Episode 45 - You say ethical, I say responsible! - How to incorporate principles of responsible inve
Updated: Mar 4, 2020
Climate change is very much front of mind at the moment after the horrendous bushfire season we are in the middle of here in Australia. It is starting to make its way into the decision-making process of investment firms and fund managers as key drivers of long-term profitability.
On this episode of the #mastersoffiancepodcast we take an in depth look at the current investment landscape, dissect another 3-letter acronym in ESG factors (Environmental, Social & Governance) and look at how you can incorporate some principles of responsible investment into your portfolio. Have a listen!
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Alex Hont 0:17
Welcome back to the masters of finance podcast. This is the first one that Chris and I are back in the studio for 2020 after our little money for jam series, and given what's happened over the Australian summer with the bushfires, and responsible investing coming to the fore, we thought we'd do an episode on it even though we've done one previously. So please have a listen to hear all about how you can invest ethically, sustainably, responsibly with climate change in mind. Have a listen.
Chris Haggart and Alex Hont are authorized representatives of Moran Partners Financial Planning. Any opinions expressed in this podcast are solely our own and do not reflect the opinions or views of Moran Partners Financial Planning or any entity we are associated with. This podcast is for informational purposes only and should not be used for or as a constitute investment advice
Okay, Chris Happy New Year 2020 I know we've done three podcasts, or two podcasts in 2020 already but here we are.
Chris Haggart 1:13
We weren't actually here though so
Alex Hont 1:15
no that was, we put those in the bank but welcomeback.
Chris Haggart 1:17
Welcome back everyone.
Alex Hont 1:19
How was your Christmas break?
Chris Haggart 1:22
I think I'm I don't know whether people are sick of you might be sick of hearing this but it was amazing.
Alex Hont 1:28
Why so Chris?
Chris Haggart 1:29
Well because you Why was it amazing? or why are you sick of hearing it?
Alex Hont 1:33
No I can listen to you a little bit more. But I only got this last one is the last time I'm going to ask you about that.
Chris Haggart 1:39
Yeah, so Naomi and I, my wife and I went down to Tasmania and for those of you who are walkers, you might have heard of something called the Overland Track. So it's a six day hike. We put everything on your back in and get rid of human communication essentially. So no mobile phones, no TV, no tech, no nothing.
Alex Hont 1:58
I joke that I did that, you know a couple of years ago went down to the Overland Track although I did it from the car park at Cradle Mountain and walked 200 meters of it then turned around and walked back.
Chris Haggart 2:08
Still beautiful though.
Alex Hont 2:10
It was amazing, Scarlett and I had a great time.
Chris Haggart 2:13
So yeah, loved it. Just, you know, no electricity either which was awesome. So circadian rhythms got reset, like bedtime when the sun went down, got up when the sun went up, and it was just magic. So yeah, awesome. Good break.
Alex Hont 2:28
Any trouble breathing down there?
Chris Haggart 2:30
No, we had a little bit of smoke in Launceston just around before we left and when we got back but um, nothing whilst we're actually on the track so well.
Alex Hont 2:40
Yeah, I mean, the reason I bring it up is everyone anywhere around the world pretty much is well aware we've had some horrendous bushfires pretty much was sort of Christmas through new years and I think New Year's Eve was one of the worst, wasn't it?
Chris Haggart 2:51
Yeah, it was pretty bad.
Alex Hont 2:53
And the air quality in in Melbourne was particularly bad I know in the lead up the air quality in Sydney or even in from November the air quality in Sydney was pretty poor as well and I mean, you know being us being in Melbourne we thought ah nah it can't be that bad, what are they whinging about and then as soon as it hit us
Chris Haggart 3:08
Oh my god the air quality is so bad.
Alex Hont 3:09
Yeah, it has to have been worse here than it was up there.
Chris Haggart 3:14
What about you mate? What did you get up to?
Alex Hont 3:16
We were mainly around because we're, we're, we just started knocking down half our house and and trying to build it back up to make it a bit safer and fix a few of the problems with it so we were packing and then we moved just before I got back into the office.
Chris Haggart 3:30
Alex Hont 3:31
So not not as much fun as what you had but still good though. Nonetheless exciting time.
Chris Haggart 3:37
That's exactly right.
Alex Hont 3:39
But the bushfire issue I guess I'm has really sparked a lot of
Chris Haggart 3:43
Yeah hasn't it
Alex Hont 3:44
a lot of debate, a lot of action. And, and I think introspection maybe but from a lot of companies as well as individuals.
Chris Haggart 3:53
Yeah I think it's focused a lot of people's minds, that's for sure.
Alex Hont 3:55
You know, I know in the news, it's been the catalyst it's been described as possibly the catalyst to to move a lot of people and organizations into doing something about climate change, where for a long time it was thought ah yeah you know, one day maybe we'll get there maybe it's real maybe it's not I don't know.
Chris Haggart 4:11
Well, it's one of those things, isn't it? Where it's been an ideological debate rather than a scientific debate. So, you know, it feels like
Alex Hont 4:20
Inspite of the science
Chris Haggart 4:21
Correct.Yeah. It it's easy for to millennials to say that. Yeah, focused a lot of people's minds and there seems to be a lot more pressure and it seems like that that seems to be having some sort of effect on those in Canberra.
Alex Hont 4:36
Yeah. Well, yeah. Well, that remains to be seen,
Chris Haggart 4:38
Correct. Yeah. Initial noises. Such but we'll see what happens with action.
Alex Hont 4:43
What's been fascinating though, is that and this has been going on for a little while now that that there's a lot of governments and companies that are saying we're sick of waiting for you Canberra to come to the party and give us a some policy around this. We're gonna do it ourselves.
