Ethical investing guide

You might be surprised where some ethical and sustainable funds invest your money.
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02.Types of fund

The industry, which can be broadly labelled the ‘responsible investment’ (RI) sector, offers two distinctly different types of fund. Their names are often used interchangeably and some RI funds use a combination of the two approaches:

"Ethical" funds

Investment strategies are guided by an ethical or moral framework.

  • The fund manager usually seeks out companies that it believes have a positive social or environmental impact. This is called positive screening — a ‘dark green’ approach.
  • At the same time the fund manager avoids companies that have a negative social or environmental impact. This is known as negative screening — a ‘light green’ approach.

Of course, how each ethical fund manager defines subjective terms such as ‘ethical’ and ‘positive impact’ differs. Their product disclosure statements, which are usually available online, should provide an explanation.

For examples of traditional ethical funds, see Deep green funds.

"Sustainable" and "responsible" funds

The majority of funds in the Responsible Investing sector define themselves as sustainable or responsible, rather than ethical. Some of these funds invest in industries such as gambling and tobacco, if they rate the companies chosen as being sustainable for the long term — a best of sector approach.

Other sustainable funds invest in industries that are usually negatively screened out, as long as the revenue that the companies chosen get from those industries is not a ‘material proportion’ — for example, 5% or more — of their overall revenue.

In fact, many of the top shareholdings of these ‘sustainable’ funds end up being very similar to the shares held by the same companies’ ordinary investment funds.

Changing names

There’s been a reduction in the number of firms calling themselves ‘ethical’, with terms like ‘sustainable’ and ‘socially responsible’ used instead.

Even the industry’s representative body, the Ethical Investment Association, has changed its name to the Responsible Investment Association of Australasia. “The name change reflects an expansion of the sector rather than a shift away from ethical investing,” says its Executive Director, Louise O’Halloran. “Our name will now be in line with the growth in the sector and capture the diversity of our members.”

Most of the sustainable funds listed in Table 1 of Funds compared restrict investment in certain industries, although some have relaxed the rules in recent times. For example, BT changed its position on uranium in 2005, allowing into its ethical and sustainable portfolios companies that mine it for use in nuclear energy, arguing that it’s cleaner than coal. That’s a controversial issue, though — some deep-green investment funds still oppose uranium.

AMP’s Sustainable Funds team thinks nuclear power and the uranium industry are neither financially nor environmentally sustainable. It doesn’t invest in companies that are ‘primarily’ involved in uranium mining, but does invest in BHP, which gets less than 5% of its revenue from uranium. For more information, see AMP's position paper on uranium.

Best of a bad lot?

Some sustainability funds take a ‘best of sector’ approach, allowing them to invest in, say, the top 20% to 35% of companies in every sector, ranked on sustainability performance grounds. This can allow funds to invest in companies from every industry, as long as they rank the companies chosen comparatively well for environmental, social and governance (ESG) criteria.

For example, Sustainable Asset Management (SAM), which developed the Dow Jones Sustainability Index (DJSI) and the Australian SAM Sustainability Index (AuSSI), can invest in any industry, as long it believes the sector and at least one of its companies are moving in a positive direction towards a sustainable future, and the sector has listed companies on the stockmarket.

The DJSI has 58 industry sectors including, for example, tobacco. Although cigarettes cause enormous health problems, SAM rates British American Tobacco as being the ‘sustainability leader’ in the tobacco sector, noting that it broke ranks with the rest of the tobacco industry by admitting that its product is addictive. “The company is moving to reduce its negative impact on society, admittedly from a very poor starting point,” says a spokesperson from SAM. “Sustainability leadership suggests that while a product like cigarettes isn’t illegal, a leading company must be in the frontline of its industry’s efforts to reduce the negative impact of its business on society, in a manner that’s in the long-term profitable interest of the company as well as the long-term social, environmental and economic interest of the community.”

SAM also gives the example of firearms manufacturer Smith and Wesson, which introduced child locks to handguns a few years ago: “That’s an example of a company evolving and leaving the dinosaurs in its sector behind.”

Jargon buster

  • Ethical investing: Investment approaches that reflect the ethical preferences of the investor.
  • Sustainability: The concept that humanity should act in a manner that doesn’t undermine the options available to present and future generations.

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