Episode Details

On the off-chance that you're one of the few people who read the information sent out by their superannuation fund, you might have noticed that in recent years they've added an Ethical Investment option. Now the exact labelling of that option will vary – it might be called Socially Responsible, Sustainable, or just Responsible, all of which are interchangeable terms for ethical investment options.

So given these options are popping up like mushrooms in a wet cow paddock, what do they mean, what's happening under the hood that makes then different to other investment options, and bottom line – should you care?

Each year the Responsible Investment Association of Australasia (RIAA) produces a Benchmark Report which tracks the adoption of ethical investment options, and their performance. In their most recent report (2017) they found that funds adopting a "core" responsible investment approach outperformed their peers over the longer term, both in the Australian share and International share space. That superior performance doesn't happen every year, but the RIAA data has found fairly consistently over the years that when measured over the medium to long term, an adoption of an ethical investment approach has delivered improved returns for investors.

And so it is for this reason primarily that ethical investment options, once an extremely niche offering that was expensive and little understood, has broken into the mainstream. In fact RIAA found that 44% of all of Australia's assets under management are now being invested through some form of responsible investment strategy.

Now there's two interesting paths to wander down at this point. The first is what does it mean to invest "responsibly", and the second is, why is the adoption of this approach leading to improved returns.

What does Ethical Investment mean?

As you might guess from the number of inter-changeable terms used to describe this investment process, there is no single definition of what makes an investment an Ethical one. This is hardly surprising, since ethics is something formed by an individual, and whilst in society there is likely to be much commonality on what is "ethical", there will also be considerable room for disagreement.

In a broad sense, ethical investment means considering "ESG" factors when contemplating an investment. ESG stands for Environmental, Social, and Governance. So in considering these factors, fund managers or investors are thinking about a business in a broader context than just the profit and loss statement and balance sheet.

The adoption of the consideration of ESG factors by professional investors has been where the bulk of the growth in this space has occurred. But of course, just because you've considered these factors, doesn't necessarily mean that you won't still decide to invest in a coal mine or a weapons manufacturer.

The next tier up is what RIAA defines as "Core" responsible investment funds. They define this subset as:

"Core responsible investment approaches apply at least one of the following primary strategies: negative, positive or norms-based screening; sustainability themed investing; impact investing, community finance; or corporate engagement."

I'd suggest that if you're someone who finds the idea of ethical investment interesting, then this definition and the fund managers that fall within it, are what you are seeking.

So let's unpack that definition a little because there's plenty of jargon in there. Negative screening means that the fund might have certain industries that they undertake never to invest in. The most common are fossil fuel mining, tobacco, and weapons manufacture.

Here's an example from one of the more stringent local listed funds:

(Companies invested in) can't be materially associated with a range of activities that could be deemed incons