Look you look at when I think when Trump got in California said, Well, you know, you might not have your own energy target or your own emissions target, but we're going to bring in our own. So the Victorian Government, I mean, Daniel Andrews have been pretty vocal in bringing one in. And I'm not saying he's perfect, because there's still plenty of things that he lets go on from a climate point of view. But at least there is there's been some leadership from these maybe not the states. So the federal government's to try and move about implementing these things that they see as important.
Chris Haggart 4:59
We're gonna drive it. Yep.
Yeah. And I think that's just the point, we've got to where, you know, people have just decided, well, if you're not going to do anything, we'll do it ourselves. And that stretches to the investment world as well.
Alex Hont 5:39
And very much so because at the end of the day, you know, we particularly Australia, we've got so much money invested and might not feel like that for a lot of people but the superannuation system is worth I'm not sure what it's worth now, but it's in the trillions, or at least it's over 1 trillion.
Chris Haggart 5:53
Yeah. It's huge. Like and it's an, in a sense, it's an we're gonna talk about this during the podcast. That, with that investment comes a lot of shareholder votes and a lot of power. So, you know, how do we how do we wield that? And who's in control of wielding that?
Alex Hont 6:10
Well, that's right. I mean, you actually have a choice as an individual about where that money goes. And you have an ability to exercise some influence, however minor, although if we, you know, if we run with the pm's notion that just because we're so small and insignificant, we can't make a difference. Maybe, you know, that line of thinking might not get you where you what you want.
Chris Haggart 6:31
No that line of thinking doesn't get you very far.
Alex Hont 6:34
So let's think about this. You know, Adani's been a big a pretty polarizing
Chris Haggart 6:39
Well that was there prior to the election that was quite a touch point or a talking point.
Alex Hont 6:45
Well, it is but I think it's been going on before the election and long after as well. I mean, this is still something that that the people in Melbourne keep protesting about. I'm not sure about the rest of the country. I mean, I know you look back at the election, it was a pretty big point for why Queensland probably voted liberal.
Chris Haggart 7:02
Well that's what they were saying that it was a bit of a middle finger to the southern states saying don't come up here and tell us how we should run our lives.
Alex Hont 7:09
Yeah. Well, I think the prospect of you know what the jobs that were being talked about as being part of that project was pretty enticing for a lot of Queenslanders. Yep. And so, yeah, it was a really big issue for the for the election. But what's been some of the interesting fallout is that there have been a number of financial institutions that have refused to, to loan the money to it to Adani.
Chris Haggart 7:34
Yeah, well, that's it and they're finding it hard to hard to finance it now. And I don't think that's it's not even necessarily Adani. I think that's across the board. And I think given what has happened over the summer, in terms of the at least, media coverage, it's kind of almost opened the floodgates for stories about about climate change action, and some of that has started to come through on the investment front.
Alex Hont 7:58
Yeah, I even saw it. Well but just before we get to the investment front I saw that Greyhound coaches have also pulled out of a contract that they had with Adani to move people to and from their mines. So it's interesting this flow on but the right the investment world is starting to change some of their ideas about that. As an example, you know, relatively recently BlackRock who are probably one of the biggest
world's biggest fund manager, right. They run index funds, so Ishares in the US. As well as a whole bunch, Ishares in Australia, BlackRock in the US, yeah,
As well as a whole bunch of other funds as well, I mean, the Ishares is not just their only vehicle. And Goldman Sachs another investment bank from the US have both come out and said, we are divesting ourselves of thermal coal, thermal coal is not going to be something that we invest or loan money to. And here in Australia, ANZ have done the same thing.
Chris Haggart 8:51
Yeah, well, they haven't taken as a strong a strong view. So Goldman Sachs has said that they've ruled out thermal coal financing for either new mines or power stations globally, whereas the ANZ have shed more than 700 million in thermal coal loans within the next four years. So they're going to reduce their exposure, which is a 75% reduction. So that brings them into line with the NAB and the CBA. But not saying no nothing at all.
Alex Hont 9:19
Chris Haggart 9:21
Yeah, it's still big. In terms of especially in energy production from a thermal coal perspective. That's, that's, that's pretty significant.
Alex Hont 9:30
Now, I sort of think that this is really very much a matter of economics rather than principle to for the for the banks for these institutions.
Chris Haggart 9:38
Yeah a hundred percent.
Alex Hont 9:39
Yeah. Because they're not you know, their creed I suppose these you know, profit for shareholders is the
Chris Haggart 9:45
Yeah, the Almighty. Yeah, this has got nothing to do with moral values or ethical reasoning. This is all about it starting to show that the costs of the cost of investing in these types of projects with when something goes wrong is just destroying shareholder value.
Alex Hont 10:04
Well, I think also anything any kind of new power plants, any new coal fired power plants cost an arm and a leg to build.
Chris Haggart 10:10
Correct. Capital intensive
Alex Hont 10:11
And they take a long time to pay back the investment.
Chris Haggart 10:15
If the world's heading in a non thermal coal direction, then is there a likelihood that you're gonna get the payback?
Alex Hont 10:21
Well, that's right, you might be left holding this asset, this power plant that's, that's worth, essentially worthless, because you can't use it. You can't make any money out of it
Chris Haggart 10:29
and then no one wants to buy it.
Alex Hont 10:30
So so I think that's a big driver of the actions of some of these financial institutions. Now, we we did have a bit of a discussion about this with another member of our team, Paul Moran, who also wanted us to make sure we covered something called greenwashing. Yeah. Yep. Which is really when companies like do things like this, take a stance and make, make, make some some big statements to say we're going green where we're becoming responsible, look at how good we're doing, and when really the term greenwashing is really referring to well, you're doing it because the economic sense doesn't stack up and then you're claiming credit for taking principles.
