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Choosing the Fund that Fits

Mon May 13th 2019

Choosing the Ethical Fund that fits

Mindful Money’s Methodology

Mindful Money aims to change the ways that New Zealanders think about their investments, so that they give greater priority to directing their funds towards social and environmentally beneficial outcomes. Investors will be supported and empowered to direct their investment towards credible forms of responsible investment and impact investment.

Many will invest directly with Responsible Investment (RI) fund providers. Others will invest through this online platform. This Methodology sets out how Mindful Money has selected investment funds to participate on the platform, and how the platform will help investors to find the fund that fits their values and preferences.

Ethical Investment principles

Leaders in the investment community, notably Larry Fink in his annual letter, are calling on corporations and investment managers to make a positive contribution to society. Much of the investment community has recognised they have a responsibility to avoid harm and contribute to positive outcomes, as shown by membership of the Principles of Responsible Investment (PRI), which has reached US$70 trillion of assets under management.

Even so, there is confusion amongst the public about the meaning of terms such as ‘responsible’, ‘sustainable’ or ‘impact’ when applied to investment, and widespread concern over greenwashing.

There are core principles at the heart of the notion of responsible investment management. Fund managers should ensure the funds they manage are not invested in companies that have socially and environmentally destructive impacts; they should use their influence as institutional shareholders to improve practices; and they should increase the proportion of their investments in companies that are managed to high Environmental, Social and Governance (ESG) standards. Leading members of the responsible investment sector will also invest at least part of their portfolio in companies that contribute to social benefit.

Mindful Money considers the core principles for credible RI are:

Fund services should meet their clients’ needs, including their values and ethical preferences:

  • Prominently display their responsible investment policies and approaches, and regularly report on ESG issues
  • seek to understand their clients’ preferences, including their ethical preferences, and how those are changing over time
  • act in ways that benefits their clients’ financial and ESG interests
  • market their products and services accurately and honestly

Investment managers should exercise corporate governance through:

  • Active engagement with management and the Board of companies they invest in (either directly or as part of a coordinated group), especially where there is poor ESG performance, high ESG risk or controversy
  • Formal voting and participation in governance processes, in collaboration with like-minded investors, to improve ESG policy and performance

Investment strategies should encourage a socially-beneficial purpose:

  • a long term approach to investment, risk and return
  • a holistic framework for assessing social and environmental impacts
  • improving ESG performance over time, recognising some ethical compromise is inevitable, but it should be defensible and reduced wherever possible
  • the achievement of social benefit as well as financial return - international targets like the Sustainable Development Goals or the Paris Agreement on climate change can be useful to align investment with business purpose

Investment funds should be transparent and disclose material information:

  • Impacts of investments on climate change, as well as positive or negative impacts on society and the environment
  • Investment choices that may give rise to investor concerns or entail compromises with ethical policies
  • Full holdings in investment portfolios

Putting Ethical Investment principles into practice

As a charity promoting responsible investing practice, Mindful Money will prioritise working with investment funds that follow these principles and put them into practice.

For managed funds, a positive social and environmental impact can be achieved through one or several of the following approaches:

  1. Avoiding investments in companies with harmful impacts
  • what a business does is often more important than how they do it. For example, a socially responsible tobacco company is an oxymoron. Sectoral exclusions are a useful tool in sectors where the business model is inherently damaging to people or the environment
  • excluding ‘sin stocks’ and other damaging sectors provides assurances to investors that their funds are not invested in businesses that are inconsistent with their values
  • exclusions of specific companies through ESG management avoids investing in companies with adverse social and environmental impacts, beyond sectoral exclusions

Mindful Money will give preference to those funds that provide sectoral or ESG screening to avoid investments that would concern most investors (see priority sectors and issues in our 2018 consumer survey).

Mindful Money will analyse the portfolios of NZ managed fund providers and publish the proportion of funding in sectors and companies of most concern to investors. Details of the methodology is in the blog, Avoiding Concerns.

2.   Investing in high ESG companies

        Portfolios should include a high proportion of companies that operate to high ESG standards. This can be achieved through active ESG management, or investing in high ESG passive funds. The use of ESG analysis is now common in the investment sector, but there is little information on how ESG is reflected in portfolio choice or ESG outcomes. This has led to a widespread concern over greenwashing.

