Investing for a better world not only feels good, it makes good investment sense and evidence to date shows that it can translate into strong investment performance.

We have long sought to put together a portfolio of Ethical and Sustainable Responsible Investments. However, up until now we have considered the menu of options available to be too restricted. There are now an increasing number of these funds in the market place, spread across the investment spectrum. This has enabled us to construct a properly diversified portfolio of well-rated specialist managers with compelling investment track records.

SRI is an investment approach that focuses on companies that contribute to a socially and environmentally sustainable world. SRI managers typically integrate environmental, social and ethical considerations as well as labour standards and corporate governance factors into investment analysis. Sustainable investing is the explicit recognition that these factors affect long-term business profitability.

Ethical investing is more about filtering out so called “offensive” industries such as tobacco and armaments manufacture. Businesses that pass the filtration process are eligible to be included in an ethical portfolio. In addition, ethical managers try to seek out and include businesses that are involved in such industries as clean energy, forest plantation and water management.

SRI and Ethical investing are different approaches to portfolio construction and there is considerable overlap in their final outcomes. For example, an SRI investor may avoid the tobacco industry because they consider that the legislative barriers, high-level taxes and increased class actions will erode company profitability over time. An ethical investor, however, will avoid the tobacco industry because they consider it unethical.

Portfolio Construction Challenges
What’s ethical for you may not be for me. For example, many consider uranium as a clean alternative to fossil fuels in addressing the issue of global warming. Others see uranium waste as an unacceptable side effect. Some investors want to avoid mining altogether but don’t see a problem with alcohol production and distribution.

How about investing in a bank that provides banking facilities to a tobacco company, or in a property trust that rents an office to a company prosecuted for industrial pollution? In most cases this information would not be available and it’s simply not practical or of material benefit to try to make investment decisions based on these secondary or tertiary level issues.

We have realised that there will not be much left to invest in if we try to meet everyone’s idea of SRI & Ethical investing. It would become more difficult to meet important investment return and diversity objectives in constructing portfolios. We also believe that most people who want to invest for a better world understand that it’s important to make a start. That it’s better to get it 95% right rather than not be there at all.

It is with these points in mind that we have launched our SRI & Ethical Portfolio. The portfolio features a selection of international and Australian share managers with both ethical and SRI features. Where available, we will include quality SRI and Ethical managers for the other asset classes such as property, fixed interest and cash.

Detailed below is a brief description of a selection of investments included in the portfolio. The table shows recent performance history compared to benchmark index performance.

 

Al Gore’s – “Generation Global Sustainability Fund”
By way of example, one fund very recently launched by Colonial First State is the “Generation Global Sustainability Fund”. Colonial has secured an exclusive distribution agreement from Generation Investment Management. Generation uses sustainability research in its selection process for buying high quality companies for the purpose of long-term investing. The company was co-founded by Al Gore, the former US Presidential candidate, and former Goldman Sachs Asset Management chief executive, David Blood.

While the fund does not yet have a performance track record, Generation has gathered together a very experienced investment team. The outlook is bright for a fund that appears to be in tune with the sentiments of a growing percentage of the investor population. Stock selections the fund has recently made include:-

Novo Nordisk – A Danish-based company established in the 1920s providing pharmaceutical solutions for diabetics. Novo Nordisk is considered a market leader with a global insulin market share of 52%. Reasons the stock was included in the portfolio:

• Ageing populations worldwide and increasing healthcare demands from developing countries provide growth potential.
• About 180 million people around the world suffer from diabetes1 and this figure is expected to rise to 330 million by 2025, Novo Nordisk is one of only three companies operating in this market.
• As well as providing treatment for diabetes, Novo Nordisk is striving to eliminate diabetes worldwide. As part of that aim, it has developed detection and prevention programs with the Chinese and Indian governments.
• It has sustainability fully embedded into its operations and undertakes triple bottom line reporting. This acknowledges the non-financial impacts of their operations on the communities in which it operates.
• There are substantial barriers to entry owing to patents, high capital intensity of insulin manufacture, complex injection devices and distribution networks. As such the company has good margins and has grown very consistently for a long period of time.
• Novo Nordisk’s flat organisational structure allows rapid decision making, which allows the company to respond more effectively to changes to patents.

Johnson Controls - a US-based manufacturer of building efficiency control systems, batteries for hybrid vehicles (50% of the business) and automotive interiors. Founded in 1885, the company operates in more than 1,000 locations with customers in 125 countries. Reasons the stock was included in the portfolio: -

• It is important to remember that quality investments will rise to their true value over time and that short term booms and busts are very often driven by sentiment and other factors that have nothing to do with the longer term value of a portfolio.

We are pleased to be participating in the growing trend towards ethical and SRI investing by making this diversified portfolio of well rated investments available. Investors interested in accessing a variation of this portfolio suited to their particular needs and investor risk profile should call us.

Andrew Condell

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The past three months has seen most share markets recover strongly from the significant correction that occurred during July and August. However, volatility continues.