Chris Haggart 11:07
Yeah, yep. Or it might well be that you're you're putting out there and from a marketing standpoint that you're no longer going to deal with thermal coal but then you're dealing with arms and or something like gambling, for example on on another part of the business and you can't really sort of stand up there on your soapbox and say, well, look how good we are.
Alex Hont 11:26
Look how ethical we are
Chris Haggart 11:27
We're doing something else. Yeah. So you know, and we're going to touch on this with some of the issues around socially responsible or green investing, ethical investment, whatever you want happen to call it. But this is I think this is definitely the starting point of a of a turn in views and how large investment managers manage money moving forward.
Alex Hont 11:51
Yeah. And I think you, you know, the point about governments are gonna have to take notice sometime soon, is we're gonna start to see that as well. I think you mentioned Finland had set a pretty ambitious target.
Chris Haggart 12:04
Yeah I was listening to a podcast the other day, I was just trying to think about it. So if anybody wants to go and listen to I couldn't remember, I think it was an NPR podcast. And basically 2035, they want zero net carbon emissions. So
Alex Hont 12:17
that's not that far away.
Chris Haggart 12:18
15 years away. So they've got a prime minister, a pretty young, female prime minister, I think in at the moment, who is the head of a coalition of I think about five or six different parties, including like, the center Party, which I think is the Conservative Party, but basically they're they're completely transitioning their economy to do as much as they can to reduce carbon emissions. And I think ideally, what they want is to become leaders in the world in that respect. And then obviously, that's going to drive interest in GDP for them from that point forward.
Alex Hont 12:53
I've had a really interesting, because transports a big carbon emission of carbon emitter and I did hear that I think it was Finland, it was definitely somewhere in Scandinavia, that they've got a lot of electric vehicles that they, they, it's making up about 30% of all sales there and climbing steeply. And I thought, well, you know, why couldn't we do that here? And it always comes back to having the infrastructure in place. Yeah. And one of the things that they McDonald's have done is they've put in charging points at all the McDonald's along the highways. Right?
Chris Haggart 13:24
It's, it's pretty smart, isn't it?
Alex Hont 13:26
It is. I mean you've got the real estate. Right? Exactly. And when I think about, you know, you drive up the Hume or you drive pretty much in on any of the highways in any direction. Yep. What is it probably only half an hour between any two McDonald's along the line.
Chris Haggart 13:38
Exactly. Yeah. And you're almost giving people another reason to stop. Yeah. 'Cause they're forced to what like from a battery perspective.
Alex Hont 13:45
Well, that's right. I mean, if they're going to stop for a 20 minute Quick Charge, or whatever it might be, and you're there.
Chris Haggart 13:50
You've got a captive captive audience for 20 minutes.
Alex Hont 13:53
That's right. So you're really made economic sense for them to do it as well.
Chris Haggart 13:57
Alex Hont 13:58
Anyway I found that really fascinating. That they've gone down that path.
Chris Haggart 14:01
But this is the thing, isn't it? It's like you take advantage of these trends and you know, the companies and businesses or services that, I guess a bit more forward thinking are going to be the ones that take advantage of these opportunities first.
Alex Hont 14:13
those that can adapt and the ones that survive. Not that I think Maccas is in any trouble. But anyway. So Chris, how, how is it? How do we invest responsibly?
Chris Haggart 14:24
It's a very good question and a very varied answer. There's a number of ways to do it. And we have we kind of covered this in a podcast. I think I said to Al this morning was last year, and he said, No, I think it was the year before.
Alex Hont 14:38
I think it was 2018
Chris Haggart 14:39
I can't believe that. It's been two years we've been doing this but anyway, longer than two years now. This is our third year, isn't it?
Alex Hont 14:46
Yeah, I reckon we recorded the first one in 2017. But we're getting off topic. Sorry. We could just ramble on for awhile. So look. One of the places that you could look is called the the UN's principles of responsible investment. Right. And I think this is a reasonable I mean, as you said that it's the the definitions are varied. And this isn't a definition, but this is at least a guide, and something that you can sort of look at or think about when making investment decisions. But the principles of responsible investment defines responsible investment as a strategy and a practice to incorporate environmental, social and governance factors in investment decisions and active ownership.
Chris Haggart 15:30
So those of you out there who have might have a. listened to the podcast or b. explored this topic in some, even in some way in the past would have seen the acronym ESG. And a lot of companies have kind of and coming back to that greenwashing statement. A lot of the big companies have said yes, we incorporate ESG into our investment selection process. REST super is one of those which will come into but then just treated it as a almost a lip service not actually integrating it completely into their philosophy or systems.
Alex Hont 16:07
So let's get into it. Let's get into the nitty gritty about this because I mean, it's easy to say, environmental, social and governance is even easier to say ESG. But what? What does it mean? Because, as you said, you know, a lot of, a lot of companies throw it around saying, yes, yes, we use it. But but let's, start with environmental? What what are the issues that we're often talking about with environmental?
Chris Haggart 16:28
So you'd be looking at companies that are dealing with mining or companies that are dealing with something that's going to potentially damage the environment?
Alex Hont 16:36
Well, I think particularly things like climate change, you know, fossil fuels and climate change, very much so because there's plenty of mining that mean everything leads to a hole in the ground, but that we still need, even though it might have a more adverse environmental impact, but maybe not as much as others. Anyway. Climate change, resource depletion, dealing with waste, you know, pollution and deforestation as some examples of what would fall under that environmental factor.
