Getting ethical about investing

Money managers meeting in Australia to discuss ethical investments argue that choosing companies on a best-of-sector basis fails the test. But is it realistic to establish an industry standard for picking stocks?

Buying stock in a company like Shell or BP because it conducts research into renewable resources does not make it a responsible investment, according to some of the fund managers attending a conference on sustainable and ethical investing in Australia last weekend. A record number of delegates turned up for the annual gathering which attracts money managers who buy stocks based on how much a company pays its staff, or whether it imports components from a third world country with a history of child labour, or whether it makes dangerous products. It is an investment alternative that is gaining popularity as money once invested in the dotcom industry starts looking for a new place to roost.

But a division is forming among the various managers who have different opinions on what constitutes a responsible investment. Some of the more conventional investors claim that big fund management firms are setting up ethical funds to be in vogue, but they are blurring the boundaries on ethics by using a best-of-sector approach to stock picking.

“This process of taking the best company in each sector, but not excluding any sectors, means that you might be eliminating the worst of the worst, but you are not necessarily investing in the best,” says James Thier, executive director of Canberra-based Australian Ethical Investment which has been operating since the 1980s and has A$120 million ($64.7 million) under management. “Based on this criteria, some of the funds connected to larger fund families would only exclude 11 of the top 100 companies in Australia for being unethical, whereas we can only find 11 companies that fit our stringent requirements.”

Delegates to the conference talked about the Hesta Fund, an ethical investor whose charter forbids investment in uranium but, through its best-of-sector approach, holds shares in the mining company Rio Tinto. (Rio Tinto owns North, one of the country’s dominant uranium producers.)

“Hesta will need to change its screening process if it wants to be known as a responsible investor,” says Terry Pinnell, a financial adviser for Directed Ethical Investment in Brisbane, who attended the conference. “There was a lot of discussion about setting up a standard criteria for the industry or an independent ranking system which would give companies an ethical rating, like a Standard and Poor’s credit rating.”

But the barriers to such an industry standard being formed are high. First, everyone investing in this manner has a different measure on what is considered responsible and what is not. Some funds might invest in fast food company McDonalds, for instance, because it spends big money on charities and education, while others would discard it based on its part in environmental degradation.

Investors like Thier say that companies need to be individually hand picked. And doing this can be time consuming and costly, requiring research into obscure sunrise industries such as complementary medicines or renewable energy. If the bigger fund managers were to scrap their best-of-sector method in favour of hand picking their stocks, they would need to widen their research nets to find companies that are not currently on their radar screens.

Pinnell says that while the industry remains immature and the definition of ethical behaviour remains ambiguous, it is unlikely that funds will agree on the right approach. “There are not that many companies which are true to the concept of sustainable investment,” he says. This is something that will need to addressed if the popularity of ethical funds continues to rise, attracting more and more money from Australia’s deep superannuation pool.