Is a new threshold for ethical investing imminent? A point where hundreds of thousands of Australian investors get serious about aligning their personal and financial values, and pour billions into ethical funds? And, if so, how can one benefit from the trend?
Ethical investing, finally, is getting serious traction in Australia. Ethical funds grew 62 per cent in 2015 to $52 billion, according to the latest Responsible Investment Association Australasia (RIAA) Benchmark Report.
Assets under management in ethical funds have doubled in two years. These funds are collectively small – about 3.8 per cent of all professionally managed assets in 2015 on RIAA numbers. But they are growing quickly as more investors favour ethical investing.
Some I know in the industry expect the sector to double again within three to five years. Should that happen, another $52 billion will flow into ethical actively managed funds, exchange-traded products and listed investment companies.
Do the math on the average investor balance in ethical funds (about $70,000 on some estimates) and another 700,000 Australians could invest ethically by 2020.
These forecasts are not as ambitious as they sound. A new generation of investors, the “Millennials” (aged roughly 25-36), show far greater interest in ethical investing than previous generations. Thankfully, they understand the power of investment capital to shape the planet and create positive community outcomes.
Rising consumer concerns about climate change bode well for ethical investing. Avoiding companies that own fossil-fuel projects, such as coal miners, is a trigger for many investors to choose ethical funds that avoid harmful sectors.
Another driver of ethical funds is returns. There was always a perception that investing in ethical funds was about values. Returns came second. Avoiding harmful sectors such as tobacco, weapons, fossil fuels and gambling supposedly meant sacrificing returns.
But ethical funds have collectively outperformed the market over one, three, five and 10 years, RIAA research shows. Many academic studies confirm that companies with high Environment, Social and Governance (ESG) ratings outperform the market over time.
Then there is risk. The boom in global shareholder activism is putting companies with poor ESG and those in harmful sectors in the spotlight. Owning responsible companies in responsible sectors is as much about risk reduction as it is about values and returns.
I see an important inflexion point for ethical investing in Australia in the next three to five years. One that takes ethical investing from a niche category to the mainstream.
Ethical investing proponents will argue this trend has been underway for years. True enough. But the figures show a rapid escalation in the past two years and forecasts suggest a bigger expansion. That should mean billions of dollars flowing into ethical funds.
When it comes to investment trends, I have learned over many years to follow the product issuers as much as the sector forecasts. Those who live and breathe investment categories each day know better than anybody about future opportunites in their segment.
The increase in exchange-traded funds (ETFs), listed investment companies and active funds that are, to a varying degree, investing ethically, is telling. Big product issuers clearly see plenty of growth ahead, so are ramping up their ethical product suite.
If anything, the risk is that too many “light-green” products come to market. They purport to be ethical but do little more than exclude sectors, such as weapons and tobacco, that most Australian investors do not have exposure to anyway. And charge higher fees.
Benefiting from growth in ethical investing
Investing in wealth managers rather than their funds has been a rewarding strategy over the past decade. Think Magellan Financial Group, BT Investment Management, Henderson Group, Platinum Asset Management and Perpetual, to varying degrees.
Australian Ethical Investment, a leading manager of ethical funds, appeals. The ASX-listed company is one of the market’s most respected ethical investors and a well-performed manager.
Australian Ethical’s funds under management grew by 35 per cent in the first half of FY2017. But the share price fell in the second quarter after weaker earnings guidance, principally because of one-off technology issues around unit-pricing errors affecting its superannuation funds.
Australian Ethical has rallied from a low of $80 in May 2017 to $90, but remains below its 52-week high of $95.20. The stock has been a terrific long-term performer: the five-year annualised total return (including dividends) is 42 per cent.
On that measure, Australian Ethical is among the market’s best-performed small-caps, but it tends to fly under the radar in discussions on hot small stocks. The company cracked $2 billion in funds under management in April 2017 – an important milestone.
Well-run fund managers have a knack of delivering rapid earnings growth when their funds outperform the market and their asset base swells. As an acknowledged leader in a fast-growing segment, Australian Ethical has significant tailwinds.
That is not new to the market. Investors bid up Australian Ethical’s price because they saw the potential for larger assets under management, fees and earnings – and the company’s leverage to growth in ethical investing.
But I suspect the market has underestimated the medium-term potential of ethical investing and overestimated the impact of Australian Ethical’s technology issues and higher staff costs in key operational, risk and compliance roles.
As a $100-million company, Australian Ethical suits experienced investors who understand the risks of investing in micro-caps. The company is due for a price pullback after share-price gains in the past few weeks.
Chartists will look for Australian Ethical to continue holding above support at $80 and break through the $95 mark where there has been previous resistance, setting up the next leg of share-price growth.
Chart 1: Australian Ethical InvestmentsSource: The Bull
• Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at June 1, 2017.