Researching Ethical Funds – A Case Study
A way of considering the ethical and sustainable investment strength of funds is through the lens of our unique Four Ps approach. This methodology is drawn from my PhD research and my extensive experience analysing managed funds. The funds in Money Matters’ most ethically strong portfolios and the investments that make up those funds are most likely to rate highly in terms of the Four Ps – Purpose, Principles, Practices and Performance Measurement.
I’ll illustrate the Four Ps framework, and how an investor can use this to help understand the ethical dimensions of a fund. I’ve shown below how I used the Four Ps to prepare for my latest podcast ‘Investing in International Shares with Pablo Berrutti’. In the podcast Pablo expands on these points. Pablo is a Sydney-based Portfolio Specialist with Stewart Investors. We discussed the ‘Stewart Investors Worldwide Leaders Sustainability strategy’ as a case study of investing in international shares. In forming a view of a particular fund’s ethical strength, Money Matters usually draws upon a range of other sources including specialist third-party research firms.
This discussion comes with the usual disclaimer. Please note that Money Matters is not endorsing or recommending the fund or strategy. You are encouraged to consult with a qualified financial adviser before making any investment decisions. Investing involves risk, including the potential loss of principal. Always consider your own financial situation, risk tolerance and ethical profile before investing in any securities or investment strategies.
Purpose
The first P is Purpose, a fund’s reason for being. For Money Matters an ‘Ethical Strong’ fund ideally has a purpose to create not just financial wealth, but social and environmental wealth, too. This purpose is expressed in terms of both ‘making money’ AND ‘making a difference’. In contrast, ‘Ethical Light’ funds may see their purpose solely as ‘making money’ and only consider environmental, social and governance (ESG) factors to enhance risk-adjusted returns. ‘Ethical Light’ funds tend towards a shorter-term horizon for their investments than their ‘Ethical Strong’ counterparts.
The Stewart website states that it aims “to invest over the long term in high-quality companies that contribute to, and benefit from, sustainable development. We define sustainability as improving human development outcomes within the environmental limits of our planet.”
Principles
The second P is Principles, the beliefs, core values and virtues that guide a fund. In my PhD I explored Aristotle’s guiding principles such as caring, courage, honesty and fairness.
Stewart Investors place a strong emphasis on the principle of ‘stewardship’. Their website notes that the Stewart definition of stewardship includes being “custodians who understand and carry out their responsibilities with integrity and respect for the people who rely on them and on whom they rely, and for the society around them. Ultimately, good stewards put the interests of others ahead of their own.”
Stewart goes as far as requiring each new member of the investment team to sign a strict code of conduct which they call a ‘Hippocratic Oath’, pledging to uphold the principle of stewardship through their conduct and work practices. This includes “We will not, however, pursue these returns to the extent that our actions will knowingly harm others”.
Practices
Having considered Purpose and Principles, let’s turn to our third P – Practices. These are the actions a fund takes to fulfil its Purpose and Principles and is where the true test of these commitments applies. At Money Matters we consider Practices in the context of four of the main ethical fund approaches:
Exclusions also known as avoidance and negative screening
Inclusions also known as positive screening
Voting regarding shareholder proposals
Engagement with companies to encourage change
Let’s explore these practices for the Stewart Investors Worldwide Leaders Sustainability strategy.
Exclusions
Stewart Investors publish a position statement about “Our position on harmful and controversial products, services or practices”. Subject to any exceptions detailed in their position statement, Stewart “does not invest in companies with material exposure to harmful or controversial products, services or practices. We appreciate that our clients reasonably expect clarity on their exposure to negative activities. The table in the position statement includes information on the products, services and practices we find inconsistent with our investment philosophy. For those products and services that generate revenue for a company, we have set a materiality threshold for direct involvement in the relevant activities of 5% of revenue (unless otherwise stated, e.g. production of tobacco has 0% materiality threshold)”.