Chris Haggart 17:08
Yep. So I guess this is when we're looking at companies when we're looking at fund managers, you know, going coming back to that discussion about the filters, either positive or negative filters that we put on, put on our selection process. So we would sit here and say, Well, you know, I want to invest in BHP, for example, well, obviously, the environmental aspects that you're going to take into consideration, obviously, because they're a miner are you going to want to look at what's their effect on climate change, resource depletion, what waste are they putting out? what pollution are they adding to? Are they are they are they contributing to the deforestation problem, and then I guess you'd put a score on that versus potentially other miners if you're looking at investing in the mining industry. Or if you want to rule the mining industry out altogether, then this would be something that would probably rule them out of your filter.
Alex Hont 18:00
Yeah, and there are some companies that do look at that, that can give scores like that. But one in particular is called sustainalytics that a lot of companies use to measure that externally measure their score. So that's worth having a look at.
Chris Haggart 18:14
And because this is pretty detailed information, this is like you can get some broad stuff, I suppose and but the, to get the real detail on, on how companies are dealing with these sorts of problems involves quite a lot of research into into their systems, processes, actions, that sort of thing.
Alex Hont 18:34
Yeah. So let's move on to the next one social. Social Factors would include things like human rights, I imagined detention of mandatory detention of asylum seekers, modern slavery, child labor, working conditions and employee relations. So really does this company do bad by people do companies do bad by people to put it in very simplistic terms.
Chris Haggart 19:01
Yeah, yeah. And I think that's, you know, we, we want, companies are doing well for the environment, but then companies are also providing good outcomes for society.
Alex Hont 19:11
Yeah, that's right. Are they are they helping people as well. And then the last one governance, which is one that sometimes quite interesting. What we're talking about really is things like bribery and corruption, executive pay, board diversity and structure, political lobbying and donations and tax strategy.
Chris Haggart 19:29
And look, whilst this is important, from an overall standpoint, this has probably been the part that those those investment managers or companies that have been in inverted commas greenwashing where they've been doing it because I can basically say yes, we look at ESG. We look through their governance and like, have they got a clean governance record? Yes. They pass the filter we can invest in them. So it's been a almost a backdoor into including companies that might not necessarily meet certain, because it's going to be different for everyone, but certain people's filters of what what would constitute a responsible investment?
Alex Hont 20:09
Yeah. I always think there's a couple of really interesting ones in here that you wouldn't have necessarily thought of it on the responsible investing part. But it really makes sense. And I guess, you know, the board diversity one is one that that I think is really important, but can quite often be just put to the back of mind.
Chris Haggart 20:25
Yeah, yeah, definitely. Well, interesting that, um, I know, we don't do this all the time. But coming to points we're gonna discuss later in the podcasts around if you're paying attention to the business news, mid to late last year, about some of the biggest superfunds getting together as using their shareholder votes to try and get women quotas on the board to 50/50 to some of the big Australian companies because there clearly isn't enough women in the boardrooms of Australia.
Alex Hont 20:57
Yep. And I think every study that's been done shows that it's beneficial to have have the diversity and the diversity.
Chris Haggart 21:03
And that's not just across sex though that's across a whole range of factors.
Alex Hont 21:08
Yeah. Now tax strategy is another one. And it's been big in the news that there are a lot of multinational companies that don't pay any tax kind of anywhere. Yep. And I think it's interesting that's being included as to whether or not a company is included under these ESG these principles of responsible investment? Yep. Right. And I guess executive pay and bribery kind of speaks for itself bribery and corruption. Mind you just a little off topic, I remember sitting in you know, Economics 101, first year uni and listening to the guy teaching the class talk about corruption. And he said, Look, it's not always bad because corruption is greases the wheels and makes things happen. I'm not talking about you know, well, what what he was talking about was not was when you go into a place that is always corrupt and all where where laws aren't enforced and, and those, you know, sort of places, the Wild West we'll call it that the corruption actually means that things get done. And there that there isn't this big stalling period there isn't this roadblock, you can get around these things that might otherwise halt progress. Anyway, this is a theoretical conversation. I'm not suggesting that we should be living in a corrupt world ot that a corrupt world would be better.
Chris Haggart 22:25
I think it's just a matter of idealism versus reality. Like, it kind of applies to what we're talking about here is that at the moment, the way things stand not everything's perfect. So you there's some issues around you know, we can't have a perfectly ethical portfolio for pretty much anybody because as you said, Al, everything leads back to a hole in the ground and what's and what's the what's the impact on the supply chains all through that so but that doesn't mean you don't you don't start the ball rolling. And make changes where you can. So it's a bit like that in the sense that, you know, if you go to a corrupt country, then if you if you don't grease the wheel, then nothing's going to happen. So it's better to do that at least have some some positive impact in in some way that you can whilst creating change at the same time.
Alex Hont 23:15
I mean, that was that was his point. That was the message I got that that yes while it's not a perfect system, it's something that we're, you know, progress is done in utilities.
Chris Haggart 23:24
Correct.It's not like we live in a perfect system here. If you think corruption is not in Australia you're mad.
Alex Hont 23:29
Yeah. Well, it's in the news.
Chris Haggart 23:30
That's why IBACs been put into place.
Alex Hont 23:33
Yeah. So let's look that's ESG environmental, social and governance issues, and they're the kind of the, the factors that that that filter in or lead in to a lot of the principles of responsible investment, but there are some issues with it. Right and that which we touched on, and I think one of the big ones is supply chains, right? And what we mean by that is you might find a company that does great does really good things, but it needs inputs to either make their product or service and make them work.
Chris Haggart 24:03
You had a really good example of this this morning.
Alex Hont 24:06
Well I don't know if it's true but but
Chris Haggart 24:10
Well that makes it tough doesn't it but alright let's assume that it is.
