- On January 19, 2017
Ethical investing has come a long way since its religious origins by Quakers and Methodists in the 18th century. It now has many names including ESG (Environmental, Social and corporate Governance), sustainable or responsible investing.
The approach to selecting assets has become more complex and the social concerns have grown broader, but the underlying theme has remained the same – use investing to help spur social action. This was primarily done through negative screening initially (such as banning tobacco companies), but now involves positive screening and engagement (such as investing in renewable energy).
This approach to investing has now become mainstream in the Australian Superannuation market, as well as elsewhere, with industry vanguards such as AustralianSuper and UniSuper offering SRI options to members and some, such as Christian Super, basing their MySuper product around their beliefs. Australian Ethical was a pioneer for funds which are defined by their ethical approach to investing, which now includes new entrants such as Good Super, Future Super and Cruelty Free Super.
Ultimately, ethical investing is interested in firms which hold stakeholder value on the same level as shareholder value. It is important to seek firms with strong corporate governance, and avoid practices which are deemed ethically questionable. This approach is justified by evidence that strong corporate social responsibility practices in firms are typically associated with enhanced shareholder value and the risk that many of the assets that are screened out will ultimately become stranded and worthless – such as polluting power generators as renewable energy gains momentum. There is also an underlying concern that the negative externalities created by certain industries – gambling, tobacco and alcohol for instance – are far greater than the potential returns.
Is there an argument that this is a trade-off of emotion and value?
Statistical evidence suggests that the rates of return between ethical investment options and non-ethical investment options do not vary materially. However, the small amount of assets in these options usually means they are more expensive as they lack scale benefits. We don’t expect any material difference in returns from the style of investing though there will be differences in levels of investment competence. Nonetheless, people don’t appear to pick these options to get better returns. In most cases, it appears that the decision for ethical investment is primarily emotive. This has created a risk that superannuants will trade off their emotions against value in products. Unfortunately, this risk has been realised, with some products on the market which appeal directly to a member’s sense of social obligation, charging exorbitant fees as shown in Table 1.
Table 1. Fees incurred on a $250,000 account invested in an ethical investment option*
* The new ethical funds and Australian Ethical also charge a buy-sell spread.
We have a Choice system, so it reasonable that employees be given the option to exercise control over the way in which their money is invested. For some, this means avoiding certain economic activities and embracing others in line with their personal ethics.
However, the impact of high fees on account balances can be enormous over time. Funds are required to carry an ASIC information panel in their PDS showing that an additional 1% in fees can cost a member 20% of their balance over 30 years. However, most members cannot do the comparisons to know that they have actually chosen a high-cost fund. Consequently, whilst some of these funds may have ethical investing models, their fees and disclosure need attention and the ASIC warning needs to be strengthened.