Sustainable responsible investing (SRI) is one of the more interesting investment strategies within the funds management industry.
The concept, also known as ethical or socially responsible investing, aims to maximise financial return and the social good.
Investors in this field generally buy stocks of companies that promote ideals including environmental stewardship, human rights and diversity, while shunning those involved in weapons manufacturing, tobacco and gambling.
It reflects the values of people who are no longer happy that their portfolios are built on companies with questionable practices.
However, the concept of SRI has faded into background amid the noise of the global financial crisis.
After years of double-digit growth, investments in the sector dropped 7 per cent to $15.724 billion in 2008, Responsible Investment Association Australasia (RIAA) data showed.
But the drop was almost entirely attributable from loss of capital rather than outflows. The SRI segment's market share of the Australian funds management industry rose to 1.9 per cent in 2008, up three basis points from the prior year.
It's also important to note the dramatic growth in the industry since the start of the century, when it managed only $325 million.
RIAA data also showed the average Australian shares responsible investment fund rose 15.85 per cent annualised for the five years to 30 June 2008, while the average mainstream Australian shares fund added 14.68 per cent per annum in the same time.
The average overseas share fund soared 13.05 per cent per annum for the five years to 30 June 2008, trumping the average mainstream overseas share fund's 4.75 per cent yearly advance in the same period.
Fresher figures from Morningstar showed that "ethical" share funds added an annualised 3.99 per cent for the five years to 30 March 2009, beating "non-ethical" share funds 5.02 per cent per annum gain in the same period. Both underperformed the S&P/ASX 200 Accumulation Index.
The idea of SRI was born in the 1960s and is still being shaped today, according to Australian Ethical executive director James Thier.
The contemporary version of the concept, primarily from the United States, originated due to the Vietnam War. Australian Ethical, an ASX-listed fund manager focusing on SRI, started in the 1980s.
"The bottom line really was people just wanted to know how their money was invested," Their says.
"In the early days people wanted to invest with their conscience, invest in things that they believed in and avoid areas they didn't support, whether they were anti-uranium or anti-native forest logging and they wanted to support industries and companies that did the right thing by the planet.
"That's still the belief but a lot of journalists at the time and now still say: 'Well it's good that you're an ethical investor but how are you going to make money out of it? What stocks are you going to find?'"
That perception is exactly what wealth managers like Australian Ethical and its rivals are trying to change.
Even in Australian Ethical's early days, the group's funds had identified early themes like renewable energy long before they became important in the context of global warming, Thier says.
Shunning superstars
The firm shuns stocks that are involved in activities including uranium mining, native forest logging and anything that is detrimental to humanity.
"And if you look at our long-term performance and our holdings, we've done very well because we've identified these issues very, very early in the game," Thier says. The Australian Ethical Equities Trust surged an annualised 8.73 per cent for the seven years to 30 April, trumping the S&P/ASX Small Ordinaries Accumulation's 5.71 per cent yearly gain in the same period.
The product has investments in a blend of Australian stocks both big and small, and also international equities.
It hasn't bought into Australian superstars like BHP Billiton and Rio Tinto, the globe's No.1 and No.3 diversified miners, and supermarket giant Woolworths.
Some examples of the equities in the trust include Petrathem, Energy Developments, Sims Group, Cabcharge and Blackmores.
Petrathem is an Adelaide-based company committed to the exploration and development of emission free, geothermal energy projects that are commercially sustainable.
Energy Developments, a Queensland-headquartered group, is involved in project development, finance, design, construction, operation and maintenance of international small scale power-generating and energy delivery projects.
The Australian Ethical Equities Trust's international equities holdings include Whole Foods Market, Herman Miller, Hyflux and SolarWorld.
Herman Miller is a US manufacturer of office furniture and equipment, as well as modern home furniture.
Germany's SolarWorld provides solar power technology and attaches particular importance to sustainable management.
Australian Ethical's other funds have also performed admirably for the seven years to 30 April.
The balanced trust, income trust and large companies share trust advanced 4.89 per cent, 4.48 per cent and 5.59 per cent per year in the period.
"Most of our funds are usually in the top quartile. Even with the global financial crisis, several of our equities funds are among the top two or three performers within their categories," Thier says.
Australian Ethical managed only $2 million in 1989 and that's grown close to $530 million today.
However, the fund manager's and the SRI sector's true growth potential is being restrained by a residual perception that ethical investment doesn't perform, even though the figures speak differently, Thier says.
It is difficult to quantify why such a performance myth is painted over the market, but Australian Ethical and its rivals are committed to changing it through constant education.
The pitch wealth managers can use is that SRI and incorporating environmental, social and corporate governance (ESG) issues within stock analysis translates into a performance boost for SRI funds, Thier says.