        Credibility can be enhanced through objective ratings of portfolios or by certification:

        • Some ratings agencies now provide a measure of portfolio ESG by aggregating the ESG scores of companies within the portfolio
        • Certification schemes can provide scrutiny over ESG processes, resourcing, capabilities and transparency

        Mindful Money will encourage all responsible investment funds to provide objective measures of their ESG performance. This could include working with a Third Party provider to generate an ESG score for their portfolio. Mindful Money will use the ESG score as an indicator of ESG management.

        Membership of the Principles for Responsible Investment (PRI) and the Responsible Investment Association of Australasia (RIAA) provide ways for fund managers to engage with RI practices, but membership does not require achievement of a high standard.

        RIAA certification requires a review of ESG management practices and Mindful Money considers that it is an indicator of good RI practice.

        3.   Investing to create positive impact (Impact investing)

            Impact investments generate measurable social and environmental impact alongside a financial return. The associated financial returns can vary from a fully commercial return through to a low or zero return.

            While the impact investment movement is growing internationally, there are currently no Kiwisaver options and few options available to New Zealand retail investors. There are opportunities, generally highly risky, available for qualifying investors in private equity, venture capital and crowdfunding. Investors seeking diversified impact investment funds can invest overseas but, if investing above $50,000, this requires a burden of tax reporting.

            Given the lack of Impact Investing managed funds, Mindful Money is seeking to encourage the registration of new sustainably-themed funds and impact funds. These may be overseas funds registering as PIE funds in New Zealand or new managed funds that are available to retail investors.

            Mindful Money will also develop a ‘marketplace’ to highlight impact investment opportunities, including seed funding, venture capital, crowdfunding, private equity funds with a strong impact component and other impact investments.

            4.   Improving Corporate Governance

                Engagement with companies to improve ESG performance should be part of corporate governance responsibility, especially since institutional investors are significant shareholders in most listed companies. Fund managers should engage, directly or through a governance service provider, and governance should be part of the mandate for contracting investment managers. Most funds hold relatively small proportion of company shares, so collaboration with other institutional investors is typically necessary to leverage change.

                Investment managers should report on their corporate governance engagement and its impact in terms of improvements to company policies or practices. Active governance is potentially a way to achieve improvements in ESG, but showing engagement is not sufficient - there needs to be credible evidence that engagement is resulting in positive business change, particularly for the companies that are subject to controversy or operate in controversial sectors.

                Mindful Money expects all investment managers to engage with companies as part of their corporate governance responsibilities, to report publicly on their engagement activities, and identify cases where engagement has led to improvement.

                Mindful Money will develop a programme, working with fund managers, the Shareholders Association and the Corporate Governance Forum, to strengthen governance of New Zealand companies and raise social and environmental disclosure, standards and performance.

                5.   Strengthening the RI Framework

                      Mindful Money aims to build a movement of educated and active investors who want to invest responsibly, and who are prepared to take action to support the development of a stronger RI sector. We will advocate strongly through all available channels, including social media, to raise public awareness of the funds and managers who exemplify best practice, and aim to work collaboratively with others in the investment sector to publicise and grow RI.

                      Mindful Money seeks to strengthen standards and the credibility of RI, working with RIAA and others, and to counter greenwashing and misleading claims.

                      Mindful Money also seeks to improve the policy and regulatory framework for investment and finance. A number of governments internationally have undertaken sustainable finance strategies and action plans, and momentum is building for a similar initiative in New Zealand.

                      Mindful Money seeks to collaborate with others to build a public awareness campaign for RI and significantly increase demand; develop clearer standards and stronger forms of certification for RI; and build an inclusive sustainable finance strategy for New Zealand.

                      Mindful Money Platform

                      As a result of the above principles, the funds that qualify for inclusion on Mindful Money’s online platform need to include one of the following characteristics (and ideally more than one):

                      • Broad exclusions of unacceptable companies
                      • Credible ESG practice verified by RIAA certification, or evidence of high ESG standards
                      • Evidence of effective engagement and verifiable outcomes from that engagement
                      • Investment in sustainably-themed sectors or companies that generate social and/or environmental benefits
                      • Contributions towards raising standards in the sector and improving the framework

                      Information on these characteristics is drawn from quarterly updates and filings on the Disclose database, reports on fund providers’ websites, independent research reports and Mindful Money’s analysis.

