Ethical and responsible funds fail to beat mainstream funds in the short term

While studies have claimed that responsibly invested (RI) or ethical funds have not compromised returns, data has found these funds have failed to outperform mainstream funds over various time periods.

FE Analytics data found that within the Australian equity superannuation fund universe, there were 39 funds labelled as ‘ethical/sustainable’. It was only over a very long-term time period that these funds were performing as well as mainstream funds. 

Over the 10 years to 30 September, 2019, the top 10 performing Australian equity funds comprised of six mainstream funds and four that were labelled as ethical or sustainable.

However, over one and five years only one ethical/responsible fund – Australian Ethical’s Australia share fund – made it into the top 10 performing super funds and none over the three years.

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Australian Ethical’s investment team head, David Macri told Super Review the fund used a fundamental bottom-up stock analysis that applied positive and negative screens to rule out harmful companies and industries such as tobacco and mining.

The fund sought out companies and sectors that had a positive impact on people, the planet, and animals as they delivered strong long-term returns and minimised volatility.

“Compared with the sharemarket as a whole, we are overweight in utilities (renewable energy), technology and healthcare and underweight in energy (fossil fuels) and materials (mining),” he said.

The Australian Shares fund also had a skew towards small caps due to the nature of their screening process.

“This skew means we don’t have the problem of ‘diseconomy of scale’. This is when funds get bigger and they can’t generate alpha that the small caps bring in their portfolio and they can’t access the illiquidity premium that part of the market brings,” he said.

“We identify these powerful trends to invest in companies that offer sustainable, attractive returns. These tend to be well-run companies that manage their environmental risks, look after their staff, and have solid corporate governance.

“As legislation and regulation increases operating costs for polluting businesses, companies involved in efficient technologies or pollution reduction should prosper.

Meanwhile, policy is increasingly being decided with sustainability in mind as ESG [environmental, social, and governance] considerations become mainstream. Companies embracing this will benefit financially.”

ETHICAL/RESPONSIBLE INVESTING CHALLENGES

Macri said one the biggest challenges was getting the industry and investors to “cut through the marketing and understand the difference between an ESG approach and a deep ethical approach”.

For example, he said, there were exchange traded funds (ETFs) that excluded armaments and considered themselves ethical despite not having a team of ethical analysts and rigourous screening processes.

“There’s been a lot of labelling recently of ESG and we’re worried that people start thinking that ESG is enough when it really isn’t a values driven approach at all,” he said.

“You expect fund managers to have a disciplined robust investment approach and the same should apply to their RI or ESG-type approach.

“If they’re doing the investment decisions themselves and it ticks all the boxes but they outsource ESG or ethical screening it shows they don’t really consider it to be all that important and that’s a red flag.”

Macri noted that another red flag was if the ESG/RI option was very similar to the underlying mainstream fund.