Responsible investment: Where do ethical boundaries lie?

Responsible investment funds have grown in popularity and are increasingly thought about in terms of environmental and sustainability issues. However, funds that steer clear of ‘sin stocks’ reflect the many values investors hold in high importance.

Ninety per cent of the funds in Australia that promote themselves as responsible investments adopt a negative screening approach, which means they will put an absolute ‘black mark’ on certain industries or companies. For example, they will not invest in companies that are involved in uranium mining, tobacco and alcohol production, pornography, armaments and so on.

However, the picture is not as clear for funds that adopt more proactive approaches, such as positive screening, best of sector, or sustainability analysis approaches. Funds that adopt these approaches tend to engage more directly with companies, actively seeking out those that have a positive impact on society and the environment, or have the best track record around environmental, ethical and social practices in their sector. While these more proactive approaches have the potential to transform the world for the better, it is arguably more difficult to define where their ethical boundaries lie.

The dilemma is also apparent in the more simplistic negative screening approach. The production of pornography, for example, is a no-no for some, but are they happy to invest in companies that receive a great deal of revenue from its distribution? Where is the line drawn and who draws that line? Fund managers catering to the needs of investors may argue that it’s up to the investor. Again, it’s not that straightforward when examining concerns around financial sustainability for income, especially following the global financial crisis.

AMP Capital Investors, for example, favours companies that perform better in environmental and social issues, which it believes make for better long-term investments.

“We think certain industries are better aligned with sustainability than others,” said Angus Dennis, senior investment specialist, SRI funds.

He said AMP will favour certain industries that have a favourable impact on the environment and society and are therefore favoured by legislation and consumers. It also looks for best of sector within these sorts of industries, while excluding industries seen to be least sustainable on environmental and social performance outcomes, like the production and manufacture of alcohol, armaments, gambling, nuclear and uranium, pornography and tobacco.

Christian Super chief executive Peter Murphy said from a super fund perspective, “it’s about what do the super fund members want”.

“We have asked our members two years in a row how important ethical investing is to them [in] the service that we’re offering, and clearly it is one of the most significant things that we have in our offering that our members really resonate with,” Murphy said.

The fund continually revises its investment approach as research and member feedback reveals a broader view on things. Murphy said while Christian Super may take a stance on something, a broader outlook may change its significance. As an example, it is rethinking its approach to the adult entertainment industry, which seems to be an area of increasing concern for members.

However, executive director James Thier said even though Australian Ethical Investments engages in investor feedback and conducts a survey every three years to discover what is important to its investors, it also takes a leadership approach.

“From our perspective, when it comes to the selection process, whilst we take input from people, we are more driven internally,” Thier said.

He said the fund manager’s level of research means it may have a perspective on an issue that may not have even occurred to some investors. As an example, looking at the climate change debate, he wonders how many people realise that methane is 20-times worse than carbon dioxide.

“We believe that we drive the process and need to be leaders in this process.”

Referring to research in the UK, the marketing and communications director of the Responsible Investments Association Australasia (RIAA), Megan Lewis, said investors are increasingly looking to their fund managers to take on a proactive stance rather than simply avoiding ‘sin stocks’.

“It’s an interesting shift,” said Lewis, who believes that as responsible investment funds grow and more investors show an interest, they will place pressure on the managers to see how they can use that money to have a positive influence.

Murphy agrees that investors have the power to bring about change and responsible funds are a means of achieving this. As an example, he said Christian Super has engaged in discussions over the last year with Westfarmers about its importation of phosphorous from Western Sahara, where there is currently a territorial dispute. Murphy believes these discussions have encouraged Westfarmers to take a broader view as to what is happening in that space and invest $5 million over the next two years towards looking to alternative sources.

Lewis said aside from ethical sensitivities and who determines what is acceptable, the overriding importance of responsible investment funds is disclosure.

“It’s important to remember that everyone will have different values and you won’t find one product that will exactly match your ethical profile,” she said. “The core principle of responsible investment is that people [investing in mainstream funds] without their knowing it may be investing in things that they don’t agree with. That doesn’t necessarily mean that you need to adopt a negative screening approach to your investment strategy — our message is, know what you own and know what your money is up to.

“If you are investing with a mainstream fund, you don’t know because they don’t disclose that.”

Lewis said when it comes to the RIAA’s certification program, disclosure is the main requirement as it’s with disclosure that investors are able to make informed decisions.

Dennis said full disclosure of stock holdings is an important aspect in being “true to label”.

“Within responsible investment funds there is a level of certainty that people will know what they’re investing in,” he said.

Thier added that the motivation for the development of responsible investment funds comes from “basically knowing what your money is doing”.