Many individuals would like to incorporate social values as part of their investment decisions, but do not want to sacrifice performance in doing so. Vicki Stylianou examines the performance of these investments and the opportunities available for SMSF trustees.
The superannuation pool in Australia has topped $2 trillion, with $2.022 trillion held as at August 2015. Of this, $592 billion was held by SMSFs, with 559,467 funds consisting of 1 million member accounts.
This is by far the largest retirement savings segment compared to corporate, industry, public sector and retail funds in terms of total assets and number of funds (not number of accounts). According to Association of Superannuation Funds of Australia August 2015 statistics, total superannuation assets increased by 9.9 per cent in the 12 months to June 2015.
Where do SMSF trustees invest their $592 billion? What advice do they receive from their advisers about asset allocation and what criteria are used when making these decisions?
In the United States, United Kingdom and European Union, responsible investment has become a major consideration for many investors when making a decision about where to put their money. This has also emerged as a growing trend in Australia.
What is responsible investment?
According to the US Forum for Sustainable and Responsible Investment, sustainable, responsible and impact investing (SRI) is an investment discipline that considers environmental, social and governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact.
There are various reasons for SRI, including personal values and goals, institutional mission and the demands of clients. Sustainable investors aim for strong financial performance, but also believe these investments should be able to contribute to advancements in social, environmental and governance practices. They promote client value from client values.
Just as there are numerous approaches to SRI, there is no single term to describe it. It has been called community investing, ethical investing, green investing, impact investing, responsible investing, sustainable investing and socially responsible investing among other things.
The Responsible Investment Association Australasia (RIAA) states: “Responsible investment is a process that takes into account ESG and ethical issues into the investment process of research, analysis, selection and monitoring of investments.”
The United Nations Global Impact Principles for Responsible Investment (PRI), launched in 2006, recognises the impact on our market-based economies of the growing array of social inequalities, environmental impacts and negative externalities that are affecting companies. It acknowledges the relevance of ESG factors and recognises the generation of long-term sustainable returns is dependent on stable, well-functioning and well-governed social, environmental and economic systems. It is driven by a growing recognition in the financial community that effective research, analysis and evaluation of ESG issues is a fundamental part of assessing the value and performance of an investment over the medium and longer term, and that this analysis should inform asset allocation, stock selection, portfolio construction, shareholder engagement and voting.
Familiar concepts
Corporate social responsibility (CSR), which has been around for many decades, is based on the ISO26000 Guidance Standard on Social Responsibility and defines CSR as: “Social responsibility of an organisation for the impacts of its decisions and activities on society and the environment, through transparent and ethical behaviour that contributes to sustainable development, including the health and welfare of society.”
Triple bottom line, coined by John Elkington in 1994, describes the separate financial, social and environmental bottom lines of companies. It measures the company’s economic value, ‘people account’, which measures the company’s degree of social responsibility, and ‘planet account’, which measures the company’s environmental responsibility.
Integrated reporting (IR) is another worldwide initiative that should be familiar to many accountants and advisers. It recognises that globalisation and interconnectivity mean the world’s finances, people and knowledge are inextricably linked. IR was created to enhance accountability, stewardship and trust. It states that providing investors with the information they need to make more effective capital allocation decisions will facilitate better long-term investment returns.
Strategies for responsible investment
There are various strategies and approaches in relation to SRI. Essentially, ESG criteria are incorporated in investment analysis and portfolio construction across a range of asset classes.
There are three common approaches for SRI, including a negative screen where the money doesn’t fund harmful things (examples include tobacco, uranium or coal mining, exploitation of people or old growth forest mining).
Then there is the positive screen where your money helps to build things such as a new low-carbon economy, and fund medical breakthroughs, technology breakthroughs or an efficient transport network.
The other main strategy is for those with shares in publicly traded companies and involves engagement with the company to encourage responsible business practices and to allocate capital for ESG principles.
SRI is where companies are generally screened out if they take part in excluded activities, but may be included if their commitment to social responsibility outweighs the negative aspects. Sustainable investing is where investments are chosen on the basis of how well a company manages ESG factors, not on what it makes or sells.
Is responsible investment growing?
So, given the greater consumer interest, has this translated into more capital flowing into responsible investing? The RIAA “Responsible Investment Benchmark Report 2015 Australia” states total assets managed under responsible investment strategies had grown to encompass 50 per cent of Australian total assets under management (TAUM) or $629.5 billion as at 31 December 2014.
