Fact Check: Terra Capital Emerging Companies

Thanks to reams of industry research, it is a truth universally acknowledged that investing ethically does not have to come at the expense of positive long-term performance.

But what constitutes responsible investing remains up for debate with one fund revoking its ethical credentials as a result of a disagreement with the Responsible Investment Association of Australasia (RIAA).

The former Terra Capital Ethical Emerging Companies fund was certified as an ethical fund last year, one of only 14 certified during the year, but this year the fund chose to remove ‘ethical’ from its title.

The reason for the move was that the high conviction fund was holding a large amount of its assets in cannabis companies, specifically those for recreational purposes. 

The use of cannabis companies was a ‘grey area’ over whether it should be included in ethical or responsible funds. RIAA chief executive Simon O’Connor said he had not seen many funds which opted to formally exclude cannabis yet as cannabis firms had not been part of the index until recently. However, he said he expected to see it in the future given how prominent cannabis firms were becoming.

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The firm said it had also seen pushback from clients on its ethical name as some would have preferred the fund to have an unconstrained ability to consider all companies. 

In light of the desire for a more unconstrained fund, the firm also changed the investment remit to remove geographical limitations and remove limits on the amount of unlisted stocks it could hold. 

Nevertheless, the fund retains its ethical investing approach even if it is no longer in the official title. This involved using a negative screen to exclude companies that have involvement in areas such as weapons, tobacco, gambling, human rights violations and environmental destruction. 

When it came to the controversial cannabis exposure, this was an area where the fund has been boosting its investment in recent months. In February 2019, the fund had 20 per cent invested in cannabis companies and this has grown to 36 per cent by June thanks to involvement with companies such as Canadian business Nextleaf Solutions and US firm Plus Products. 

In its latest fund newsletter, the firm said it had spent time in North America this year visiting cannabis companies and found the highest margins would be via access to US customers through premium brands. 

“Our research confirmed our investment thesis from the first half of 2018 which is that access to US customers through premium brands will lead to highest margins. A new focus for the fund over the past quarter has been health and wellbeing CBD products- following our trip we expect this will be a bigger market than the recreational cannabis market.”

PERFORMANCE

However, when it comes to performance, the fund fails to achieve its investment remit, which when combined with the need for mandate changes, means it fails Fact Check. However, Fact Check appreciates it only has a three-year track record so performance may improve over ‘the long term’, following the mandate change.

It aims to invest in small cap emerging companies utilising a high conviction, high concentration approach. Its objective is to deliver superior absolute returns over the medium to long term by investing in small and mid-cap companies as well as unlisted companies. 

According to its Product Disclosure Statement, the fund aims to achieve 5 per cent annually but this has only been achieved in the first of its three full-year tenure. In 2016/17 it returned 24 per cent but in 2017/18 and 2018/19, it reported losses, according to FE Analytics. 

Overall, the fund has returned 21 per cent since inception. While this sounds good, it is less than half the 48 per cent returns by its benchmark. 

Over one year to 30 June 2019, the fund has lost 7.9 per cent, according to FE Analytics, versus positive returns of 1.9 per cent by its S&P ASX Small Ordinaries index benchmark. It has lost 13.8 per cent versus benchmark returns of 26.6 per cent over three years to 30 June 2019. 

A spokesperson for the firm said the reason for the recent underperformance was the volatility of the small and mid-cap company sector. The sector, which was the best-performing ACS sector in 2017/18, has been one of the worst this year with returns of just 1.7 per cent in the 2018/19 financial year. 

The fund was also impacted by its high conviction approach to its portfolio with the 10 largest constituents of the fund making up nearly half of the portfolio. 

Despite the underperformance, the firm said it would continue with this investing approach so it will be interesting to see if the recent changes will have an positive impact on future performance.