Regarding the issue of fossil fuels – the position statement says, “We will not invest in companies that have a material exposure to the exploration, production or generation of fossil fuel energy.” Stewart Investors adds: “We define fossil fuels as coal, unconventional oil & gas (arctic drilling, oil sands, shale energy), and conventional oil & gas. The Funds consider exploration, extraction, power generation, transportation, distribution, refining or providing dedicated equipment or services as part of the value chain.”
Human rights is another example of an exclusion where Stewart states: “We do not invest in companies with poor records in relation to globally accepted human rights norms and standards, including modern slavery, child labour, capital punishment, indigenous rights and community impacts. No materiality threshold applies to this item.”
Another example is bribery and corruption for which Stewart states: “We do not invest in companies where we have formed the view that there appears to be cultural or systemic weaknesses that we believe can lead to bribery and corruption being perpetrated.”
Inclusions
Turning to the second Practice – ‘Inclusions also known as positive screening’ - the Stewart website describes how the fund has an overarching approach of wanting to include companies well positioned for long-term sustainable development. In a section on the website titled ‘How we select companies’ an analogy is provided of “walking along a beach looking for 50 of our favourite shells”:
“We know what we are looking for in our collection, but we won’t be looking at every shell on the beach to find them. And we are likely to spot new shells each day we go and will continue to do so for years to come. Such is the task of operating in a universe of 65,000 companies.” Further on, the website says, “When we get to the beach, how do we know where to start looking? Our emphasis on long-term sustainability positioning helps in this regard as we have a strong focus on seeking out those companies which support and profit from the ongoing transition to a genuinely sustainable future. In simple terms this means human development within the ecological limits of our planet. This is where we focus. Companies immediately stand out for providing sustainable goods and services, responsible finance or required infrastructure.”
The website provides a range of investment examples that I highlighted to discuss with Pablo including:
Infineon Technologies, a German listed company with a market capitalisation of $48bn. Infineon is described as a “Leader in the field of power management semiconductors”. The company was spun out of Siemens in 1999 and has established itself as the world’s go-to provider of chip design for energy efficient data centres and artificial intelligence, transport (for automotive power distribution in electric vehicles), smart homes and buildings, robotics, and power conversion for renewable energy.
HDFC Bank, an Indian listed company with a market capitalisation of $132bn is described as: “The leading mortgage provider in the world’s largest democracy, with the largest, youngest, and best educated population of any country”. The company was founded in 1977 by H.T. Parekh to provide banking services to the unbanked people of India. More recently, it has brought digital banking services to this large population.
Voting
At Money Matters, we consider that a fund with a record of strong voting in favour of shareholder proposals for environmental, social, and governance action is generally more ‘Ethical Strong’ than a fund that does not vote or votes against such proposals.
The Stewart website shows that in the last calendar quarter there were 332 resolutions from 26 companies to vote on. An example of one of these was governance where the fund voted against the appointment of the auditor at several companies. The website states: “We did this as they have been in place for over 10 years and the companies have given no information on intended rotation. We believe rotating an auditor on a relatively frequent basis (e.g. every 5-10 years) helps to ensure a fresh pair of eyes are examining the accounts and follows best practice.”
Another example relates to Expeditors, a service-based logistics company with headquarters in the USA. The website states: “We voted for a shareholder proposal encouraging alignment with the Paris Agreement with regards to greenhouse gas (GHG) emissions targets” – I also asked Pablo to expand upon this.
Engagement
The Stewart website notes that the Principles for Responsible Investment (PRI) defines engagement as “interactions between the investor and current or potential investees on ESG issues. Engagements are undertaken to influence (or identify the need to influence) ESG practices and/or improve ESG disclosure”. The website then states: “To us, engagement runs much deeper than that” and includes the following:
As long-term, bottom-up investors, our interactions with companies aren’t limited to ESG issues in a transactional sense. Rather, we seek to build relationships around a shared objective of improving the company’s quality and sustainability positioning for the long-term benefit of all stakeholders.