Australian equities enjoyed an 11.1% recovery during the 3 months ending 31 October 2007. Resources and banks were strong performers during this time. Strong profit results and the growth in business credit helped drive the share market higher.

 

The Australian dollar has also been driven up in recent times, hitting US$0.93 in October. The strong Australian dollar can be attributed to a widening interest rate differential between Australia and other countries, particularly the US, and the continued strong demand for resources. The US Federal Reserve has cut official interest rates by 0.75% in an effort to stimulate the economy and offset the economic effects of the housing downturn. The Reserve Bank of Australia (RBA) in contrast, has increased rates by 0.50% over the past few months in response to inflationary pressure building. Interestingly this is the first time that Australian interest rates have moved in the opposite direction to US interest rates. This is further evidence of the decoupling of the two economies.

 

Australian economic growth continues to increase, with the resources boom helping to drive GDP growth above 4% over the past year. Unemployment remains low at 4.2%. These factors, together with expansionary government fiscal policies and wage growth, are pushing inflation above the RBA 2-3% target. In a response to increasing inflation, the RBA has increased interest rates again, to the disappointment of the Howard government.

Although many international share markets performed well during the past few months (4.9% in local currency), the appreciation of the Australian dollar reduced this to -0.3%.

News of the fallout from the subprime crisis continues to play out. Large global financial institutions have recently announced large losses as a result. For example Citigroup (US$11billion), Morgan Stanley (US$3.7billion) and Merrill Lynch (US$8.4 billion). It is expected that more financial institutions will announce subprime related losses and there will be further ructions in share markets across the globe as a consequence.

Another risk for global share markets is the stalling US economy. The US Federal Reserve has reduced interest rates, which it hopes will stimulate economic activity. If this is unsuccessful and if consumer spending continues to fall as a result of the housing market crisis, a US recession may result. Market analysts continue to closely monitor this situation and it is expected that share market volatility across the globe will continue.

Brendan Gallagher

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We have seen a big increase in the number of clients asking us to establish and manage direct share portfolios in recent years. The latest “2006 Australian Share Ownership Study” conducted by the Australian Stock Exchange shows 6 million Australians or 38% of the population were direct share owners. No doubt, this has since increased with the stellar returns enjoyed by investors since the figures were released.

Share portfolios can provide solid long-term growth. They are an important diversity counterbalance to property portfolios. They are relatively liquid compared to property as you can take profits and sell down some of your portfolio to fund house renovations, school fees, holidays or other expenditures along the way. They can provide a regular tax effective income stream. Tax effectiveness comes in the form of franked dividends with tax already paid up to the level of 30%. Capital gains are concessionally taxed after 12 months with only half the gain being taxable. You can negatively gear a share portfolio with the interest costs being fully tax deductible.

The types of share portfolios that clients are seeking fall into the following four main categories: Growth, Income, Tax Effective and Emerging Companies, or a combination of these. An investor’s specific needs will determine which portfolio is most suited to them. Retirees are typically looking for income portfolios whereas younger share investors are often attracted to growth or emerging companies’ portfolios.

 

The portfolios are quite different however, there are overlaps. With the exception of the emerging companies, there is a core holding which is represented in all portfolios. This establishes a solid blue chip base to the portfolio, which provides growth and tax effective income. The weighting to particular stocks will vary depending on the portfolio type. At the time of writing, our core portfolio was comprised of BHP, RIO, Woodside, QBE, Westpac, Wesfarmers, Woolworths, Westfield Group, NAB and AMP. All of these stocks are ASX top 50 companies.

The portfolios are well diversified amongst different investment sectors with the weightings varying depending on the portfolio focus. Growth portfolios are more focused on materials, resources and energy with the income portfolios favouring banks, telecommunications and income securities.

Additional allocations for our income portfolios include Fairfax, Telstra, St George, Ramsay Health Care and CBA Pearls. The growth portfolio includes PBL, Toll Holdings, and Lihir Gold and Brambles. Particular stocks within each industry can display more income or growth characteristics depending on the share price relative to earnings and the unique characteristics and operations of the company.

Our main equities research sources are Goldman Sachs J B Were (GSJBW), Macquarie Equities and van Eyk Research. While our Investment Research Committee uses many other information sources, the research provided by these sources is the primary tool used when constructing our preferred portfolios. We receive and have access to a vast array of information in the form of daily and weekly updates, bulletins and detailed economic and company reports. We use multiple research sources so that we can cross-reference ideas and recommendations. This acts as a safety net.

Macquarie and GSJBW have two of the largest equities research teams in the country. This means they cover many stocks and have teams of dedicated sector specialists that provide in-depth, quality and up to date information about the companies they are researching. This type of research is not available to the discount mum and dad investors.

The share market is a market place of buyers and sellers and there are two sides to every transaction. When managing direct share portfolios, it is the quality and timeliness of research that makes a big difference in outcomes, and determines how frequently you are on the right side of the transaction.

The combination of growth, income, tax effectiveness and accessibility makes share portfolios a powerful wealth creation force that should be considered by any investor interested in building long-term wealth.

Andrew Condell

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