Ethical screening processes and its effect on returns
The Board has raised the question as to whether an ethical screen can be implemented without substantial impact on the income or maintenance of capital value.
Indeed the question as to whether the ethics of industry plays a role in the performance of listed companies has been a topic that has attracted significant attention over recent decades from investors, academics, analysts and product manufacturers alike.
Ideological reasons aside, from a quantitative standpoint it's clear that any strategy that reduces the number of investment opportunities available to us is likely to reduce returns and increase volatility. Best case scenario returns will be close to that of an unconstrained portfolio.
Our approach / methodology
To get a more fair and balanced assessment of the costs or benefits of SRI we approached the question of impact on investment returns from three distinct, yet ultimately related angles:
Our analysis finds that implementing an ethical screen to The Jack Brockhoff Foundation’s portfolio can be expected to reduce prospective returns by roughly >$38,000 per annum (0.09%).
The level of fees is proportional to The Foundation's allocation toward equities; therefore if the level of equities was reduced (increased) we would expect this cost to also fall (rise).
While the overall cost from implementing the suggested ethical screen is low in proportion to The Foundation’s long term return objectives it is prudent to consider the cost of this decision against the potential benefit that may be achieved from investing with an unconstrained mandated. In other words, is more "good" achieved from increasing Foundation disbursements or by avoiding particular sectors.
Furthermore, the Board must consider the practical and administrative implications. Placing exclusions on assets based upon their behaviour invariably increase the chance for a policy breach, particularly if sections of the portfolio are managed via external unit trusts or internally by The Foundation’s staff.
In conclusion, we find that while implementing an ethical screen does come at a cost it is unlikely to have a substantial impact on The Foundation's investment income or ability to preserve the inflation-adjusted value of the corpus. It does, however, present a number of administrative challenges and responsibilties that will require ongoing monitoring and management.