Flexibility needed to track the best companies
Old Nick Capital Management has recently launched an Asia-focused fund which takes an innovative approach to providing alpha by targeting companies in “disadvantaged industries”: that is, Asian corporations that are the victims of societal discrimination.
Such companies either own so-called “vice” businesses (such as tobacco, alcohol and pornography) or are traditionally operated companies in pharmaceuticals, energy and heavy manufacturing. They are penalised by regulators and harried by pressure groups.
Not only does this market prejudice increase the cost of capital for such companies, but the potential costs of compliance with the plethora of restrictive legislation being introduced would reduce their profit margins; their competitive advantage would clearly suffer.
In addition to seeking to identify “best in class” companies in these industries, Old Nick Capital plans to use its strong industry and government relationships to lobby at the highest level. Regulations on the environment, human rights and labour conditions clearly need to be curbed. The fund is also in discussions with regional stock exchanges to encourage them to maintain current disclosure requirements or, in some cases, even relax existing regimes to lessen the compliance burden on companies.
Old Nick’s portfolio manager, Lew Siffer, said: “There are lots of potential opportunities to invest in companies that are creative and nimble enough to manoeuvre their way around the complex regulatory environment beginning to be formed around Asia. We exist to support these single-bottom-line companies and to enable them to continue doing business as they always have done.”
Alright, I admit … none of that was true (although maybe there is the germ of a business plan in there somewhere).
It is true, however, that one successful US mutual fund follows a strategy of investing only in companies which are engaged in businesses that some would view as sinful - or, at least, as less than completely wholesome. The aptly named Vice Fund, set up in 2001, focuses exclusively on the alcohol, tobacco, gaming and defence industries. Its top five holdings at the end of July 2010 were Philip Morris, Lorillard and Altria (all cigarette companies) and Carlsberg and Diageo (multinational purveyors of alcohol).
And the “inconvenient truth”, perhaps, for virtuous socially responsible investors is that the Vice Fund was well ahead of the market last year. The fund was up nearly 17% as December drew to a close. It was ranked among the top performers in Morningstar’s large-blend fund category.
This might upset some in the sustainable investment community, who ruthlessly screen out all companies operating in these industries. For example, Sentinel Investments in the US is typical: it avoids companies that produce tobacco or alcohol products, weapons or nuclear energy, or are involved in gambling.
But screening is subjective, and one man’s evil may be another’s good. Ave Maria Mutual Funds, another US mutual fund family invests according to certain religious principles of the Roman Catholic Church. It avoids companies involved in contraception and abortion or whose policies are judged to be anti-family.
While Ave Maria shuns pornography (including hotel chains with in-room porn TV channels) and some pharmaceutical, healthcare and insurance companies which have links to family planning, it has no objection to some of the other “sin” sectors.
In recent years, it has invested in United Technologies, which makes Blackhawk helicopters, General Dynamics, builder of Abrams battle tanks and the Stryker combat vehicle, and Smith & Wesson, one of the largest weapons manufacturers in the world.
A barrier to the widespread acceptance of responsible investing has been the perception that it automatically translates to lower investment returns: some argue that limiting your investment universe by screening out some companies should entail a performance penalty. This misconception is being gradually corrected as the market recognises that the current philosophy of responsible investment is proactive; it need not imply a material reduction in the investment choices.
Certain investors (such as shariah fund managers) will always choose to reject certain businesses on religious or ethical grounds. However, the next generation of SRI practitioners is trending strongly towards ESG integration, or analysis of environmental, social and governance issues in companies across all industries.
Unlike the old school of socially responsible investing, the new wave is being led by some deliberately non-idealistic investors who are responding to a growing conviction that SRI investing is simply good business.
Indeed, even the managers of the Vice Fund have argued that they are not seeking to promote depraved behaviour by the general public, and have been keen to emphasise their own clean living habits. They explain that the Vice Fund is really an alternative sector strategy, focusing on four industries which offer true investment merit.
Throughout the economic cycle, people will continue to drink, smoke and gamble and nations will need to defend themselves. In addition to this resilience during periods of recession, companies within these sectors have high barriers to entry. And there is little risk that tobacco or alcohol products, at any rate, will be made obsolete by newer technology.
Moreover, Jeff Middleswart, who manages the Vice Fund, would probably also argue that the companies in the fund’s portfolio are, in many ways, best of breed. He targets profitable companies with growing cash flow that pay dividends, buy back shares and have clean balance sheets, as well as deep management teams.
In an interview with an American newspaper last year, Middleswart argued: “These are stocks with the (financial) characteristics everybody
says they want, and we’re getting them at a discount. That’s because certain people don’t want to own them.”
The point here is not to provide free advertising for the Vice Fund in a column about sustainability … but to emphasise that in order to capture value, analysts need to be flexible. For many investors, rather than limiting the investable universe, it may be more appropriate to include ESG factors into the investment process and, in doing so, identify companies best positioned to benefit from investment performance over the long-term.•
Alexandra Tracy is the chairman of the Association for Sustainable & Responsible Investment in Asia (ASrIA)