"We believe you can provide investors with both an investment philosophy that makes them feel good and delivers exceptional returns," he says.
An example he cites is international buildings material company James Hardie Industries.
"The risk of what asbestos can do to you was established in 1926 in medical journals and Australian Ethical picked that up and we avoided investing in that company," Thier says.
"So it shows you that SRI funds like ours anticipate these left field risks and left field opportunities far before they hit home. "Currently we're researching around the issue of climate change. What happens if a carbon tax comes in? We've seen research that shows a carbon tax could cut asset values of coal fired power stations by 50 per cent.
"We're looking ahead and into the future and seeing that people want to be healthy longer and naturally healthy, and so maybe there are some demographic changes in terms of complementary medicines and organic foods.
"These are left field things which affect investments."
The extra research is justification for higher fees charged by SRI funds, according to Thier.
So-called "ethical" share funds charge annual fees of 1.81 per cent while "non-ethical" share funds cost 1.60 per cent, Morningstar data showed.
The Australian Ethical Equities Trust had a 2.02 per cent yearly charge.
"People do say you are more expensive. Our argument is that you're getting more from it and over the long term you're getting more than compensated for the fees in the returns," Thier says.
One of the curiosities about the segment is how stakeholders decide they want to invest in funds and companies that uphold SRI values.
There are two ways it can come, Thier says.
"A number of clients go to their advisers and say ethical investing is what I want, I know I want to invest ethically and invest in harmony with my values and I believe these things are important to the world," he says.
"The other way it can come up is advisers through their fact find and who know your client can ask if you want to invest in ethical and sustainable factors?"
Australian Ethical has over 1200 financial advisers on its database who have used the firm's products on a regular or semi-regular basis.
Despite the group's long history, none of its trusts are on model portfolios or dealer groups yet.
"Certainly model portfolios are something we're keen to get on, but you know it requires changing the attitude from advisers of 'does ethical investing perform?'" Thier says.
Perennial Investment Partners partner Richard Macdougall constantly deals with the same performance myth perception from advisers.
"I don't know how long people want to look at these things for and realise that you're not actually losing performance by investing in these types of funds," Macdougall says.
Perennial's Socially Responsive Trust has added an annualised 7.12 per cent gross of fees for the five years to 30 April, outpacing the S&P/ASX 300 Accumulation Index's yearly 6.61 per cent gain in the same time.
The fund, with around $50 million under management, does not invest in BHP, Rio, Woolworths and a dozen other stocks that constitute a large part of the benchmark.
"We won't invest in BHP due to its uranium mining activities and Woolworths is also the largest gaming machine owner and operator in Australia," Macdougall says.
"We don't invest in gaming companies full stop. Some other funds have a materiality clause saying that if the business is driving less than 10 per cent of group earnings, we'll still invest in it.
"After consultation with our clients we decided to exclude them completely."
Instead, the fund outperformed through bets on Westpac Banking Corporation, Telstra, Cochlear, Woodside Petroleum and QBE Insurance Group.
Think before investing
Perennial's Socially Responsive Trust was formed in 1999 after parent IOOF surveyed around 5000 retail clients and gained positive responses for a product of this nature.
The fund's investment team looks at factors including environmental management, human resources management, occupational health and safety (OH&S), corporate governance and other ESG related factors before investing in companies. The product uses SIRIS research, is certified by RIAA and subscribes to CGI Glass Lewis for governance research. That is in conjunction with the normal financial analysis the fund conducts on stocks.
Companies with operations in tobacco, armaments, uranium, gaming, loggers of old growth forests and firms which perform inhumane testing on animals are shunned from the trust's investment universe.
"You've got to think before investing companies like BHP and Woolies - what is the long-term sustainability of some of the industries they are in?" Macdougall says.
"If you look at the gaming industry, you have licences issued by the government and if you don't perform your duties in a sustainable way or you don't behave like a good corporate citizen, your licence can get taken away.
"Now that has massive impact on shareholder value.
"I take the example of Tattersalls and Tabcorp. There were times under previous management teams that neither behaved in the interests of a number of their stakeholders. Consequently, they lost their gaming licences in Victoria."
Perennial's Socially Responsive Trust also uses its votes at companies' annual general meetings and often voices its issues to their boards.
Macdougall is concerned about social issues confronting oil company Oil Search, whose operations are mainly based in Papua New Guinea.
"Oil Search's relationships with Papua New Guinea's highland communities have been very good over the last 20 years," he says.
"Their interaction and the way they've treated, employed and helped a lot of those communities have been important in Oil Search's development.
"But the big liquefied natural gas development going on there is being proposed with ExxonMobil as joint partner, and that would see ExxonMobil become the operator of the project.
