Language is crucial when it comes to ethical investing. Terms such as “responsible”, “ethical”, “ESG”, “impact” are used interchangeably but don’t necessarily mean the same thing.
There is no standardised umbrella term for ethical investing, so it needs to be a personal decision as individuals have different morals and ethics.
What is ethical investing?
The lack of uniform rules around what ethical investing requires becomes problematic, with many funds using ‘ESG’ (environmental, social and governance) as a marketing tool. Definition matters – you need to know your product.
Investors need to think critically before choosing which investment strategy is most effective and suitable for them.
The idea of ‘green-washing’ and ‘impact-washing’ may arise in ethical investing, with some funds claiming to have a robust ethical framework, but may only be using the ‘ethical’ brand as a marketing tool.
Investors can protect themselves from this by urging their fund to be transparent with their investment process and portfolio holdings.
Investors should review how ethical investment products filter and define their screening (both positive inclusions and negative exclusions) of companies.
They should also look at the level of ESG integration, if a responsible investment committee exists, if they incorporate such things as the United Nations Sustainable Development Goals, or if they look at a company’s balance scorecard or report on ESG objectives and not just a focus on profit and loss statements.
Many index providers such as MSCI have ratings methodology which helps investors identify ESG risks and opportunities within their portfolio.
Why do investors pick ethical ETFs
In the Australian ETF Universe, Ethical ETFs increased a whopping 69% to almost $1b in FUM in March 2019.
We believe there are 3 key reasons driving this demand: 1) Performance; 2) Impact Investing; and 3) Feeling Good
MSCI research dispels the myth that ESG hinders performance, as companies with robust ESG practices had higher profitability, more stable earnings, lower volatility and less controversies (such as bribery, corruption and fraud).1
On the other hand John Collett reported that most ethical super funds underperform regular balanced funds over 10 years.2
There is mixed evidence of weather ethical ETFs provide consistent outperformance. Over recent periods, it seems ethical investment is winning. Investors have seen Ethical ETFs boast outperformance and believe that they can do financially well by making ethical investments.
2) Impact Investing
‘Impact investing’ refers to investing your money for the purpose of seeking positive social and environmental impact alongside a financial return.
Every dollar you spend should make an impact and align with your values with the companies or products you are investing your money in. Many of the population have negative views on industries such as tobacco, fossil fuels, and gambling.
To make an impact, investors believe that changing their portfolio to choose financial products that divest from companies in these industries will mean these companies will become less valuable as their share prices fall, ultimately hoping this leads to corporate policy change, reduced investment interest, and an overall decrease in demand for their services.
The challenge with this is some active stock pickers who may not share the same non financial motive. They may see this as a profit opportunity to find potential unloved and undervalued companies and invest heavily into them.
3) Feeling Good
Sometimes, for the pure simple fact of feeling intrinsically good and performing sensible human deeds, investors believe they are doing the right thing by not investing in unethical companies.
Investors may feel some remorse, or believe it is morally wrong to profit off companies who engage in certain business activities. Regardless of performance or returns, their morals, ethics and sense of corporate responsibility are the highest investment criteria priorities.
They develop a sense of well-being and a strong moral compass when selecting investment products that have ethical companies in their portfolios.
A deep dive of Australian share ethical ETFs
There are 3 Broad Australia Ethical ETFs available on the ASX:
- BetaShares Australian Sustainability Leaders ETF (FAIR)
- Russell Investments Australian Responsible Investment ETF (RARI)
- UBS IQ MSCI Australia Ethical ETF (UBA)
Let’s examine their top 10 holdings and stock % allocations (as of March 2019):
|Brambles||4.7%||Commonwealth Bank of Australia||8.9%||Commonwealth Bank of Australia||9.4%|
|Telstra||4.2%||National Australia Bank||4.7%||CSL||6.6%|
|Dexus||3.9%||CSL||3.3%||National Australia Bank||5.2%|
|A2 Milk||3.4%||Suncorp||2.1%||Rio Tinto||2.7%|
FAIR’s top 10 looks very different as they removed the big banks due to fossil fuel financing, whereas RARI and UBA hold the big banks. This also poses the notion that because Ethical ETF holdings are very different to a market cap weighted ASX ETF, that performance may differ.
Some of these companies are not always as clear cut ‘ethical’ as they seem.
For example, do you consider Telstra an ethical company given 3% of their revenue comes from Foxtel which showcases pornography? Do you consider Woolworths an ethical company given 15% of their revenue comes from alcohol, or that it has a stake in a company that earns money from gaming machines? Socially responsible is truly in the eye of the beholder.
Some questions that we propose to investors:
- Should ESG Funds own Australian banks after the Royal Commission exposed that they charged dead customers? This is why it is important to review the ETF’s index methodology and ESG screening criteria to determine why certain companies are selected.
- How active should the ETFs be with their criteria? For example, the BetaShares Global Sustainability Leaders ETF (ASX: ETHI) removed Facebook after the Cambridge Analytica scandal. Does this make it an active fund? With increased human oversight, there may be higher transaction costs of the ETF, but more agile alignment to ESG concerns.
- Are ESG funds with high fees ethical to their own investors given what we know about the impact of high fees on performance?
How have Australian ethical ETFs performed?
|3 Years (p.a.)||N/A*||9.58%||11.63%||11.46%|
Sector tilts may be the key driver of performance, and sectors go through cyclical periods of outperformance and underperformance. For example, RARI was a notable underperformer due to its larger allocation to financials (which suffered due to the Royal Commision) and had no allocation to technology (which had a positive year).
Compared to the broader Australian sharemarket, the 3 Australian Ethical ETFs have quite different sector tilts. For example, FAIR has a greater allocation to Technology and Communications, RARI has more Financial shares, and UBA has a larger position in the Health Care sector.
There are also a range of Ethical Global Share ETFs covering different markets across the globe:
- BetaShares Global Sustainability Leaders ETF (ETHI)
- UBS IQ MSCI World ex Australia Ethical ETF (UBW)
- Vaneck Vectors MSCI International Sustainable Equity ETF (ESGI)
- Vanguard Ethically Conscious International Shares Index ETF (VESG)
- UBS IQ MSCI USA Ethical ETF (UBU)
- UBS IQ MSCI Europe Ethical ETF (UBE)
- UBS IQ MSCI Japan Ethical ETF (UBJ)
- UBS IQ MSCI Asia APEX 50 Ethical ETF (UBP).
Like other investment ‘themes’, ethical investing continues to win investor’s money as they appeal to a certain group of people who want their investments to reflect their personal values.
We offer an ethical option as a theme for Australian Shares however we appreciate that what is ethical to one person may not be to another.
Over the short to medium term, ethical ETF performance is mostly driven by their tilts to different market sectors (like technology and financials), rather than the underlying ESG factors that go into screening companies.
Ultimately we believe that investors should consider the extra costs and risks that come with investing in Ethical ETFs. Higher costs mean that over the long run they are more likely to underperform the broad index while their different sector exposure means they will have more variable returns.
Where they are comfortable with these extra costs and risks, Ethical ETFs provide a ‘feel good’ alternative to investing in the broad market.
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1 MSCI Weighing the Evidence: ESG and Equity Returns (2019)
2 SuperRatings May 2018 Data