.

This year the boom in uranium stocks has split what had been a fragile coalition of Australian-based ethical investment funds. Most funds linked with mainstream investors, such as the big four banks and leading insurers, have allowed uranium investments on their books. A minority, including early local leaders in the field such as the listed Australian Ethical Investments, have gone the other way and banned all uranium holdings.

The commodities boom, and the wider good fortune of the mining market, has not been good news for Australian-based ethical investments, whose concerns for the environment have made them avoid resource stocks.

As the debate surrounding uranium (the raw material for nuclear material) has intensified, the outstanding issue for any investor in ethical investing is that the word “ethical” must come first, and “investing” must come second; in other words, factors other than profitability can exert strong influence over ethical fund managers.

As James Thier, executive director of Australian Ethical Investment and a member of its investment committee, suggests: "When we review companies, first they have to meet our non-financial criteria, and once they get through that hurdle we will look at their financial performance."

Funds spectrum

In the Australian market, there is still a wide spectrum of fund managers who claim to belong inside the ethical investing camp. Portfolio Partners, one of the market's best-known institutional investors, recently launched "Australia's first long/short" ethical fund known as Portfolio Partners Sustainability Trust.

The fund received positive press coverage for becoming the only Australian fund manager (not linked with a religious organisation) to sign the United Nations Principles for Responsible Investment. But the UN agreement clearly has relatively soft inclusion criteria. Craig Bingham, the managing director of Portfolio Partners, says the Australian company has defined “sustainability” on its own terms.

"Our funds are based on common sense, good practice and we seek ethical outcomes," he says. But this explanation cuts to the heart of the problem: when it comes to ethical investing there is no benchmark, there are no international standards that everyone must satisfy. As a result, companies can virtually write their own ticket. At worst, an ethical investment fund is whatever its promoters think it should be.

The other outstanding problem is a lack of tradeable investments in popular ethical investments, such as alternative energy, organic food or health products and devices. At the very least, this lack of depth in investment alternatives skews ethical funds towards small-cap investing. For example, Australian Ethical Investment has more money in regional banks than the “big four”. Most fund managers sidestep this lack of depth by opening global funds such as Hunter Hall's new Global Ethical Trust, which actively seeks “good” investments around the world. (For a profile of Peter Hall, see The Non-Conformist).

But Thier at Australian Ethical says: "The majority of ethical funs in Australia are really just 'avoidance' funds. They will really just avoid the worst of the worst rather than trying to support the best of the best." Thier also suggests there are problems of funds achieving an “ethical” brand too easily. Inside the ethical investing industry, the cynical practice of branding some funds as “ethical” primarily as a marketing device is known as “greenwashing”.

Separately, some highly regarded conventional fund managers take umbrage at the occasional inference that just because they're not officially “ethical” they may be in some way inferior. Globally, one of the most successful managed funds of all time has been the Templeton funds group founded by Sir John Templeton. As Martin Warwick, general manager of the ASX-listed Templeton Global Growth Fund, says: “Templeton has always been run on the highest principles and Sir John Templeton actively avoided anything he regarded as unethical. Many fund managers would try to do that, but they don't shout it from the rooftops."

As research from Morningstar reveals in the tables below, the range of performance from ethical funds is almost as wide as their definitions.

