There are many things you should be worried about when choosing your KiwiSaver scheme. But whether that scheme is investing ethically – commonly understood to mean shunning tobacco, alcohol, gambling and armament stock – is not one of those things. Although greed may not be good, in this case itis very sensible.
To begin with, let’s dispense with the idea that an ethical investment strategy will necessarily be a profitable one. There is no convincing evidence that ethical funds have outperformed the broader market. Although the profits of unethical companies may fall as future societies become more enlightened, history shows that such sensible predictions are far from certain.
Take, for example, Altria Group, the former Phillip Morris. Ethical quandary or not, it would have taken a brave investor to buy this stock in 1957, knowing the troubles looming for the cigarette industry. Nevertheless, Altria has the distinction of being the single-best performing stock in the S&P500 over the last fifty years (returning 8400%).
Regardless of its strategic merits, the fact remains that ethics, unfortunately, are not free. The requirement to screen companies for ethical shortcomings imposes another layer of fund management costs, while at the same time constraining the ability of your manager to do what he or she is paid for – identifying investments with desirable risk/return qualities. Ethical requirements also rule out the cheapest investment option, the purchase of passive index-tracking funds.
This is hardly a minor concern given that fee levels, not manager selection, will probably be the single greatest determinant of the return of your KiwiSaver scheme (for a given mandate).
A further concern is that unethical stocks have the desirable quality of performing well when overall market conditions are unfavorable. International conflicts are in general bad for stocks but great for armament companies, and addictive products can be relied upon to generate sales even when consumer spending is in retreat. Hence unethical stocks can provide insurance for share portfolios.
But suppose you can live with sub-standard investment returns in order to register your disapproval of certain industries. Will your investment stance actually affect the producers of unethical goods?
Consumer boycotts of unethical products hurt the bottom line of the companies. But it is unclear that boycotts of investing in these companies can ever be as effective. A switch to ethical investments doesn’t change the total amount of capital available, and capital is fungible. If an unethical company’s revenues remain intact, it follows that the value of the company is unchanged, and there will always be amoral investors willing to provide funding to companies trading below fair value.
In the above situation, the net result of ethical investing is a transfer of investment returns from ethical investors to unethical ones. In fact, a "Vice Fund" has already been established to invest exclusively in unethical stocks.
Strict ethical investment is not even feasible in the KiwiSaver environment. Almost all KiwiSaver providers will employ sub-managers in specialist investment fields, making it impossible in many cases to determine the exact holdings of a portfolio. The only specialist ethical KiwiSaver product currently available has overcome this problem by concentrating investments heavily in New Zealand stocks – which should ring warning bells about the potential for ethical criteria to produce high-risk, undiversified portfolios (only suitable for a small subset of investors).
Even then, the ethical status of a given stock is hard to guarantee – witness the outcry last year when it was reported that some of Rakon’s generic components had made their way into American missiles.
The Rakon example highlights the potential for narrow ethical guidelines to quickly balloon, ultimately to the detriment of the ethical investor. Most people would be happy to ascribe unethical status to cigarette manufactures. But with obesity a major health hazard, we can envisage fast-food manufacturers soon being relegated to unethical status. Global warming casts an unfavourable ethical light on energy companies and energy-intensive producers. Then we have the problem of related parties – should we shun supermarkets for selling cigarettes, or banks that lend money to unethical companies? Let’s not even start on the rules laid out by major religions regarding the lending of money for interest.
Although this may sound like fear-mongering, the KiwiSaver utilisation of portfolio investment entities rules out tailoring investments to an individual’s definition of what is ethical and what isn’t. Inevitably, ethical funds will end up being one-size-fits-all, with a huge chunk of the investment universe excluded.
The fundamental goal of Kiwisaver is to ensure that your wealth is adequately protected for your retirement. This is no easy task, so why complicate matters by trying to use your investments as an outlet for your ethical beliefs? Ethical decisions are outside the expertise of investment managers. Asking your KiwiSaver provider to make ethical decisions on your behalf is akin to asking your accountant for marital advice.
Although "unethical" investment may pain your conscience, ethical investment is more likely to harm your returns than to damage the companies you eschew. Ensuring that your KiwiSaver provider maximizes your returns should be the sole focus. Once you are assured of this, you can look forward to your golden years and the opportunity to spend your ill-gotten earnings in the most ethical fashion imaginable.
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