Alex Hont 24:13
Let's let's do a hypothetical where let's just say there is an electric car company that's what
Chris Haggart 24:19
Yep, that's a well known electric car company
Alex Hont 24:22
Could be any electric car company, Chris. But they make electric cars, electric cars, we all think are great, are a better alternative to the the petrol engine from an emissions point of view, right? But there's a lot of inputs that need to go into these electric cars. And while the electric car company might be seen as a as an ethical or sustainable investment, and it's doing really good things. We need to get the inputs things like cobalt and lithium that need to be mined from a hole in the ground somewhere. Yep. And where are they being mined? You know, there comes back to this to well there's the environmental part, obviously for mining but you know, we we take, we're weighing up that we need the lithium, we need the cobalt because we need to make these batteries and we need to make these cars go. But then there's a human rights issue as well, you know, are we looking at some slave labor? The social part, or you know, what are the working conditions? Where is this stuff coming from? And so, yeah, this is the supply chain, the company itself might be great, but it's really hard to go through the supply chains, and make sure that all the inputs are still also complying with these principles of responsible investment and ESG factors. So it's one thing that's been really hard to quantify, and you have to really do a huge deep dive to try and get that information.
Chris Haggart 25:34
And I'm sure along the way, there's going to be very few pure companies out there. I think it's just the nature of the world is just,
Alex Hont 25:45
I mean, even if you looked at at solar panels, right, they still take aluminium they still take I'm not even sure what might what the you know, often there's silicon or something in there. So there's things that still need to be dug up and processed and manufactured to get to some point to get to that point. So the payback period from the hip pocket might only be a few years, but I wonder what the payback period is from a resource point of view. So the same with electric cars, but
Chris Haggart 26:11
yet well our existence is the same. Well, we're users of resources just by being alive, it's about trade offs, isn't it? So again, coming back to that it's not a perfect system, but we need to try and do the best we can.
Alex Hont 26:25
I think ultimately, anyone that's looking that has an interest in this and is looking into it, is looking for something that does more good than bad, correct, right. And there has to be it's very hard to measure but you have to be able to try and come up with a with a reason or or see, see that that the good will outweigh the bad Yep. So that's probably my my main issue when investing in looking for responsible investments, but there are some other ones and I think another big one is what's your personal view? You know, ethics is different for everybody.
Chris Haggart 26:55
Alex Hont 26:57
Its its, its objective.
Chris Haggart 26:59
Yeah. And like this is coming back to the the old discussion around say Woolworths for example, so, you know, typically major businesses, supermarkets, obviously, you know, what's their, what's their supply chain? Are they how are they dealing with farmers? Is that all? Is that all? What's your view on that?
Alex Hont 27:19
Ah Chris, they give fruit to my kids. What are you talking about? They're angels. Coles don't give fruit to my kids. At least I don't think they do.
Chris Haggart 27:28
and then obviously you know they've got the gambling aspect to the poker machines and where do you stand on that? I could ask 10 people and probably get three or four different views. So every everybody's views are different so how do you create a perfect ethical portfolio?
Alex Hont 27:46
Well, it's going to be different for each person. And it's always really hard to satisfy everyone. Look there there are some other issues and I think in the past, we've seen really high fees for a lot of the ethical investment options that have been offered by fund managers. And, you know, I can think of a particular ethical superfund that had ethical in their name. I'm not going to name them. But I remember looking at, this is a little while ago,
Chris Haggart 28:11
It's still there because I did a comparison a couple of weeks back.
Alex Hont 28:14
I don't know, I think that the fees have come down from what it was because I remember I remember looking at it going at two and a half percent a year for the fees on this super fund and I thought, was gobsmacked. You know, we run most of our funds at somewhere between about total, you know, total costs of about point five and point nine. Yeah, right. So it's more. It's more than two and a half times the cost.
Chris Haggart 28:38
And I guess that's and that's look to be honest, that's probably going to come down over time. I think as this becomes like anything becomes more commoditized or ubiquitous then.
Alex Hont 28:48
Chris Haggart 28:49
Yeah. you're unable to continue to charge those type of fees.
Alex Hont 28:53
Yeah, and we're already seeing it, there's a ETFs around, exchange traded funds around that you can buy and sell on the stock exchange and in your superfunds a lot of the time, but have these ethical overlays or sustainable overlays and they're charging 40 or 50 basis points or you know half a percent which is a far cry from that two and a half percent you're talking about um so they're definitely coming down and it also means that we have you know, these things we can use them we have the tools to create a reasonably priced portfolio that does everything you want it to do.
Chris Haggart 29:20
Yeah, correct. Yeah, it definitely gives us more options which is great. And and that is a trend that's definitely happening we're seeing more and more investment houses bringing out these funds and that's because of demand. Yeah, all of this ties back to vote with your feet, vote with your money.
Alex Hont 29:35
Well, it historically they've been quite hard to access as well. I mean, other than is these these expensive funds, but if you want if you wanted to find something, they just weren't that many products.
Chris Haggart 29:45
Yeah, I remember doing research on ethical portfolios pre financial crisis, and I was borderline impossible. Like, there was the one fund investment that we shall not name and that was it. And then it's progressively got more and more over time.
Alex Hont 29:59
Yep, yep. So it's getting better.The last of the kind of issues is that if you want to go and find some of these companies, often those companies that are making them, you know, really in in the renewable energy or they're, you know, that are sort of a lot more they're a lot more speculative. There's a lot more risk involved. And a lot of them, you know, we don't even know if they're going to end up being profitable.
Chris Haggart 30:25
Well, that's the thing isn't? It's hard to know.
Alex Hont 30:27
So they tend to be small and illiquid. So you can't buy in and out of them easily.