Our engagement is prioritised at a company level, and we engage on issues including: pollution; natural resource degradation; biodiversity and climate change; fair wages, gender pay gaps and incentives; governance; human rights and modern slavery; diversity, equity, and inclusion; as well as addictive products.
Engagement takes many forms but we broadly adopt three main approaches, without any specific order of priority, often utilising more than one method over the length of the engagement:
Bottom-up: driven by company analysis and monitoring, by engaging directly with companies we seek to build strong, long-term relationships.
Thematic: cross-cutting issues identified by the investment team, often supported by commissioned research, and always related to company circumstances.
Collaborative: tackling systemic issues that affect investee companies, and companies outside our fund portfolios. We take both lead and supporting roles, working together with peers, the wider industry and clients.
In our podcast, Pablo provides further insights for listeners with some fascinating examples of engagement.
Performance Measurement
Having considered Purpose, Principles and Practices, we turn to our fourth P - Performance Measurement. This is qualitative and quantitative reporting on how a fund’s Practices and investments have made an environmental and social impact, reflecting its Purpose and Principles. This is in addition to the usual consideration of a fund’s financial performance.
The fund’s website provides a ‘Portfolio Explorer’ described as a tool “to tell the stories of the companies we invest in … so that our clients and other stakeholders can see why we believe that the companies we invest in are making the world a better place”. The website explains how this tool provides four views:
Map: Use this global view to find detailed company information including our investment rationales, risks and areas to improve.
Sustainable Development Goals (SDGs): The 17 SDGs are globally agreed goals that countries have committed to achieving by 2030. The SDGs offer a vision for the future towards which sustainable investment efforts can be directed.
Climate solutions: We map companies to Project Drawdown’s c.90 climate change solutions. Project Drawdown is a non-profit organisation that has modelled over 90 different climate solutions that it believes will contribute to reaching ‘drawdown’ – i.e. the future point in time when levels of greenhouse gases in the atmosphere stop climbing and start to steadily decline. The solutions are diverse and cross-cutting, and show the systemic change needed to avoid catastrophic warming.
Human development pillars: We have developed our own 10 human development pillars, by reference to, amongst other things, the UN Human Development Index that we believe encapsulate the essence of human development.
The Stewart Investors Annual Report provides further description of the strategy’s performance across various dimensions. It also looks ahead stating:
“We remain focused on delivering our investment philosophy with an exclusive focus on identifying and investing in high-quality companies that contribute to, and benefit from, sustainable development. In addition, we have several specific priorities, that include:
continue to evolve our approach to engagement tracking and reporting
make progress on existing engagement activities, including climate, conflict minerals in the semiconductor supply chain, smallholder supply chains, diversity, plastic waste
undertake new research tenders on sustainability issues to support our investment and engagement activities
enhance our Portfolio Explorer tool on our website to incorporate more data and improve usability.”
Pablo expanded on Performance Measurement sharing his specialist expertise measuring and managing the challenges of making a difference. He also provided insight into what he and Stewart Investors fund are looking forward to.
I hope you have found this walk through of The Four P’s – Purpose, Principles, Practices and Performance Measurement – a useful way of learning more about how an ethical fund can be considered. To learn more, listen to our podcast for a very informative conversation with Pablo.
Now for another Disclaimer: The content provided in this blog is for informational purposes only and should not be construed as investment advice or an endorsement of any specific investment product or strategy. Any references to specific investment products should not be considered as recommendations to buy, sell, or hold such investments. You are encouraged to consult with a qualified financial adviser before making any investment decisions. Money Matters does not endorse or recommend any specific investment products or services mentioned in this blog. Past performance is not indicative of future results. Investing involves risk, including the potential loss of principal. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed. Always consider your own financial situation and risk tolerance before investing in any securities or investment strategies.