SRI to profit from changing times and climates

While Australia’s politicians wrestle with the issue of global warming, Australian investors have been paying increasing attention to socially responsible investing (SRI).

However, the latest analysis released by leading research house Lonsec suggests that while SRI is certainly gaining traction in Australia, with mainstream managers paying greater attention to global warming and other environmental issues, the bottom line for investors is that they are not being unduly rewarded for their conscientious approach.

Lonsec’s 2006 Australian and International SRI Sector review suggests that if investors are expecting to extract additional alpha by embracing SRI, then they are likely to be sorely disappointed.

In the end, of the six Australian equity SRI funds and two international equity SRI funds reviewed by Lonsec, only three received its second highest rating (‘recommended’), with the remainder being downgraded to ‘investment’ grade.

The following domestic equity funds were reviewed by Lonsec as part of its 2006 exercise:

~ Perpetual’s Wholesale Ethic SRI Fund;

~ AMP Sustainable Future Australian Share Fund;

~ Challenger Socially Responsible Investment Fund;

~ IOOF FlexiTrust — Socially Responsible Shares Fund;

~ Australian Ethical Large Companies Share Trust; and

~ Australian Ethical Equities Trust.

The following international equity SRI funds were reviewed:

~ Hunter Hall Value Growth Trust; and

~ AMP Sustainable Future International Share Fund.

According to Lonsec, the Perpetual, AMP and Challenger funds each received “‘recommended’ ratings, while the remainder were rated at ‘investment’ grade”.

The Lonsec analysis makes interesting reading for environmentally conscious investors because it clearly explains the reasons why SRI funds, while performing reasonably well, have not kept pace with the market leaders.

“Over the three-year period to December 2006, the average absolute return for the Lonsec Australian equity SRI sector was 23.5 per cent per annum,” it said.

“While this is an excellent result in absolute terms, it is nevertheless somewhat lower than that delivered by the average Lonsec assessed large-cap Australian equity manager of the same period (24.6 per cent).”

The analysis said however that, in contrast, over the past 12 months the Lonsec Australian equity SRI sector had outperformed the mainstream large-cap sector.

Looking at the reasons for the relative performance of SRI funds and the manner in which they have become more competitive over the past 12 months, Lonsec points to the industrialisation of China and the way in which this has had a significant impact on Australia’s energy and mining sectors over the past three years.

“This has been a mixed blessing for SRI/ethical funds. While the S&P/ASX 200 Accumulation Index has delivered a total return of more than 130 per cent since the trough in the market in March 2003, the majority of this growth has been driven by the materials and energy sectors,” it said.

“These sectors represent the typical underweights for the majority of SRI/ethical funds that use negative screens as part of the determination of their SRI/ethical investment universe.”

The Lonsec analysis said, however, that SRI/ethical managers have been able to gain exposure to the materials and energy sector by way of mining and energy services companies.

“Rather than buying ‘pure’ mining stocks, these fund managers may invest in mining services companies to gain an exposure to the resources boom,” it said. “While this sector does have some limitations, managers with meaningful exposures have managed to keep pace with many large cap mainstream Australian equity managers.”

The Lonsec analysis went on to note that fund flows into SRI/ethical funds had remained strong, but that the rate of growth had slowed compared to the pervious year.

“This outcome is not all that surprising given that the Australian market has delivered returns in excess of 20 per cent a year over the last three years, and many investors are now asset allocating away from Australian equities into international equities, rather than avoiding the SRI/ethical sector,” it said.

“Interestingly, Lonsec is seeing more evidence that some of the more traditional (mainstream) managers are beginning to think about how environmental and social factors are likely to affect share price performance,” the analysis said.

“This practice continues to gain traction in light of the broader acceptance of global warming as an environmental threat, which brings with it previously unidentified risks and opportunities.”

Looking at the case for SRI investing, the Lonsec analysis examines arguments both for and against the practice and concludes that it does have a future.

“Lonsec believes that over the longer term socially responsible investing will play a significant role within the mainstream investment market,” it said.

“Consumer demand for corporations to take greater accountability for the impact that their activities have on the environment is likely to be the driving force behind greater demand for SRI funds,” the analysis said.

It said a number of opinion polls in the US had shown that a large segment of the population believed climate change was a real problem and over a third believed that it was a major factor behind the recent hurricanes in the Gulf of Mexico.

“Lonsec believes that as this trend continues to grow there will be increased pressure on mainstream (traditional) managers to place greater emphasis on assessing the social and environment impact of a company’s operations,” the analysis said.