Chris Haggart 30:31
Correct. And prone to large fluctuations in price movement. So it's, it's been difficult in the past because you almost allocate them to the fringe of the portfolio and say, well, this is almost a gamble in a sense.
Alex Hont 30:45
Yeah, we hope it makes money one day.
Chris Haggart 30:47
Yeah, but there's a there's a strong possibility that it might be worth nothing.
Alex Hont 30:54
Alright, so we've talked a little bit about what is ESG, we've talked about some of the issues we see with it. But let's get into the fun stuff. How do we then bring this in and incorporate it into our portfolio construction? Oh, sorry, how do we how do we then what are the approaches that we can take to try and to implement this in our portfolios? I look, I think the first one we'll start with is what we call integration. And that really is around you. Putting these factors into your investment selection process, and giving, using those to influence your decision as to whether or not you want to invest. And an example I, I came across fairly recently, I was at one of the Magellan updates at the end of last year, and they've started talking about using the ESG process, using ESG factors in their investment process to work out whether or not companies are going to be profitable, you know, well into the future. They take a long term view on whether they invest. And so it's really a matter of including that including that thinking in your idea of whether or not they're going to be profitable. Yeah, we talked about giving it a score and that's, you know, often companies will have their own kind of scorecards to work out whether, what they think of the prospects of a company, and this is just another factor that that influencestheir thinking in that respect.
Chris Haggart 32:08
And touching on that story, all that kind of feeds into the next step, which is kind of screening. And we've talked about that in the past, which is, you know, applying filters to determine a list of potential investments, whether they're included or excluded. And that may be through a scorecard or may just be through, I'm in, I'm out. Yeah, kind of selection process.
Alex Hont 32:27
This is probably the most common one that we see or that we use, which really a way to say and it's probably what people ask for most of the time, is to say, I want to invest but I don't want to invest in XYZ in the common ones, you know, are fossil fuels, armaments, tobacco, alcohol, gambling, there's a whole bunch of other ones.
Chris Haggart 32:48
That's pretty much most of them. Yeah.
Alex Hont 32:50
Well no. There's a big long list.
Chris Haggart 32:52
In terms of like, from anecdotal evidence of clients coming in and saying I don't want to invest in then yeah, they're really, really the top five.
Alex Hont 33:00
So that's the screening approach where we're saying we'll invest in everything, but we're going to exclude all these other companies, or exclude any companies in this particular industry. The last and then the next one is what we call themtic or impact investing. So really, this is around finding a thematic or a theme, or an industry that you want to support or a company that does a particular good. And investing in that company. There's a couple of companies that I've come across that are that are worth looking into not investing. This is not a recommendation
Chris Haggart 33:34
This is not investment advice. Just this is information only.
Alex Hont 33:37
Yeah, but but if you want it to have a look at some of the some examples of companies that are in the energy generation space, and there's a company called 1414 degrees, which does large scale silicon batteries, essentially which where silicon stores heat and it's a really interesting take on and they've just listed I think last year, maybe it was the year before but but it's an interesting way that you can take this sort of energy storage theme, and buy company like that, share price hasn't been great. I own a very small number of shares. And I've lost, lost money on that investment.
Chris Haggart 34:12
It's one of those things, though, isn't it's like some of these will some of these will survive and be the BHPs of the future. And others want Yeah, it's just a matter of which ones will and, and which ones will fall by the wayside.
Alex Hont 34:26
There's another company called Carnegie wave energy out of WA who were trying to build a generator that harvests the power of waves.
Chris Haggart 34:34
Yeah. Which is, it's pretty, pretty awesome in that respect. Yeah.
Alex Hont 34:37
And Chris, you came across another one called impact Investment Group. Yeah, I can't claim this one of my clients. Sandy, who's out there. She brought this to me a few years back. And yeah, look, they're a group that start their own basically, like projects like it might be we're going to set up a wind farm or solar farm at some location in Australia and they'll ask a whole bunch of people to basically put money into what's known as a managed investments scheme. So it might say, I don't know, let's say we need $10 million, we're going to go, they're going to go through their network and say, well, who wants to commit the money? And once they've got to the $10 million mark, they initiate the investment and you become essentially a unit holder or a shareholder in in what that specific project does. Without being a company in that sense. So you're just investing in a specific project?
Yeah. And I think a lot of these look like solar farms, wind farms, or things like that.
Chris Haggart 35:35
Well, it's something where there's a clear, revenue generation.
Alex Hont 35:38
Yeah. So these are, they call it the magic or impact investing because we're looking for a very specific impact and in these particular areas. The next part is really what we sort of touched on around engagement and, and, and proxy voting. I suppose when you as a shareholder can sit, you know, you have a vote, you have a voice within the company that you own. Yep. And you can use your influence, potentially to to help change that what the company's behavior is.
Chris Haggart 36:08
Well this is the thing. This is the the power of money in that sense. Like, I think a lot of people with an ethical mindset have felt quite disenfranchised with the system if we want to put it in inverted commas over the last 20 years. I think we're finding more and more people who are wealthy or have got themselves to a point where they're reasonably wealthy now can vote with their feet or their money that carries with it a vote on how boards work, how merges, demerges, companies, projects, or work and if you've got a, as we talked about with the superfunds, if you've got a large voting bloc, then you've got the ability to influence how a company behaves.
Alex Hont 36:48
Yeah, and let's think about this large voting bloc idea. Right. So there was an article fairly recently about a hedge fund guy from the UK.
Chris Haggart 36:58
He's a TCI fund manager.
Alex Hont 37:00
And what's his name?
Chris Haggart 37:01
Chris Hon. So for those who want to know it was in The Age or the Sydney Morning Herald on the 29th of Jan, which is today.
