July 2006

The Nation Reviewed

The myth of ethical investment

By James Kirby
Illustration by Jeff Fisher.

Did you know that Woolworths now controls 14,000 poker machines? The supermarket company has followed the money down the street to the pub, where cash that some might say should be spent on groceries is instead being spent on the often fruitless activity of trying to get three oranges in a straight line on a screen. So, is Woolworths still a supermarket chain, or is it a gambling company? And if it’s a gambling company, should ethical investors – those of us who try to exert some control over what’s done with our money – avoid investing in this immensely popular stock?

After a decade-long share-market boom – only marginally clouded by the reversals of early June – ethical investing has moved from the margins to the mainstream. From a standing start in the 1980s the industry has flourished, and today there is at least $7 billion in funds that lay claim to being guided by ethical considerations. But when you get that sort of money washing around, the pioneering idealists that started the industry suddenly face stiff competition. What’s more, the working definition of “ethical” becomes malleable.

The stakes have risen so high because of compulsory superannuation. On 1 July 2005, “superannuation choice” became law, allowing employees to choose where they invest their superannuation money. It’s no coincidence that the range of ethical funds is widening dramatically. But are all these funds, well, ethical? If Woolworths’ gambling activities came as a surprise to you, no doubt it will seem just as odd that some ethical funds have invested in the asbestos company James Hardie and the uranium miner BHP.

It’s a problem of definition. For efficiency’s sake, commentators like to lump all the ethical-style funds together. But inside the industry, there are apparent distinctions between ethical investing, representing the original purist approach; socially responsible investing, a kind of pro-active ethical investing less likely to have outright bans on companies; and sustainable investing, which is evolving into a pragmatic approach that seeks to “do the right thing” for long-term growth. Unfortunately, the distinctions don’t amount to much. Everyone, it seems, has a different definition; some players even define their principles on the run. As the Catholic theologian Germain Grisez warns, “While certain ethical investment vehicles are advertised as ‘socially responsible’, the notion of socially responsible here may not reflect a judgment conformed to Christian principles.”

Why has it come to this? Why can’t ethical funds apply a baseline test of “Christian principles”, or a similar, secular version of an ethical litmus test? The answer lies in the highly competitive nature of financial services: everyone wants to invest ethically, but nobody wants to lose money.

Last year, as resource stocks – which are often avoided, on environmental grounds, by ethical funds – drove the market higher, ethical funds failed to keep pace. The ratings agency Morningstar has said that mainstream funds gained 21.9%, while ethical funds rose by 18.89%. There’s the rub: 3% in lost profits. Over the longer term, the news is better. A swag of local and international studies show that ethical investments do not necessarily do better or worse than mainstream funds. In the vernacular of investment management, they are “cost-neutral”.

Still, it’s surely logical that the more restricted your investment range, the less likely you are to make money. This problem is most acute for purist ethical funds that want to invest in progressive new products such as medical technology or telecommunication software. For overseas funds located in London or New York, there is no lack of choice. In fact, both the US and the UK have deep enough stock markets to maintain specialist indices such as the Dow Jones Sustainability Index and the 4Good Index, which provide a benchmark for ethical investments. But there are slim pickings for the Australian funds, forced to make the best of the meagre offerings on the resource-laden Australian Stock Exchange.

One of the oldest and largest ethical funds on the ASX is Australian Ethical Investment, which has led the pack in banning Woolworths after its move into gambling. But AEI is suffering because of its hardline approach. Many of its rivals are growing faster than it is. While AEI and other traditional funds still espouse such high-minded ideals as “the preservation of endangered eco-systems”, newer fund managers such as Ausbil Dexia talk about “ethical opportunities”.

In the battle to gain a few extra percentage points, the ethical war may be lost. James Thier, an executive director of AEI, says ”ethical” must always come first, and “investing” second. “ That’s our rule,” he explains over (predictably) a soy coffee in a Paddington bookshop.

Who should we believe? I have my superannuation controlled by the superannuation consultant Mercer, and the whole lot is in “socially responsible” investments. I signed a form a few years ago and sat back thinking that my nest egg would sidestep nuclear reactors and godforsaken all-night pokie joints. But has it? Recently, I rang the Mercer inquiry line and asked what ”socially responsible” actually means: does it exclude nuclear power? A cheery voice at the end of the line said, “They avoid all that sort of thing.”

“Could you be more specific?” I asked. “Does it have uranium-mining investments or not?”

“I’ll have to refer you to the product disclosure document,” came the reply. “As I thought, sir, it says here the fund will consider issues like you mention when it invests.”

Yes, but consider is not the same as prohibit, is it? I often consider giving up eating meat, but I never do it. I don’t want my ethical-investment fund to consider; I want it to decide. Which, funnily enough, brings us back to supermarkets. Woolworths is modelled on Wal-Mart in the US. In 2004, it was revealed that Wal-Mart habitually locked night-workers in its stores to protect merchandise, and that, in many cases, employees did not have access to a key. The practice came to light when an employee had his leg crushed in a Texas store and could not get out. On 6 June this year, the world’s largest superannuation fund, Norway’s state fund, sold all its Wal-Mart stock, forcing down the Wal-Mart share price. The fund, a model for the Australian government’s Future Fund, would no longer deal with the giant US retailer, citing the company’s “systematic human rights abuses” as the reason for its decision.

The Norwegian state fund is not an “ethical”, “socially responsible” or even ”sustainable” fund. It’s just a fund run by people with ethics. We’d all probably be better off if there was no ethical-investment “industry”, and instead more funds run by ethical fund-managers.

James Kirby
James Kirby is a financial journalist. He is the author of the book series Business Secrets, and the managing editor of the online Business Spectator and the Eureka Report.

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