CPD: Socially responsible investment

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How does the evolution of social responsibility offer investment opportunities?

First there were ethical funds, then came the broader ‘socially responsible’ investments. Today, the socially aware approach to investment is complemented by impact investing, another investment approach that offers diversification and reasonable yields in strong business sectors.

In this article, DomaCom explores the evolution of social responsibility and how it pertains to investment opportunities.

The origins

Australia’s oldest ethical fund dates back over 30 years; it was soon joined by a small peer group whose differences lay in a perspective as to what was, and wasn’t, an ethical investment. Ethical funds typically use negative screens for stock selection, excluding companies as dictated by the relevant investment mandate.

There are differences in the ethics applied to each fund; while some might have a blanket ban on companies in specific sectors or with stated business attributes, others would take a less hard-line approach and limit exposure to such companies.

Common examples have included:

  • resource stocks that mine uranium – some ethical funds would have no exposure to the company in question, others might limit the portfolio’s exposure to that business
  • gambling stocks – while some funds would exclude all companies with revenue derived from gaming stocks, others may exclude a casino such as Crown, but allow some exposure to a business such as Woolworths with its gaming related revenue stream.

The evolution – ESG

The next wave in socially responsible investment was the emergence of ESG, the inclusion of Environmental, Social and Governance factors in stock selection. While ethical and ESG investment approaches are related, there is a key conceptual difference; ethical funds tend to avoid sectors, while ESG integrates those principles into its investment decision making.

Investment managers using ESG factors generally use a positive screen to actively seek companies with desirable ESG attributes, or which are actively working to improve in these areas. Figure one outlines some common ESG issues considered by investors:

 

 

The focus on ESG is a global trend – the United Nations Principles for Responsible Investing (UNPRI), launched in 2006, reflects the view that ESG issues can affect the performance of investment portfolios and believes investment managers must give ESG factors appropriate consideration if they are to fulfil their fiduciary duty.

 

 

The evolution #2 – socially responsible investment

Socially responsible, or sustainable, investing is a little more broadly defined. Arguably, socially responsible investment embodies both ‘ethical’ and ESG investment. SRI approaches may use both negative and positive screening of sectors and companies. Rewarding good corporate citizens is an important motivation of SRI investors; companies with strong ESG ratings will generally be a more robust business that both contributes towards environmental sustainability and the health of society, but is also a sustainable – and profitable – business.

The adoption of socially responsible and ESG metrics into company analysis by mainstream fund managers has grown over the past decade; ESG metrics are examined in addition to the usual financial and macroeconomic drivers that investment managers analyse. Increasingly, fund managers see the integration of these metrics as a source of alpha, or above benchmark return, to their investors. A recent academic study[1] examined the mechanisms through which value is typically created using ESG from both a corporate and investor perspective; while the final report will be released at the end of 2017, a summary finds the adoption of ESG factors benefits both company and investor.

The Australian Centre for Financial Studies (ACFS), a not for profit research centre within the Monash Business School, has released a study[2] that found growth in the broader SRI market in Australia and New Zealand is accelerating, growing 247% from 2014 to 2016 to reach $516 billion. An important indicator of how mainstream socially responsible investment has become was the report’s finding that 70% of Australia’s largest superannuation funds have made some form of public commitment to responsible investing, with approximately half having dedicated SRI options available.

Impact investing

An impact investment generates a measurable social or environment benefit, as well as a financial return. While a socially responsible investment approach is generally an application made to a portfolio of investments, impact investment tends to focus on a single asset or set of assets within a specific class; examples include clean energy, sustainable agriculture and social enterprise.

Impact investments are of particular interest to millennials, the next generation of investors and, potentially, advice clients. A 2016 report by Toniic[3] found strong links between the values of young adults and their investment decisions; 79% of those surveyed described themselves as impact investors, seeking both financial and social impact returns. According to Impact Investing Australia, investors are aiming to triple their allocations to impact investments over the coming five years.