"Now ExxonMobil don't have the track record of relationships that Oil Search does, so from our point of view it's reasonably important as a shareholder of Oil Search that they are still involved in those relationships going forward."
He goes back in time to the example of the Bougainville mine off Papua New Guinea controlled by Conzinc Riotinto of Australia (CRA), which is now known as Rio Tinto.
CRA and the Papua New Guinea government's relationships with the community had broken down and the big copper-rich mine has not operated since those relationships collapsed around 20 years ago.
"You've got a community without income and you have shareholders without an asset - that's a lose-lose situation," Macdougall says.
Another interesting aspect about the SRI segment is that there are funds that don't inherently incorporate SRI or ethical principles but still fuse ESG factors within their financial analysis.
Playing politics
As a long-term investor, Tyndall believes that ESG considerations can affect the fundamental performance of investment portfolios, Tyndall's head of research Roger Collison says.
The firm's products aren't branded as "ethical" or with an SRI tag. The Tyndall Australian Share Wholesale Portfolio has added 7.91 per cent each year for the 10 years to 30 April, outpacing the S&P/ASX 200 Accumulation Index's 6.21 per cent annual gain in the same time. "Logically, it makes sense that those companies that integrate ESG considerations into their culture are well managed as they have a long-term outlook and plan for the business, which suits our own investment philosophy," Collison says.
"For example, [forestry group] Gunns is very controversial as it is turning Australian native trees into woodchips and exporting them abroad.
"Now a traditional analyst would look at Gunns and assess the profitability of its activities and consequently value the shares and the business.
"While we believe all those things are necessary, they're not a sufficient measure of value, and the reason why is there are a lot of Tasmanians against Gunns' activities and therefore there are a number of risks we need to take into account.
"For example, there could be a political response and the government may say 'you can't do these activities anymore' and there are also activists climbing up trees and disrupting Gunns activities.
"We believe that good analysis needs to take into account not just the earnings of the business, but in addition to that the risk to those earnings."
If the company still seems like a good investment after evaluating all the ESG risks and fundamental analysis, Tyndall will invest in it, Collison says.
Tyndall has also had discussions with Rio Tinto aimed at making the miner divest its stake in uranium producer Energy Resources of Australia (ERA).
"ERA is conducting its uranium mining operations in Kakadu. That's not a very good place to be mining in our view," Collison says.
Kakadu National Park is a well-known tourist attraction in Australia's Northern Territory.
It is on the United Nations Education, Scientific and Cultural Organisation's World Heritage List.
ERA's Ranger uranium mine is located within the park.
"We think the risks of doing significant environmental and hence reputational damage is particularly high and we have previously lobbied Rio Tinto to exit that business because we felt the risks were excessive.
"Now we still invest with Rio Tinto but we have try tried to use our position as a shareholder of the company in order to get them to change and sell their shares in ERA."
While Tyndall uses its position as a shareholder, Australian Ethical prefers a more passive approach.
"We vote with all our shares and actually do dialogue with companies," Thier says.
"However, what we try to do is identify and invest in companies that have excellent ESG principles and records from the start.
"So we will identify companies that are doing the right thing, but if they stray from their course we will engage with them, but we're not going to have dialogue with companies that don't already acknowledge the need for appropriate change.
"We're not going to try and turn the Titanic - that's not what we're about."
Thier is confident the SRI sector's fall in assets is only temporary and that in the long run the sector will do very well. "I certainly think this is an area people and superannuation funds are thinking more deeply about," Thier says.
"A number of people are also investing in direct shares using their own ethics and avoiding certain companies in their share portfolios and self-managed superannuation funds. That's an area where we'll never know the full statistics of.
"There is no reason why responsible investing couldn't become an established niche with 10 to 15 per cent of the entire Australian funds management industry in the longer term."
However, Perennial's Macdougall isn't as optimistic as Thier.
"I would be absolutely thrilled if that happened," Macdougall says.
"However, it's hard to see it happening. The industry still needs to get its message across and change the perception that SRI funds don't perform as well as mainstream funds."
Macdougall still feels the SRI sector has critical mass now and could band together to gain a larger piece of the Australian funds management industry by educating the planners, retail investors and institutional investors.
"There are enough of us around that have survived, have got critical mass and good performance, so I think we can get people to say 'that fund suits my values and the way I think about things, so I'll invest with them,'" he says.
Macdougall agrees that the industry needs a consistent message.
One of the points he makes is that the SRI sector uses a spectrum of terms including "ethics" and "sustainability".
"As soon as you start using the word ethical you venture into people saying 'what is it you're trying to do?' And the message starts to get confusing," Macdougall says.
