The ethical dilemmas for investors

Summary: The ethical investment sector is far from cut and dry, with fund managers relying heavily on external investment analysis tools provided by companies like MSCI. But 'ethical' comes without a precise definition - just look to Martin Currie and Australian Ethical. 

Key take-out: Retail investors will find that fund managers can have vastly different ethical investment charters, which may be at odds with what they personally believe is ethical. Some diversified companies can be easily ruled out, alongside those with serious misconduct issues.

Some of Australia's most familiar household names, and heavily invested stocks, are among those currently blacklisted by some ethical fund managers.

Excluded businesses include the likes of Woolworths, Wesfarmers, Myer and Coca-Cola Amatil, while the Big Four banks find their way through the ethical screen for some money managers.

When it comes to excluding companies from its own ethical fund entirely, Martin Currie Australia said it leans on “the very severe red flag” used by MSCI.

Martin Currie Australia portfolio manager Will Bayliss disclosed on Wednesday he had reduced his Ethical Income fund's holding in Commonwealth Bank when the recent AUSTRAC allegations surfaced, but he isn't necessarily intending to draw down further.

Bayliss diluted Commonwealth Bank from 4.5 to 3 per cent of the fund's holdings for risk mitigation purposes after meeting separately with CEO Ian Narev and an ex-AUSTRAC anti-money laundering expert. A single company is capped at making up 5 per cent of Martin Currie Australia's Ethical Income fund.

MSCI currently has moderate-to-severe ratings for misconduct on Commonwealth Bank, but Bayliss said “it's a moving, not a singular story” considering APRA and AUSTRAC enquiries are only just beginning.

Meanwhile, right now the fund is barring our major supermarkets, Woolworths and Wesfarmers, for alcohol revenue of more than 5 per cent, Myer and Premier Investments for taking more than 5 per cent of revenue from fur, and Coca Cola for its Jim Beam partnership.

What's the screening process?

Ethical fund managers may in part ‘outsource' their screening process to external providers like MSCI. It's better equipped to keep track of changes, big and small, across more than 50 United Nations agreements on matters such as fair labour, human trafficking, and women and children's rights.

For example, MSCI has attached a red flag to BHP Billiton for severe impact on local communities and toxic emissions and waste. While BHP might make the grade on addressing climate change, and have strong company fundamentals, a single red flag could be enough to deem the company ‘unethical' from a fund manager point of view.

Resource companies are noticeably missing from Martin Currie's fund, but Bayliss said this doesn't always come down to ethics. Earnings volatility may also factor in.

“We can't own companies that exceed 20 per cent coal-fired generation, but can own companies with a mix,” said Bayliss.

“We aren't saying we can't own fossil fuels – we're saying the world we're in is demanding more gas than the black coal in the Hunter Valley.”

Executive-staff pay gaps and company culture also weigh into ethical assessment, which have both been widely talked about of late.  

However, if a company has sound fundamentals and no severe ethical red flags, but falls short on measures like skill or gender diversity, it could get through screening on outlining detailed plans alone.

The fine line on ethics

Investors could find two ethical fund managers have vastly different ethical charters. Ethical investing is still a nascent space, so the ins and outs are sometimes subjective.

Where Martin Currie's fund includes all the major banks except NAB, another ethical fund manager, Australian Ethical, has never kept Commonwealth Bank or ANZ in its portfolio.

Stuart Palmer, the Head of Ethics at Australian Ethical, considers things like their sales practices and how integrated environmental and social impacts are in credit assessment decisions.

“We haven't assessed ANZ or CBA to be aligned with our charter, with different considerations,” said Palmer.

“CBA has had a lot of issues in different parts of the business over the years, raising concerns, and while it's really hard from the outside looking at the culture, an indicator of culture is the frequency of these events occurring.

“All the banks have had their individual events and I wouldn't single out ANZ as being better or worse than Westpac or NAB, but one barrier for them is the climate alignment test – they are historically a big funder of fossil fuels, and we moderate over time the commitments they are making to redirecting capital.

“We accept in big organisations there are things that will go wrong, so we have to look if there's a systemic cultural issue, and that's always the challenge. It's ongoing monitoring, but you look at trends over time. Incidents can be so serious on the negative or positive side which change our view, but that's an exception to the rule.”