In investing, sin is no longer in.
Last year investment managers were surprised by the reaction of KiwiSaver members to their funds being invested in nuclear weapons, tobacco, landmines and cluster munitions. Ethical investing, which has always been on the fringes of the industry, suddenly became mainstream. It’s a brave KiwiSaver manager who still includes these investments under the guise of what’s best for their members.
For a long time though the managers had a point. Traditional ‘sin’ stocks, particularly alcohol and tobacco, had been very profitable. Given the primary role of any asset manager is to maximise returns to members, their response was that they were doing the right thing by having mainstream funds include these companies. For those concerned with their money being invested this way, many kept underperforming ‘ethical’ funds on the side.
In 2017 the landscape shifted dramatically. KiwiSaver members voted with their wallets, and basically commanded their managers to exclude some sin stocks.
Simplicity joined several managers in pressuring offshore suppliers to bring out funds we could invest in on behalf of our members, and the suppliers did just that.
Given the speed of the response, little old NZ got some global investment giants to move swiftly and decisively. It made the headlines in the business pages, but for me it was a moment all KiwiSavers should be proud of as, in a way, we helped move the world one step closer to conscious investing.
At that time we also began a project to see if extending exclusions was a sensible investment idea ie. we wanted to challenge the old precept that sin was in when it came to investment returns.
The results, quite frankly, stunned us.
Individual surveys on investment returns are fraught with the hazard of misinterpretation. The results can be skewed dramatically by the time periods involved, and by what is classified as a ‘sin’ stock.
There is a line of righteousness here too eg. cast the definitions too wide and you can have nothing to invest in eg. by some definitions, no company uses no fossil fuels and none has a zero carbon footprint.
However, great store can be placed on longer-term data, and what statisticians called ‘meta-data’ ie. a survey of surveys, which works out the long-term trends and irons out imperfections in analysis and methodologies.
It’s in this ‘meta-analysis’ that the investment case for removing traditional sin sectors becomes compelling. The largest one, involving analysis of over 2,000 academic papers over the last decade, shows a positive correlation between removal of well-accepted sin sectors and better returns.
Our own analysis showed that had Simplicity been investing for the past five years, we would have better returns in all our funds, from another 0.19% p.a. return in our conservative funds, up to +0.79% p.a. more in our growth funds. Over time, those returns should compound up to be significant for investors. The impact in growth funds could be as significant as having the lowest fees.
This is a big deal, and those companies in the excluded sectors should be thinking long and hard at their raison d’être. These companies ultimately underperform when their customers walk away from their products and services as too risky, and suppliers of funding to the companies (banks and shareholders) sense it will continue.
It’s already starting to happen, although it’s not immediately obvious, and often the changes may appear glacial. But it’s a brave bank now that funds tobacco companies, and that will be the same soon enough with fossil fuel extraction, weapons, pornography and alcohol.
The best example I’ve seen recently of this change is the virtual impossibility of deep sea drilling for oil in environmentally hazardous areas. It’s not that the oil and gas isn’t there, there’s tons of it below the frozen waters. But the reason the oil companies won’t drill is because no one will provide insurance for mishaps. It’s just too risky and expensive. And if oil companies want to take on the risk, they have to be extremely sure of their cash flows for decades out so they can weather the cost of any accidents. As ‘electric everything’ challenges their very existence, they won’t do it.
Fossil fuel companies have a particular problem too with what they already have in the ground, ready for extraction. There is growing concern that all that oil and gas is the ground is valued too highly, with the prospect of demand being slow enough that it remains in the ground forever as a ‘stranded’ asset and worth nothing.
And there is the reality now that people don’t want their savings propping these industries up. A recent Consumer Magazine survey showed a clear majority not wanting their money invested in the industries we’re excluding ie. Nuclear power, Weapons, Tobacco, Pornography, Gaming and Alcohol. Companies in these sectors make up about 15% of the total worldwide, so it’s significant, but not dramatic.
In financial markets, for the longest time, ‘sin’ was ‘in’. It was a very brave fund manager who would do what we’re now doing, and removing all sin stocks from all our funds.
The impact for the new economy is like a rising tide. Day by day it won’t appear dramatic, but longer term it will lift many boats. Nearly all technology and new economy industries are profit-seeking businesses, so at every juncture, from seeding through to listing on stock exchanges, they interact with financial markets. The connection here is obvious, the more money available for investing, the more opportunities there are. Our move here, part of a global trend, will only accelerate the capital available for new era companies.
This is, of course, a well-established trend. Moving away from traditional sin stocks will just speed it up. Financial markets have been in love with technology for quite some time now, because doing so makes money. They do so because they deliver what consumers want.
To my mind, it is this key point which is key to understanding why sin stocks have become under-performers. Smarter, more informed consumers have decided to either not to consume so much of a bad thing (eg. tobacco), choose never to consume (eg. weapons, gambling) or pay nothing for it (pornography). They have well informed moral precepts too which drive their consumer behaviour e.g.. in pornography and gambling.
So, in this sense consumers are making more informed decisions, and new era companies are treating them like the savvy, smart consumers they are.
By contrast, some of the ‘sin’ stocks are vulnerable to marketing and product strategies akin to the more base instincts, or praying on vulnerabilities and weaknesses. They are successful many times in this, ‘sin’ has been ‘in’ for millenia, but it feels like the tide is slowly and powerfully changing.
Companies that appeal to the head and heart are winning out over those trading on emotions and instinct. I know I’m starting to sound like a sociologist rather than an investment manager, but I do believe in human progress, and that that progress manifests itself, over time, in smarter consumer behaviours and more successful businesses. There is a great opportunity in appealing to peoples better angels and improving minds.
Now, wonderfully, investing with a conscience it’s a no-brainer. And there is something very nice about letting our members' money do the talking.
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