Alex Hont 37:08
Is it? Yeah. As we record this
That's when I printed it, January 27 okay yeah the article says world's most profitable hedge fund is now a climate radical, it's an inflammatory headline but it got me reading the article.
We love inflammatory headlines. Chris, we try and give inflammatory podcast titles.
Chris Haggart 37:30
We do but so he's doing exactly this. So you know, his hedge fund currently holds US 30 billion, so $44 billion in Australian assets. And he's out there basically looking for companies that have weak or poor management teams, buying their stocks at a cheap price because management hasn't been doing a good job. And then basically going and saying, well, you need to do X Y Z or we're going to dump your shares. Yeah, obviously this the board doesn't want
Alex Hont 38:02
Or we'll remove you as board members
Chris Haggart 38:04
Yeah correct Yeah.
Alex Hont 38:06
When you're when you're someone of that size you have a lot of votes at shareholder meetings and have board elections you know, so you have a fair bit of power there to try and make force. force the company to change
Chris Haggart 38:19
This type of shareholder activism. Look, Stephen Main's pretty good at it in Australia. He's when he used to run was it Crikey before he moved on? you know.
Alex Hont 38:28
Yeah, not sure.
Chris Haggart 38:29
Doing this sort of stuff. So there's there's definitely people out there doing it. It's just a matter of finding them.
Alex Hont 38:35
So one of the big issues is who has that much voting power who can vote with a block like that? I mean, you know, he might take significant stakes in companies and have a lot of votes but let's think about this in Australia. I mean, like hear's a call out to you industry superfunds. Step up to the plate. Yep. Right. You know, you're some of the biggest funds in the country you got, you know, I think Australian supers at geez I don't even know what it is. Yeah, is it 200 bil or something? It is a conglomerate. It is just mega and to think of the number of shares that they would have to own in a lot of Australian companies, if they decided that we want to actually make an impact and have want climate change to be, or responsible investing, not just climate change, but principles of responsible investment. If they wanted to make a change, they could go to just about every board of every company in Australia and say, we want you to do this. Yep. Right. Or we kick you out. Yep. Now they might not have the power to kick people out, because that won't have the majority stake in companies and but nonetheless, they've got a huge amount of power.
Chris Haggart 39:37
Yeah, yep. Well, obviously, there's, there's some complexities around that because they've got duties as trustees to look after the retirement benefits of their members. So they can't be too willy nilly with the activism but there, they definitely are in the best position of any voting bloc in Australia to make a difference from a board directional standpoint.
Alex Hont 39:59
Well You know, this comes back to our you know, what we opened with really is that if, if there's a lot if everyone's starting to think that there's going to be long term economic problems for companies, long term profitability problems for companies that aren't acting responsibly enough, isn't that, don't you owe it to your members then?
Chris Haggart 40:17
Yeah you do 100% Yeah.
Alex Hont 40:18
For their retirement benefits?
Chris Haggart 40:20
I don't disagree. I was just thinking about in terms of like, and we're gonna touch on this, was that 35 year old guy who sued REST super. So
Alex Hont 40:27
Chris Haggart 40:28
23 yeah, but
Alex Hont 40:29
Chris Haggart 40:30
Yeah I know. Who sued REST Super last year because they didn't, because they greenwashed their investment process and didn't take into account investing for climate change, which is what they said they would do.
Alex Hont 40:42
Yeah. Which is really interesting to think that, you know, people are going to start taking these actions. I know it's happened in Holland already. Where I can't remember who it was actually but there was a group of clients that that took their bank, I think it was, yeah, I could be wrong on that. I might have to do a bit more research.
Chris Haggart 41:00
But I'm sure it's happening around the world. This is not just isolated. It, you know that there's definitely more demand. And we see that anecdotally coming through the office like heaps more people are asking for an ethical portfolio.
Alex Hont 41:13
Yeah. Yeah. That's right. Now, with everyone asking for an ethical portfolio, Chris, it has thrown up a few portfolio construction problems for us.
Chris Haggart 41:24
Yeah. And that comes back to some of the issues around you can't account have a perfect silver bullet.
Alex Hont 41:28
Yeah. And I think one of the big areas that well, because we have had limited access to it, well, it just hasn't been the same, the number of investments or the types of investments availble to us. One of the areas that I think right at the moment, and this sort of goes back to other issues around interest rates in in the world today, but
Chris Haggart 41:45
almost crossing a bridge here to investment outlook here.
Alex Hont 41:49
Yeah, I'm trying to stay away from that a little bit, but just to try and make the point that that the fixed interest market or the defensive assets, so things like bonds, have traditionally, it's been relatively easy to hold bonds because interest rates have been coming down, bond prices have been going up. But bonds have also paid relatively good level of yield, you know, so if you buy the bond, you get the get the fixed income, right? It's like a, think of it as a term deposit if you if you're not quite sure how the bonds work. Now, but but the problem we have is that if interest rates go up, the prices of bonds go down. Yep. So do you really want to be investing in an investment that you think the, where you think the price is likely to go down? Because we think longer term interest rates have to go up from where they are? Because they're so low? Yeah. And what does that mean for your future returns over the next few years? So there are bond green bond funds, there are bond funds that have an ethical or sustainable overlay on them. But that doesn't change the fact that their bond funds.
Chris Haggart 42:47
Alex Hont 42:47
And what we found with our portfolios, particularly is that we've been moving out of these fixed rate bond investments progressively over the last probably 15 months, or no, probably 12 months, nine months now.