MSUSTAINABLE FUNDS
Fund Name	Morningstar Rating	3 yr pa return	Market Cap ($m)	MER
AMP Capital Investors Sustainable Fut Bal Growth	**	16.2	53.41	0.77
AMP Capital Investors Sustainable Future Aust Shr	****	27.02	250.52	0.72
AMP Capital Investors Sustainable Future Intl Shr	***	13.43	51	0.87
AMP Capital Investors-Sustain Fut Aust Share C A	****	28.01	11.66	0.97
AMP Capital Investors-Sustain Fut Bal Growth C A	***	16.09	1.86	0.97
AMP Capital Investors-Sustain Fut Intl Share C A	***	13.22	7.25	1.07
AMP Flex Life TP - AMP Sustainable Future Aust Sh	'”	'”	0.19	'”
AMP Flex Life TP - AMP Sustainable Future Bal Gth	'”	'”	0.2	'”
AMP Flex Life TP - AMP Sustainable Future Int'l Sh	'”	'”	0.02	'”
AMP FLI - AMP Sustainable Future Aust Share Fund	****	26.79	13.01	2.15
AMP FLI - AMP Sustainable Future Bal Growth Fund	'”	'”	11.02	2.1
AMP FLI - AMP Sustainable Future Int'l Share	'”	'”	7.94	2.25
AMP FLS & CS - AMP Sustainable Future Aust Share	****	24.41	4.28	'”
AMP FLS & CS - AMP Sustainable Future Balanced Grw	'”	'”	2.75	'”
AMP FLS & CS - AMP Sustainable Future Int Share	'”	'”	1.34	'”
ANZ OA Alloc Pen ING Sustainable Inv-Aust Sh EF	'”	'”	0.05	1.8
ANZ OA Alloc Pen ING Sustainable Inv-Aust Sh NEF	'”	'”	0.78	2.35
ANZ OA TAP ING Sustainable Inv-Aust Sh EF	'”	'”	'”	'”
ANZ OA TAP ING Sustainable Inv-Aust Sh NEF	'”	'”	'”	'”
BT Australian Sustainability Share Fund	'”	'”	3.8	'”
BT Institutional - Aust Sustainability Share Fund	**	23.92	61.93	'”
BT Institutional - Intl Sustainability Share Fund	****	12.16	12.56	'”
BT PPSA - Australian Sustainability Shares	***	25.51	0.4	'”
BT PPSA - International Sustainability Shares	***	12.52	0.1	'”
BT PPSI - BT Institutional Aust Sustain Share	***	23.97	2.01	'”
BT PPSI - BT Institutional Intl Sustain Share	****	13.13	0.56	'”
BT PPSS - Australian Sustainability Shares	*	21.42	0.5	'”
BT PPSS - International Sustainability Shares	***	11.22	0.2	'”
ING Integra-ING Sustainable Inv-Australian Shares	'”	'”	1.06	1.65
ING OA Alloc Pen-ING Sustain Inv-Aust Sh	'”	'”	0.15	1.8
ING Wholesale-Sustainable Inv Australian Shares	***	26.44	23.41	0.95
ING Wholesale-Sustainable Inv Global Shares	*	11.89	11.44	1.1
SignatureSuper - AMP Sustainable Future Aust Share	'”	'”	0	'”
SignatureSuper-AMP Sustainable Future Balanced Gr	'”	'”	0	'”
SignatureSuper-AMP Sustainable Future Int'l Share	'”	'”	0	'”
SuperLeader Sustainable Fut Balanced Growth	'”	'”	8	'”
The Dexia Sustainable Global Equity Fund	'”	'”	68.5	'”
Morningstar bases its overall ratings on a fund’s risk-adjusted performance compared with the performance of other funds in its asset class. If a fund scores in the top 10% of its category, it receives five stars. If it falls in the next 22.5%, it earns four stars. A place in the middle 35% results in a three star "neutral" rating. Funds in the next 22.5% get two stars and funds in the bottom 10% get one star. Star ratings are recalculated monthly.

But there is evidence that money moves more slowly into funds that have tighter ethical guidlines. It's also interesting that funds bringing in very strong returns over the past year were not as strict as those stuck to traditional ethical principles. The Howard Government’s announcement that it would allow the export of uranium to China deepened divisions in the ethical industry. BT Ethical Investments, a top-performing fund, had no problem with uranium exports. In fact, BT has uranium miner BHP as its biggest single holding, at more than 12% of its portfolio.

As the tables reveal, Australian Ethical's flagship Balanced Trust has a three-year return of just 14%, meanwhile BT's ethical group, which has substantial holdings uranium, can boast a three-year return of 24% for its Australian Sustainability share fund.

Australian Ethical’s James Thier says it comes down to which word comes first for the investor: “ethical” or “investing”. Their, who was recently quoted as saying that Australian Ethical would never invest in uranium, said: "If sending uranium to China is not an ethical issue, I don't know what is."

The basics

So, if you're interested in ethical fund investing, here's what you need to know:

1. If you put your money in “ethical” investments, there is no evidence the move will make or lose you money, provided you diversify.

2. The terms ethical, sustainable and socially responsible are often used interchangeably; there are no international standards or definitions.

3. Purist funds such as Australian Ethical, have clearly missed the upside from the commodities boom in Australian in recent years.

4. There is rancour in the ethical sector over cynical use of the ethical investing brand to attract new capital.

5. Some ethical funds don't just avoid industries, they often seek out “good” industries, which puts them in the active management category.

6. Ethical investing funds are small in dollar terms and have a bias towards small-cap funds, which can affect their results.