Focus on sector exclusions short-changing investors
31 October 2017
Focus on sector exclusions
Investment managers’ approach to responsible investing may be overlooking their fiduciary duty to act in members’ best interests, Kiwi Wealth has warned in a white paper.
With the responsible investment practices of KiwiSaver funds in the spotlight during the past year, most fund managers had made changes to the way they invested members’ funds. In the main, New Zealand fund managers were using exclusions, or negative screening, of entire sectors from investment portfolios as their responsible investment strategy.
“That falls short of international best-practice and certainly not what we consider to be true responsible investment,” said Kiwi Wealth chief investment officer Simon O’Grady.
“Sector exclusions are a blunt instrument. It’s an approach that can actually work against investors, and means managers may be neglecting their fiduciary duty to act in investors’ best interests in the extreme.
“Not only are sector exclusions inflexible and limited in building investor value, it’s an approach that doesn’t necessarily effect any real or positive change in the behaviour of companies within excluded sectors.”
Kiwi Wealth’s white paper examines responsible investment in New Zealand. Investing in an imperfect world: our take on true responsible investment found that only by fully incorporating environmental, social and governance (ESG) considerations into investment management investors could have the best chance of achieving their desired financial and public good outcomes.
That meant truly responsible investment required a considered, nuanced approach, with clients acting in partnership with their fund manager.
“Responsible investment isn’t just about reflecting personal values. It’s about managing risk to long-term shareholder and stakeholder value.
“It raises many important issues for the New Zealand wealth management industry, and it’s a real challenge to strike the right balance on these issues while acting in the client’s best financial interests.”
A 2016 Kiwi Wealth-Responsible Investment Association of Australasia (RIAA) survey confirmed most New Zealanders want to be responsible with their investments in addition to achieving strong financial returns. 42% of the 1,000 members surveyed stated a preference for fund managers to be active shareholders, positively influencing company performance through active engagement, rather than divesting all shareholdings (19%).
“As a bare minimum, zero-tolerance exclusions are helpful for those sectors that are illegal or have strong public policy arrangements against them, such as whaling, tobacco and controversial weapons.
“But to best meet responsible investing and fiduciary objectives, you have to incorporate ESG factors at the security level as an active part of the investment process. The typical construct for Exchange Traded Funds, while helpful for providing low-cost access to global markets, doesn’t allow fund managers to do this.”
Kiwi Wealth’s answer was to build its own enhanced index fund to better meet the changing views of New Zealanders on responsible investing.
“We identify and exclude individual companies that are being particularly irresponsible in environmental, social and governance areas, rather than just throwing out any sector with potential issues. We then ensure that companies with a better ESG profile are emphasised because these companies tend to perform better in the long run.
“In our view, not incorporating those ESG considerations in stock selection is out of line with best practise, and may overlook our fiduciary duty to act in the best interests of clients.”
To complement its sophisticated firm-wide approach to responsible investment, Kiwi Wealth is now the only default KiwiSaver scheme provider to have all funds independently certified as being responsibly invested by RIAA.
The white paper can be accessed at www.kiwiwealth.co.nz/ri-whitepaper