Investing ethically doesn’t hurt returns

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The image many investors have of ethical investing is the use a negative screen – a list of “sin stocks”, such as tobacco, alcohol, gambling and firearms companies, that are excluded from a fund’s portfolio.

While negative screens are still in widespread use, and have been expanded to cover environmental, diversity and human rights concerns, a range of other approaches are now in use.

These include impact investing, which involves investing to make a positive social and environmental impact, and ESG integration, a holistic approach where environmental, social and governance issues play a part in all facets of the investment management process.

Investors can no longer simply say they want an ethical fund. They have to find out how a chosen fund approaches ethical (socially responsible or ESG) investing.

The other image many investors have is that they have to give up investment returns to invest ethically. According to the Responsible Investment Association of Australia, the number one reason people do not invest in ethical funds is that they worry that there is a tradeoff between ethical investing and fund performance.

However, the latest research suggests that socially responsible investing does not come at the cost of lower returns. Earlier this year the Australian Centre for Financial Studies released a report on ethical investing in Australia, including a survey of a wide range of studies on the impact of ESG on investment returns.

The report uses the term socially responsible investing, encompassing environmental, social and governance investment decisions, ethical investing and values-based investing. It looks at any investment process that includes non-financial factors, including the use of negative screens and positive screens.

The report says: “Investment theory suggests that imposing restrictions on investable assets will shrink the investment opportunity set available to an SRI fund manager. SRI funds may underinvest in financially attractive opportunities and suffer from a loss of diversification. The result is that they would be expected to underperform.”

But based on its review of available studies, ACFS found that “the balance of empirical evidence would seem to suggest that socially responsible investing does not come at a detriment to financial returns.”

One US study that looked at fund returns between 1981 and 1990 concluded that “investors can expect to lose nothing by placing their money in socially responsible funds.”

Similar findings have been made in studies conducted in the UK, Germany and the US.

The evidence is not unanimous, with some studies reporting evidence of underperformance by SRI funds and some showing outperformance.

Joint analysis of 20 academic and broker studies by the United Nations Environment Program and Mercer found 10 showing evidence of a positive relationship between ESG factors and portfolio performance, seven reporting a neutral effect and three a negative association.

The biggest analysis to date was conducted by Deutsche Asset Management, working with the University of Hamburg. It looked at 2200 studies and reported that 90 per cent of the studies found “at least a non-negative relationship between ESG factors and corporate financial performance and a majority reporting positive findings.”

The Responsible Investment Association of Australia’s latest Responsible Investment Benchmark Report shows that “core” responsible investment grew by 26 per cent last year to $64.9 billion, making up 4.5 per cent of Australia’s total assets under management.

“Core” strategies apply a “primary ethical strategy”, such as a negative or positive screen, sustainability theme investing, impact investing, community finance or corporate engagement.

Taking broad responsible investing into account, where funds incorporate ESG principles, the RIAA says the total responsible investing market was worth $622 billion last year, an increase of 9 per cent over the previous year.

Simon O’Connor, the chief executive of the RIAA, says the association has certified 120 investment products, up from 45 a couple of years ago, and there are another 35 awaiting certification.

Phil Vernon, the chief executive of Australian Ethical, says the company’s superannuation fund has achieved the fastest growth in the industry, with an annual growth rate of 35 per cent over the past few years.

Vernon says ethical investing is the “secret sauce” behind this growth. The group’s investors are very engaged, with more than 100,000 signed up as facebook friends.

“For 43 per cent of our members, climate change is their number one ethical concern. We turn this concern into action, as our portfolio is fossil fuel free. We have actively campaigned against Adani and we consistently lobby government for positive environmental change,” Vernon says.

In 2010, fund manager Martin Currie launched its Equity Income fund, designed to provide sustainable and growing dividend yield from a portfolio of Australian shares. In 2015, it launched an ethical version of the fund. The Ethical Income fund uses a combination of a negative screen and an “ESG impact” screen.

In the year to June, the Equity Income fund produced income of 7.9 per cent and a total return of 15.9 per cent. The Ethical Income fund produced income of 8.2 per cent and a total return of 13.1 per cent over the same period.

Will Baylis, Martin Currie Australia portfolio manager, says the group uses a number of different approaches to ethical investing. It is a signatory to the United Nations Principles for Responsible Investment.

It subscribes to the MSCI’s ESG Impact Monitor and avoids stocks which have red flags, which indicates that a company is involved in a “severe” controversy that involves the environment, customers, human rights, labour rights or governance.

It also relies on the views of governance consultants Ownership Matters and ISS Australia.

“We weigh ethical values equally with investment values,” Baylis says.

“We do quality risk assessment. We look at sustainability. We are an active manager and we vote on resolutions are company meetings. And we have some negative screens.”

Catalina Secretaeanu, an associate director of ESG research and ratings group Sustainalytics, says that with growing investor interest in ethical investing there is increasing diversity in the approaches being taken.

“There is a lot of change. It is all about your preferences. Some investors like the simplicity of screens, while others like the explicit objective of an impact investment approach. Others like to see their investment manager be active in their engagement with companies. There is no single answer,” Secreteanu says.

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