Investments managed under core responsible investment strategies – those traditionally referred to as ethical or SRI, including screening, as well as impact investments, community finance and sustainability-themed investments – rose by 24 per cent to $31.6 billion (after having increased 50 per cent the previous year). According to Morningstar, TAUM in Australian managed funds at the same point in time was $1270 billion (an increase of 15 per cent on the previous year), meaning that total responsible investment portfolios represent 50 per cent of TAUM in Australia.
In the EU, impact investing inflows jumped 132 per cent to over 20 billion euros between 2011 and 2013 in 13 European countries (according to non-government organisation Eurosif in its latest survey), making it the fastest-growing SRI strategy. Capital allocation to engagement and voting, which implies active shareholder voting to influence a company’s behaviour in order to increase their disclosure on ESG matters, grew 86 per cent over the period. Assets invested in green bonds and micro-finance ventures grew 22 per cent to 16.8 trillion euros in this period.
The US SIF, the Forum for Sustainable and Responsible Investment, in its 2014 “Report on Sustainable and Responsible Investing Trends in the United States”, stated as at year-end 2013, more than one out of every six dollars under professional management in the US – over US$6.57 trillion – was invested according to SRI strategies. From 2012 to 2014, SRI investing had a growth rate of more than 76 per cent.
That means 18 per cent of the US$36.8 trillion in TAUM is involved in SRI.
The UN PRI initiative has 1380 signatories to its six principles, including asset owners, investment managers and service providers, with US$59 trillion in assets under management, up from US$4 trillion at inception in 2006. This is an increase of almost 15 times in less than nine years.
Does responsible investing lead to better financial performance?
A growing body of academic research shows a strong link between ESG and financial performance. The UN PRI cited a study by Eccles et al (2011), who conducted an empirical study over 18 years and found, over the long term, corporations that adopted environmental and social policies many years ago significantly outperformed those that hadn’t, both in terms of stock market and accounting performance. In 2012, Deutsche Bank conducted an analysis of 100 academic studies, 56 research papers, two literature reviews and four meta studies and found CSR and ESG are correlated with superior risk-adjusted returns at a securities level. They noted CSR has evolved into ESG. Studies of fund performance (SRI that relies on exclusionary screens) show SRI adds little upside, although it does not underperform either. ESG at an analytical level works for investors and for companies both in terms of cost of capital and corporate financial performance. That is, positive and ESG approaches appear to perform better than the negative/exclusion approach.
The world’s oldest socially responsible fund, the Pax World Balanced Fund, was launched in the US in 1971, while the Vice Fund was launched in 2002 and is the industry’s oldest ‘sin fund’ (as they are known). Over the years there has been no equivocal winner in terms of returns.
The RIAA “Responsible Investment Benchmark Report 2015” assesses the performance of responsible investment funds compared with their benchmark index and the average of equivalent mainstream funds. It found:
- Core responsible investment Australian equities funds strongly outperformed both the ASX 300 and the average large-cap Australian equities funds in all time periods across one, three, five and 10 years.
- Core responsible investment International equities funds outperformed the average large-cap international equities fund over one, three and five years, but slightly underperformed over 10 years.
- Core responsible multi-sector growth funds (that is, balanced funds) outperformed their equivalent mainstream multi-sector growth funds across all time periods of one, three, five and 10 years.
- Polling indicates 69 per cent of Australians believe it is important that super funds make responsible investments and avoid harmful investments.
- This year’s research has also observed new responsible investment product offerings targeting both retail and institutional investors and across asset classes, including exchange-traded funds, fixed interest funds, banking products, ESG smart beta funds and impact investment offerings, as well as themed bond issuances.
Options for SMSF investors and advisers
For SMSF trustees and advisers wanting to make an ethical investing choice, there are various options. Australian Ethical managed funds are one option, with 25,000 Australian clients (according to its website) and SMSFs being featured.
Choice suggests investors do their own homework and find out exactly where their money is going. They suggest if you’re considering ethical investment, that you look for an RIAA member fund. This is the peak body that created a certification program with the New South Wales Department of Environment and Conservation and the Victorian government in 2005 with a view to making uniform standards of disclosure for these types of products. Funds that pass qualify to carry an RIAA certification symbol. RIAA has 150 members managing over $500 billion in investments.
In the US, a 2015 report, “The next generation of American giving” by Blackbaud, found baby boomers contribute 43 per cent of charitable activity, and an Edge Research study estimated this same group gives US$47 billion a year in charity. The studies also conclude there has been a shift from estate planning to wealth management. Philanthropic strategies are now becoming a fundamental service and represent an opportunity for advisers. These services include impact investing with quality asset management, foundation creation, social entrepreneurship and tax planning.
Conclusion
Consumer demand and superior financial performance have driven a huge growth in ethical investment around the world, including Australia. This represents a great opportunity for SMSF advisers and trustees.
