Sunday, January 25, 2009

Ethical Managed Funds

What is ethical investing and why should you choose an ethical fund manager?

Ethical or socially responsible investing is not an easy term to define. I always considered it to mean not buying shares in companies which operate in sectors such as gambling, tobacco, alcohol and mining of minerals such as uranium which might be considered damaging to society or the environment. So I always figured that an ethical managed fund would be one which holds investments outside of these sectors.

Having done a done a little research on this topic, it seems that this area is more complex than I first thought. According to the Responsible Investment Association of Australasia, there are a number of methods which fund managers (or investors generally I guess) can adopt in their approach to ethical investments.

Broadly speaking, there are 4 different methods. These are Negative Screening, Positive Screening, Best Of Sector and Sustainability Analysis.

Negative screening is essentially what I've already described. The fund manager will simply avoid investing in certain sectors of the stock market like those I mentioned above, but beyond that, they can buy shares in whatever companies they like provided they don't operate in those industries.

Positive screening on the other hand aims to identify specific companies whose operations are likely to have a positive impact on society and the environment. I guess you could consider this a more active approach.

The best of sector approach does not discriminate between industries but rather will seek out investments, within each sector, in a company which is seen to be the most 'ethical' in that sector. So the fund manager may invest in a company within the gambling industry but they would choose the company which could be considered a leader when it comes to sustainability.

Finally, sustainability analysis involves analysis of the entire stock market using information from a broad range of sources then ranking companies based on a set of standard criteria.
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Within Australia, the main players in this space seem to be Hunter Hall and Australian Ethical Investment.

Hunter Hall run a number of funds and seem to have a bias towards value investing. According to their website, Hunter Hall employ a negative screen which "restricts investment in companies that derive revenues associated with the sale of armaments or tobacco, gambling, cruelty to animals, destruction of the environment and uranium mining". You can choose from both listed and unlisted funds.

Australian Ethical Investment offer 5 different retail funds and a superannuation fund. As far as I can tell they seem to use the positive screen approach to their investing. And I'm sure I read that both Hunter Hall and Australian Ethical Investment donate a set percentage of profits to charity each year.

An interesting piece of information I picked up during my research is that the name of the Marketing Manager of Australian Ethical Investment is Roger Green. Does anyone else find that amusing?

One thing I kept reading was that ethical managed funds are more likely to underperform the market because they are restricted in what they can invest in. Given the recent resources boom on the Australian stock market, I'd be curious to know how these funds have fared over the past few years when compared to their 'less ethical' peers.

But even if there was evidence of underperformance, I suspect that if, as an investor, you feel strongly enough about social issues or about the environment to choose an ethical managed fund, then wearing a potential performance hit for your beliefs probably wont bother you too much.

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