Social responsibility a rising priority for funds
Exclusion and engagement two ways to ensure holdings reflect values
ast week’s column looked at the issue of KiwiSaver investments in companies that manufacture cluster munitions, anti- personnel mines or nuclear explosive devices.
This week’s column examines the wider issue of socially responsible investment or sustainable and responsible investment, both referred to as SRI. This is an issue that will become increasingly important in the years ahead.
SRI is a generic term that combines the financial objectives of investors with environmental, social and governance ( ESG) issues. This is based on the concept that companies which place a great deal of importance on ESG issues will achieve superior financial returns.
The problem with implementing SRI is that we all have a different view of how the world can be improved. Many investors do not want to support certain products, including armaments, tobacco, alcohol and gambling facilities, while others are concerned about a number of broader issues including the impact of businesses on the environment and the widening gap between senior executive remuneration and wage earners.
There are two basic ways that investors can achieve their SRI objectives:
1) Negative screening whereby investors decide that they will not buy shares in companies involved in certain industries. These can include arms production, animal testing, businesses that violate human rights, those that have an adverse impact on the environment and companies involved in pornography, gambling, tobacco and alcohol.
2) Investors can become actively involved in governance issues to ensure that companies adopt best practice ESG strategies. This strategy involves engaging with management on ESG issues and voting against directors who have a history of not taking ESG issues seriously.
The Norwegian Government Pension Fund Global — the world’s largest sovereign fund with $ 1.2 trillion under management compared with NZ Super Fund’s $ 30 billion — takes SRI very seriously.
The Norwegian fund adopts the two- pronged approach described above. It does not invest in companies that are involved in the production of anti- personnel landmines, cluster munitions, nuclear weapons or tobacco. It also has conduct- based exclusions covering companies that seriously violate human rights, cause severe environmental damage or are grossly corrupt.
The fund also excludes organisations that have seriously violated individuals’ rights in war and conflict situations or have seriously violated ethical conventions.
Companies excluded by the Norwegian fund under these criteria include Serco Group, which manages AMP Responsible Investment Balanced Fund Craigs Investment Partners kiwiSTART Quay Street Balanced SRI Fund Grosvenor Socially Responsible Investment Balanced Fund Super Life Ethica Grosvenor Socially Responsible Investment Growth Fund OneAnswer Sustainable International Share Fund prisons in New Zealand, Airbus Group, Boeing Co, Wal- Mart and Rio Tinto.
Earlier this year the Norwegian fund decided to exclude thermal coal producers and electricity generators that use thermal coal. As a result the fund excluded an additional 50 companies, including ASX- listed New Hope and Whitehaven Coal.
One of the issues with SRI is that funds are less likely to exclude industries that have significant operations in their own countries. For example, the Norwegian fund has Balanced Balanced Balanced Balanced Growth Aggressive — 24.1 20.6 14.4 19.0 4.3 banned thermal coal but the country has minimal coal production and most of its electricity generation plants are hydro powered.
Genesis Energy, which uses thermal coal and is over 50 per cent owned by the New Zealand Government, would not be an excluded company under the Norwegian criteria but, even if it was, it is unlikely that the NZ Super Fund would exclude this NZX- listed company.
It is also highly unlikely that New Zealand would ban investment in alcohol producers, given the importance of the wine sector to the country and the substantial amount of financial and human capital invested in the burgeoning craft beer industry.
It is also highly unlikely that we would exclude investment in the dairy industry even if there was clear evidence that it was contributing to global warming and was polluting our rivers.
There is also the issue of whether distributors should be excluded as well as producers, particularly as far as tobacco is concerned. The Norwegian fund excludes 21 tobacco producers whereas the NZ Super Fund excludes 140 tobacco companies, a number of which appear to be distributors only.
One of the potential issues regarding tobacco is that the NZ Super Fund was a major shareholder in Z Energy until recently and service stations are an important distributor of tobacco products in New Zealand. A 2005 AC Nielsen survey showed that tobacco products were the number one non- petrol product, in terms of dollar sales, for service stations. The report noted that tobacco products made up more than 35 per cent of service station business.
A later survey showed that service stations have a 28 per cent share of the tobacco retail market, after dairies and supermarkets.
The other way the Norwegian fund, which owns 1.3 per cent of all global- listed equities, exercises its SRI and ESG objectives is through active engagement with companies. The fund calls itself “an active owner” and in 2015 held 3520 meetings with companies’ management and voted at 11,562 shareholder meetings. Its website has a record of all its voting decisions over the past three years.
In the past 12 months the Norwegian fund has revised its view on three major topics — children’s rights, water management and climate change — and will be placing much greater emphasis on these issues in the future. For example, it believes water shortages and water pollution are becoming major issues and businesses should have clear water management strategies, particularly as they rarely pay a commercial price for their water.
The engagement side of the SRI issues is just as important as the exclusion process and most New Zealand investors focus on the engagement side. The New Zealand Shareholders’ Association does an excellent job of engaging with companies and most New Zealandlisted companies have an open door policy to investors.
Most New Zealand fund managers are active are far as engagement with companies is concerned and exercising their voting rights at shareholder meetings.
There are six specific SRI KiwiSaver funds as identified by Mary Holm in her last two columns. These are listed in the accompanying table but there is no funds under management ( FUM) figure for the AMP Responsible Investment Balanced Fund because it was only launched on July 28.
There are a number of common characteristics to these six SRI funds:
They are small. In aggregate they represented only 0.2 per cent of total KiwiSaver FUM at the end of June.
Their fees are high. SRI fees range from 0.69 per cent to 1.49 per cent for the March 2016 year with an average of 1.22 per cent.
Their investment returns are below average. For the June 2016 year the returns varied between plus 6.8 and minus 11.4 per cent for an average of minus 0.4 per cent for the 12- month period. For the five years ended March 2016 these SRI KiwiSaver funds had an average annual return of 6 per cent. These figures are after fees and tax.
The problem with SRI is that it is an expensive process at a time when most investors are placing a huge emphasis on fees. The SRI exclusion process is complex and involves a large amount of research and analysis. Passive funds that have an SRI screening process usually charge higher fees than passive funds that mirror an index. These index- based funds may include manufacturers of cluster munitions, anti- personnel mines or nuclear explosive devices.
The other issue is whether SRI funds, particularly passive SRI funds, spend most of their time on the exclusion, rather than the engagement, process. There is mixed evidence on the issue as to whether SRI passive funds engage with management and whether they actually vote their shares at shareholder meetings.
The engagement and voting process is just as important as the exclusion process and most New Zealand KiwiSaver managers engage with NZX- listed companies and vote their shares, both here and overseas.
As a consequence, KiwiSaver investors should not assume that nonSRI funds do not take their SRI obligations seriously and there is a general acceptance that KiwiSaver funds will have to commit more resources to this complex and controversial issue in the years ahead.
Brian Gaynor is an executive director of Milford Asset Management.
The engagement and voting process is just as important as the exclusion process and most New Zealand KiwiSaver managers engage with NZX- listed companies and vote their shares, both here and overseas. The problem with socially responsible investment is that it is an expensive process . . .