Chris Haggart 42:59
No it's been even longer than that, I think, yeah,
Alex Hont 43:02
Anyway, we've been, you know, because interest rates can't really go any lower, and there's so little upside potential from them. So we've been having to look for other types of fixed income investments that maybe have a floating rate, or maybe do something a little bit different at the fixed rate bonds. And we think we've got a pretty good fixed income portfolio set up for our clients. But we can't do what we're doing in that portfolio with an ethical portfolio. They just aren't the instruments available to create their portfolio. Yep. So what we'd say is we're not it's not unethical. Yeah, we just can't tell you that the investments that we've got in this part of the portfolio all meet this idea of having an ethical or sustainable overlay.
Chris Haggart 43:42
Yeah, at least for now, like, I'm sure that this will come. Because that's a space that definitely needs some new entrance because it's a clearly obvious glaring hole. But the rest of the portfolio, the equity side is all is all pretty good. It's just a fact that the fixed interest component, well, the typical defensive part of the portfolio is, is it's much more difficult. And to be honest, for most people, I think it would be fine. But I think if I was to overlay my personal ethical views, and I'm pretty sure Al, your ethical views, it probably wouldn't necessarily stack up, but it wouldn't be bad. It would just include the banks, for example, which
Alex Hont 44:21
Yeah, I mean, there. That's right. And it depends where you sit on what you think of the banks. And as well, yeah, again, comes back to your own personal view.
Chris Haggart 44:28
Again and then aside from obviously, the actual investment theme with interest rates.
Alex Hont 44:32
Yeah, yeah. So you're right. It's not bad. It's just if I'm thinking about creating a portfolio that I think is the best for somebody who wants to generate a positive return, correct? Yeah. I can't use these ethical funds as much as I might otherwise have used them in the past.
Chris Haggart 44:50
Because it's the same. Although this is talking about portfolio construction in reasonable detail. The same factors of building any portfolio are there is that you know, you want to take some risk for rate of return for some means or ends for whatever your goals happen to be? So we're not going to throw the baby out with the bathwater just to make an investment. And that might not meet your, your overall needs.
Alex Hont 45:14
I'd certainly rather not do that. Because that makes for a much harder conversation later on. When someone says to me, why didn't my portfolio do very well? And I say, because you wanted these investments that I didn't want you to have.
Chris Haggart 45:23
Yeah. Correct, yeah.
Alex Hont 45:25
Yeah. So we're not saying you can't do it. We're just saying it's not it's not what we're seeing is the best. potential option, right at the moment,
Chris Haggart 45:34
You know, but I would say 75% of the portfolio is there as we stand but and and that it will come over time. So we have a solution. It's just not a perfect solution.
Alex Hont 45:43
No, I mean, look, the other kind of I wouldn't call it a problem. But one of the issues is we we do run some income portfolios, and we don't really have the same sort of income targeting solutions that have an ethical overlay. So we won't be, you know, we would still think it would perform more or less in line with a normal portfolio. But the income growth split would be different.
Chris Haggart 46:09
and I think this is that's, that's speaking to the maturity of the industries whereas the those that are working in thematic industries like wind, solar etc are fairly capital intensive and then your return from that type of investment is on the growth side rather than the income generation side. So, I think again, over time over the next 10 or 15 years as these industries mature, we can we can be fairly certain of regular cash flows from the companies that have that have taken market share and are fairly secure. So, again, it's just going to be a very evolving space.
Alex Hont 46:46
So I hope that that you what you've got out of today is is realizing that there's many parts to this ethical and responsible investment solution and we certainly have a solution we've, I've put in, Chris and I have put in many many hours researching and putting together some portfolios, that that would do as much as we think we can to reasonably meet this objective of having an ethical, sustainable overlay to invest responsibly. So please come and have a chat to us to talk about that if that's something you're interested in, if you want more information, there's a few places I recommend you start having a look at. One is if you look up the UN principles for responsible investment, there's some links on there that'll take you through, they're the principles themselves and what all this stuff kind of means and where some of the and even probably look for some of the signatories, some of the fund managers that are signatories to the to the UN, PRI.
Chris Haggart 47:39
Some pretty inspiring videos that are going on and some of those linked websites.
Alex Hont 47:42
It's true. The other point I'd look at is probably climate action 100 Plus, and also the responsible investment association of Australasia (RIAA) as well, they, they do a certification, for for investments and so a lot of the exchange traded funds or managed funds you'll see in Australia will have the notion some some sort of certification or designation from them. And the last one is probably if if you're really interested in the data and you want to see how how some companies get themselves rated have a look at sustainalytics, as well. And see, you can probably just google search all of those things to see. Find out a bit more information about them.
Chris Haggart 48:20
If you're interested. There's hours and hours in those suggestions that Al's sent through and no doubt you'll find you'll find your own as well.
Alex Hont 48:28
So I think that pretty much wraps up our ethical investment part two, yep. So yeah, that was great fun, Chris.
Chris Haggart 48:37
Really interesting. That sort of stuff is, is great. I think it's again, as I said, it's a watch this space, this is just going to keep happening.
Alex Hont 48:43
Yep, it should, it should, in fact, get get better and better as they should be more and more options out there. And hopefully, we'll be able to fix our little portfolio construction problems.
Chris Haggart 48:53
So yeah, I've no doubt.
Alex Hont 48:53
Alright, thanks again. See you next time.
Chris Haggart 48:56
Excellent, guys. See you next time.
Alex Hont 49:08
Thanks for listening to this episode of the masters of finance podcast. If you want to hear it again or hear any of our other episodes, you can find us on iTunes, Stitcher, or Spotify. Or you can also head over to our website at www.moranfp.com.au to find all the episodes and some other material that we have for you. If you want to get in touch with either Chris or I, you can find us on social media or get in contact with us through the website. We hope you enjoyed this episode and look out for the next one coming soon.
Transcribed by https://otter.ai