During reporting season the Fund benefitted from holdings in Suncorp, Ooh Media, TPG Telecom, NIB, JB Hi-Fi, Brambles, Nick Scali, and Telstra while CSL (not held), GWA, Medibank and Wesfarmers (not held) detracted from relative performance. Of the 32 companies that are held in the Fund, 21 reported their results at June year end and we were satisfied with the business performance in 19 of them. The Fund established 4 new positions in companies during a period of share price weakness following their results. Pleasingly, 22 companies held by the Fund increased dividends in the last financial year.
Standards and stockpicking
As we thought about opening Ethical Partners we were cognisant of the great deal of trust required to allow someone else to manage your money and we are reminded daily of the additional expectation we created when we put the word “Ethical” on our office door. In society (and in financial institutions in particular, right now) there is a strong movement focused on fairness - of companies towards their customers, of sporting teams towards the rules, of society towards the planet and other people.
When it comes to investments we know you expect a high standard of us and we expect a high standard of the investments we make on your behalf. As Ethical Partners is a stock picker our focus will always be on the individual company positions and, in our view, the quality of those positions is paramount to our clients’ future returns. We look at prospective investments through the lens of the balance sheet, cash flow and quality of management and also consider risk in supply chains, human rights policies, potential environmental liabilities and which countries businesses operate in. Our belief is that understanding companies deeply in all of these areas sets a higher standard and gives us greater insights.
Looking into these issues helps us assess which companies have reasonably considered the risks of the business they are in.Companies we engage with can expect that we will ask questions of their management team around balance sheet, profitability, industry position, supplier segmentation, waste and energy saving programs, independent audit of factories, location of major outsourced manufacturers or owned operations, workforce training and safety, among others. It is no surprise to us that the best companies are already disclosing information on these issues and from a shareholder’s point of view, we are more attracted to these businesses, while, of course, remaining disciplined on valuation.
Our preference for companies and management teams that have considered the human and environmental side effects of their business carries more than a feel good factor. While “ESG” issues have been talked about a lot in recent times, we highlight below that they are not new issues and havebeen instrumental in determining risk for shareholders over the long term. One area where Ethical Partners is different is that we have developed a way of formally incorporating these factors into our Investment Process in order to avoid identifiable risks upfront and encourage corporates to lift the standard.We call this the Ethical Partners Operational Risk Assessment (EPORA). Specifically, our Investment Process via the EPORA seeks to identify selected risks such as country, industry, human rights and environmental risks. The following cases are examples of where such risks were prevalent.
Of course Ethical Partners will not be able to identify future operational risks at all companies accurately, however with all three of the above companies failing to get through our Investment Process and therefore being ineligible from any investment by the Ethical Partners Australian Share Fund, risks like these would have been and are being avoided by our clients.
It’s about risk
When considering prospective investments we think about risk as more than share price volatility. To us it is also a risk if businesses we hold engage in questionable practices in the pursuit of profit, both from a moral and financial perspective. While we like to see businesses doing well, we will avoid investments in companies where we feel a short term profit motive stands above other considerations because the behaviour that it can encourage can put favourable long-term outcomes at risk. The idea that the risk of carrying on a business activity could be larger than the financial gains that could accrue, is an interesting concept for the shareholder to consider.
There are also numerous examples, however, of Australian companies that do manage all aspects of their business soundly and have done well socially, environmentally and financially. Companies that have a thoughtful approach are highlighted when we apply our Investment Process including applying an analysis of their balance sheet, cash flow, management quality, human rights policies, country of operation, industry and environmental factors. On the positive side, a company that has a healthly culture, a successful and trusted brand and a proud and energised workforce is often the projection of a company dealing with these types of issues well.
Standards and returns
Australian listed companies such as Dulux, GWA and Orora amongst others rank particularly well in our Investment Process and operationally at least (with valuation being the other risk) we would consider these examples of everyday companies that just do things well and as a result,operate with lower business risk, in our view. We consider these three businesses through the lens of our Investment Process below.
In summary it is our job to buy shares of companies at the right price, taking into account their financial prospects, and we feel our Investment Process gives us the best chance of choosing companies more likely to deliver better returns with lower social, environmental and financial risk.
Nathan Parkin Matt Nacard
Investment Director Chief Executive Officer
During December 2020 the Fund returned 2.11% versus the S&P/ASX 300 Accumulation Index of 1.32%, outperforming the market by 0.79% (after fees). Overweight positions in Renewable Energy and Transition Commodities and an underweight position in Healthcare contributed to relative performance while an overweight position in Food Products and an underweight position in Information Technology detracted from relative performance.
Ethical Partners has made a submission to to the inquiry on the Climate Change Bill. In our view it is clear that we desperately need whole of government support around the important elements of this bill.
Biodiversity is a very important area of engagement for us at EPFM, and an area of increasing interest for investors. Experts believe that we are in the midst of the Earth’s sixth mass extinction event -some 75 per cent of terrestrial and 66 per cent of marine environments have already been severely altered by human activity and one million species face extinction – many within decades.
During October 2020 the Fund returned 2.85% versus the S&P/ASX 300 Accumulation Index of 1.89%, outperforming the market by 0.96% (after fees). Overweight positions in Insurance stocks and an underweight position in Metals & Mining contributed to relative performance while overweight positions in Consumer Staples and Media & Entertainment detracted from relative performance.