While there is significant potential for impact investing in Australia, the conversion of projects to transactions has, until recently, been limited by the technology required to create an investible asset. The fractionalised investment platform developed and used by DomaCom can facilitate the transformation of an impact investment to an investible asset.

Impact investment case studies

#1 Sustainable agriculture

As the world’s population continues to grow, so too does the demand for agricultural production. As illustrated in figure three, it’s estimated that the world’s population will increase by 2,376 million by 2050, from 2015 figures. Asia and Africa will account for most of that growth. These regions are experiencing significant urbanisation and economic growth, which in turn fuels a growing middle class.

 

 

Food demand worldwide is likely to surge in the years ahead. Australia’s perception as a clean and green source of food has seen increased demand for dairy, meat, fish and grains. There is a solid investment case for rural property. Research by the Rural Bank of Australia[4] found that in all states, the median price of agricultural land has trended higher; the national median farmland price increased by 9.3% in 2016, following a 5.3% increase in 2015 and a 6.8% increase in 2014.

Figure four illustrates this growth on a state-by-state basis; over 20 years the median price in most states recorded average annual growth above 5.5%. According to the Rural Bank, taking a long-term view of the performance of Australian farmland values is appropriate given the cyclical weather and market conditions that characterise farming in Australia. Add to that, many Australian farmers consider farming to be a long-term career and lifestyle, often with the livelihood of the next generation in mind.

 

 

Despite the growth in both demand and the value of land in the agricultural sector, there are limited opportunities for investors. At the same time, farmers are seeking capital to expand and innovate, to implement a range of sustainable practices, and to improve economies of scale.

Fractionalisation provides financial advisers with the opportunity to enable clients to both take advantage of an emerging thematic and an impact investment with the potential to deliver positive socially responsible and financial outcomes.

#2 Clean energy

The Federal Government’s Clean Energy Finance Corporation estimates the potential investment in the clean energy sector will be between $3.5 billion and $5 billion by 2020, yet now it only provides 0.9 per cent of Australia’s electricity output compared with 2.4 per cent by OECD countries.

To provide investors with exposure to clean energy projects, DomaCom recently launched a biofuel project with Utilitas, a project that also heavily involves the town of Casino in the shire of Richmond Valley, northern NSW. This is an investment opportunity that merges a socially responsible energy investment in rural Australia with a projected eight percent yield for investors.

The project aims to raise capital for the land and the development costs, and the biohub will be leased to the operating business run by Utilitas. An ongoing leasing fee or income stream will be paid to the investors in the DomaCom Casino biohub sub-fund. Investors in this sub-fund are holding an interest in the land and the plant and are not investing in the operating business.

As well as providing a key community asset to a rural town, an investment in a community project provides a range of positive impacts; it enhances the community, adds to the town’s business centre, and importantly, leads to employment opportunities and encourages population growth.

Projects with a social conscious are important to many investors; fractionalised investment, or crowdfunding, can facilitates this. While the millennials may not be as cashed up as their baby boomer parents, they will be the next generation of accumulators and the evidence suggests they support impact investing. Any measures financial advisers can take to engage with millennials and help build an investment portfolio that resonates with them, which includes assets that they can believe in – as well as ones that provide a financial return – will provide for a better future, for our world and your business.

 

 

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[1] https://www.unpri.org/page/how-esg-engagement-creates-value-bringing-the-corporate-perspective-to-the-fore
[2] Australian Centre for Finance Studies, A review of socially responsible investing in Australia – May 2017
[3] Millennials and Impact Investment, 2016, Toniic
[4] Australian Farmland Values Report 2016 – Rural Bank of Australia
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This article provides general information only and has been prepared without taking account the objectives, financial situation or needs of individuals. The information contained in this article reflects, as of the date of publication, the views of DomaCom Australia Limited ABN: 33 153 951 770, AFSL 444365 (DomaCom) and sources believed by DomaCom to be reliable. We do not represent that this information is accurate and com­plete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. © 2017 DomaCom Australia Limited.

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