5 ethical investing ideas

A trickle of interest in ethical investing is turning into a torrent as more people realise this style of investing is achieving better risk-adjusted returns and delivering social good.

Core responsible investment strategies, which encompass ethical investing, had almost $65 billion in assets under management in December 2016. Latest data from the Responsible Investment Association Australasia (RIAA) shows this number has grown 26 per cent from the previous year.

Another $557 billion is put through broad responsible investment strategies that use Environmental, Social and Governance (ESG) filters. Unlike ethical investing, which avoids broadly harmful sectors, responsible investing assesses companies on their investment and ESG merits.

The combined effect is institutional investors putting almost $1 in every $2 of professionally managed assets in Australia through responsible investment filters – a remarkable achievement that is pressuring companies to lift their corporate social responsibility.

Several factors are driving this boom. The United Nations Principles for Responsible Investment encouraged institutions to be active owners and incorporate ESG decisions, such as the firm’s approach to gender diversity, human rights or climate change, into their ownership.

Retail investors are contributing to the responsible investing boom through their investment choices. Nine out of ten superannuants and investors surveyed by RIAA expect their money to be invested responsibly. Younger investors, in particular, expect their capital to be used to fund companies that help rather than harm the planet.

Product issuers are responding to these trends by launching Listed Investment Companies, Exchanged Traded Funds and other vehicles based on ESG or ethical investing. More products should, in theory, lead to greater competition and lower fees – a lingering problem for ethical funds that have historically charged higher fees because of extra company screening.

Potential for higher returns is perhaps the biggest driver in ethical funds. There has been a false perception over the years that ethical investing involves sacrificing some return.

Core Australian responsible investment share funds outperformed the S&P/ASX 300 index and average large-cap Australian equity funds over one, three, five and ten years to the end of 2015, RIAA data shows. Sustained outperformance is rare in active funds management.

Risk is a less considered part in ethical investing. Owning companies in harmful sectors, or those with poor ESG practices, has never been riskier. Bad corporate behaviour is increasingly disclosed by whistle-blowers and amplified on social media. Investing in companies that have strong ESG practices and operate in sectors that do not hurt the planet helps reduce an emerging layer of risk.

My sense is that many more ethical funds will come to market in the next few years to meet rising demand for ethical investing. The risk is that some new products are “ethical-lite”; designed to attract inflows into this style of investing yet offering basic screening of harmful sector companies and relying on fund mangers with limited expertise in this field.

Investors can also choose from several unlisted ethical managed funds such as Perpetual Wholesale Ethical SRI, Generation Wholesale Global Shares, AMP Capital Responsible Investment Leaders International Shares and the BT Sustainable Balanced Fund.

Here are five ASX-listed or quoted funds/companies that make the grade in ethical/ESG investing:
 

1. Morphic Ethical Equities Fund (MEC:ASX)

The Listed Investment Company joined ASX last year through an IPO and, like many recent LIC IPOs, trades at an 11 per cent discount to its stated pre-tax Net Tangible Assets (NTA), ASX data shows. New LICs often trade at a discount to NTA.

Morphic Asset Management has a good record in global investing and strong expertise in ethical investing. The LIC invests in global stocks and excludes companies involved in coal, uranium mining, oil and gas, intensive animal farming and aquaculture, tobacco and alcohol, armaments, gambling, rain-forest and old-growth logging.

Unusually, the LIC can take short positions in stocks that have poor ethical practices.
 

2. Australian Ethical Investment (AEF:ASX)

The micro-cap fund manager’s performance shows why it often pays to buy shares in the company that manages the funds, rather than the funds themselves. The ASX-listed fund manager is a well-established, respected leader in ethical investing.

Australian Ethical increased funds under management by 31 per cent to $2.82 billion in FY18.  The share price is at $142, down from the 52-week high of $173. Technology problems with its systems hurt Australian Ethical last year, but the well-run manager is superbly leveraged to the ethical investing boom.
 

3. VanEck Vectors MSCI International Sustainable Equity ETF (ESGI:ASX)

This new Exchange Traded Fund is part of an emerging breed of ETFs that provide index exposure to global stocks with high ESG ratings. ESGI tracks a new benchmark index, the MSCI World ex-Australia ex-Fossil Fuel Select SRI and Low Carbon Capped Index.

The index excludes fossil-fuel companies, alcohol, weapons, pornography, nuclear power and other sectors considered harmful. Companies that are high carbon emitters are also excluded.

In addition, the ETF includes companies with strong ESG ratings, giving investors the best of both worlds: exclusion of harmful sectors and inclusion of ESG exemplars. An annual management fee of 55 basis points is attractive for this level of screening.
 

4. BetaShares Global Sustainability Leaders ETF (ETHI:ASX)

ETHI, another ETF newcomer, provides exposure to 100 large global stocks that are climate-change leaders and rate well on responsible investment considerations.

The ETF has a high weighting in US equities and about a third of stocks in its index are tech stocks. ETHI could offer more growth than competing ETFs given the tech-stock weighting and comes from one of the market’s most innovative ETF issuers. Its ethical screening, however, may not be as stringent as other funds that focus primarily on sector exclusion.
 

5. Russell Investments Australian Responsible Investment ETF (RARI:ASX)

The ETF provides exposure to a responsible investment portfolio that is enhanced for ESG considerations. It excludes companies involved in tobacco, alcohol, gambling, pornography and armaments, as well as producers of carbon-intensive fossil fuels.

The ETF’s dividend yield and franking credit focus suits income-seeking investors who want to invest in ethical Australian companies. An annual fee of 45 basis points is attractive.