                      Helping investors find the fund that fits

                      Mindful Money’s online platform will help users to ‘find a fund that fits’. This reflects the inherent complexity of matching diverse preferences of investors with different strategies of providers. There is no credible way to recommend a fund according to a single measure of ethics or responsibility.

                      Mindful Money’s approach recognises that each investor has a different set of values, preferred investment approach and risk preference. These three factors – values, preferred investment approach and risk preference – are at the heart of the 3-step approach on Mindful Money’s online platform.

                      Based on investor preferences and objective data on providers, Mindful Money uses a multi-criteria approach to recommend a range of funds to the user, supported by key measures such as RI policies, past returns and risk. The user can then choose the fund that fits.

                      It is important that the values are determined by the user. These may be sectors (eg. gambling, pornography, fossil fuels) or issues related to controversies (eg. human rights, animal welfare). In future, when the broader range of investments is added, the platform will include the positive choices that investors can make. The criteria will also specify what investors want to include (eg. renewable energy, affordable housing, etc).

                      The preferred approach of the investor is determined through their choices amongst the most common RI strategies. The investors will choose amongst different combinations of sectoral exclusions, ESG management and impact investing (when available); active or passive funds; and fees.

                      The risk preference is selected by the investor, through a combination of their time horizon for investing and the attitude of the investor towards risk and return. The categorisation of those preferences into different risk categories is based on the criteria used on the government’s Sorted website.

                      Investors will be encouraged to seek the guidance of a certified Financial Adviser if they are unsure or if they have questions on the right fund for their personal circumstances. The Mindful Money platform includes a list of the registered financial advisers who are PRI members, RIAA members and RIAA-certified.

                      Identifying funds that fit users' criteria

                      Information from fund providers is primarily drawn from quarterly filings on the Disclose database. This provides a short fund description and information on fund performance, as well as information about their responsible investment approach in the Statement of Investment Policy and Objectives and the Product Disclosure Statement (PDS). Further information is drawn from the fund’s website and, for those certified by RIAA, from the Responsible Returns section of RIAA’s website.

                      Sectors excluded by funds are verified through checking the lists of current securities in their portfolios. The analysis will also deconstruct the portfolio of indirect investments, where a fund invests in another fund as part of its portfolio. Mindful Money’s analysis checks the content of these indirect investments for consistency with investment policy wherever there is data available (currently around 98% of indirect investments). This can show if a fund has stated an exclusion for gambling, for example, but has gambling companies in their current portfolio.

                      The integrity of ESG management used by a fund is more difficult to verify. Some funds have commissioned an external agency to rate their portfolios, based on the ESG scores of companies within the portfolio. Mindful Money considers this is good practice and is encouraging all funds on the Mindful Money platform to undertake an ESG rating of their portfolio to build confidence in the integrity of their ESG management. There are still few funds that have published this information.

                      Verification can also be provided through credible certification processes, such as RIAA’s process. Mindful Money has worked with RIAA on a recent review of that process. The RIAA certification process is currently the most robust way to verify that funds are using ESG management.

                      On the platform, the criteria specified by investors will be compared with the attributes of different investment funds, and a short list of funds recommended to users. They will be provided with information on fund attributes, such as past returns, fees, investment approach and the latest PDS, with comparator tables.

                      When investors are ready to make a decision, they will be linked to the fund provider to invest, with an API to identify Mindful Money as the source of the lead. Providers will contribute a small fee to help pay for Mindful Money’s costs of social marketing of RI and operation of the platform. There is clear messaging on the platform explaining that investments through the platform will result in a financial contribution to Mindful Money and allow the platform to remain free for users.

                      Income from donations or contributions from fund providers will initially be used for promotion of RI and platform operating costs. In the future, any additional income will be used to fund charitable work on issues such as financial inclusion, environmental improvement and sustainability.

                      Visit the Mindful Money website and find the fund that fits your values.