November 15, 2017 / Regnan Archive

The news of British American Tobacco joining Lockheed Martin—one of the world’s largest sellers of cluster munitions—in the Dow Jones Sustainability Index (DJSI) raised some eyebrows in the superannuation industry. Tobacco and cluster munitions have been divested by major Australian and New Zealand super funds in recent years.

The explanation (that it is a “best of sector” index) hardly clarifies things. We hear about ‘value’ and ‘values’; ‘screening’ and ‘integration’, and catch-all terms such as responsible investment, ethical investment or ESG. But what do they mean?

The best place to start is to understand that all of these terms describe something between ‘value-based investing’ and ‘values-based investing’.

Values-based investing means including extra (‘values’ related) rules when investing. There are many ways to do this. It can include restricting decision making or limiting the investible universe based on a set of values, or using an investment process that gives these factors extra weight. These values may be important for members, trustees or stakeholders. Screening (ethical screens), divesting and tilting all fall into this category.

Value-based investing is different. While it covers some of the same social or environmental information as values-based investing, it uses this within its ordinary investment process to improve performance. In essence, it uses ESG to gather a more complete picture of a business’ value drivers and to make better predictions about how it will perform.



Expressing values through investing has a long history, starting with religious groups wanting investments that conform to the rules of their faiths. Many religious institutions continue to avoid investments in companies that make profits from weapons, gambling, lending money at interest, alcohol or stem cell research, to name a few.

For a long time, the super industry was hesitant about whether values-linked investment strategies were consistent with the Superannuation Industry (Supervision) Act 1993 (SIS Act). APRA’s Prudential Practice Guide SPG 530 – Investment Governance makes it very clear that ordinary fiduciary requirements—for instance risk and diversification—continue to apply, but nothing in the SIS Act suggests that if these are met, values can’t also be applied.

Many super funds have diverse members, and in the past, the question “whose values?” often sent the whole topic to the ‘too hard’ basket. Now, this is changing. Some funds extrapolate member values from those evident in surveys of the broader community. Community and member expectations are also being communicated more directly to super funds. A recent example is calls for ‘divestment’ – a call to remove a small number of companies or industries from a portfolio (also known as ‘screening’) which is now common across the super industry. Tobacco Free Portfolios, the initiative started by Dr Bronwyn King, is a good example of how member values are being taken into account by trustees and applied to the fund’s investment approach.

Although the idea can be simple, a decision to screen a portfolio can require some careful thought. Is it only manufacturers that should, for example, be excluded from a tobacco free portfolio, or retailers too? How much can a company earn from tobacco sales before they need to be excluded? How should one treat a healthcare company that profits from cigarette substitutes?

Funds often worry that responding to member or stakeholder expectations means getting tangled in this complexity. Some also fear a ‘slippery slope’ in having to respond to further pressure. These concerns are successfully addressed by funds that take a proactive approach: being prepared with an internally agreed framework for these decisions and testing it in advance with some plausible stakeholder scenarios. To avoid unintended consequences, it is also important to communicate with integrity and precision about any decisions. An approach that can be riskier is to delay, or to bury one’s head in the sand. Poorer outcomes can result from being forced into a quick decision later, when under more intense pressure and in the spotlight, without a well-thought through plan.



The idea that ESG analysis could improve investment performance is newer. It has grown with the realisation that, on average, 50 per cent of the underlying value of a company today is attributable to intangible value. Another way to think about this is the ‘invisible infrastructure’ a company relies on: its brand and reputation with its customers, its employee efforts and ingenuity, how efficiently it is organised for effective risk management.

Markets are not good at processing this kind of qualitative information. Share prices often get a sudden boost when a company announces large scale reductions in staff numbers, ignoring what this means for future performance, when fewer staff might mean unhappier customers, sluggish innovation, problems with products or compliance. A company’s impact on employees, local communities or the environment can also mean future profits may be hindered by regulation, a poor reputation affecting sales, or from problems in securing funding.

It is worth noting that many funds are already taking climate change risk into account in their portfolio. While climate change presents wide ranging risks over the long term, it is one of many ESG factors that funds need to consider.



Both strategies are legitimate and serve different purposes. Values strategies are more likely to arise from community, member or stakeholder feedback, or trustee beliefs; while value strategies owe their popularity to their financial potential and/or fiduciary lens.

Since it is a fiduciary’s responsibility to monitor all risks – including long-term risks that financial markets tend to ignore, the real choice is whether or not to apply a values strategy on top of the value strategy.



Good investment governance means trustees must know what the different strategies mean. The first step is to ask the following questions:

Q – Is the impact of the investments the main focus?                    

Yes = values basis

Or, is the main focus the impacts of these issues on the investments?

Yes = value basis

Following the tragic deaths of more than 1,100 people in the collapse of a garment factory in Bangladesh in 2013, Regnan received two very different client calls.

One rang to check that its values-based ESG research took account of how responsibly Australian companies managed their supply chains. The other call, from a client of Regnan’s value-based ESG research, wanted a second opinion on their own analysis, which predicted little impact from this issue for Australian retailers.

New regulation, changes to consumer behaviour, or security of supply were unlikely to become problems for the Australian retailers Regnan reviewed. It was corporate responsibility that would drive many Australian retailers to support improved health and safety practices in their supply chain.

Importantly, there was no contradiction in Regnan saying “yes” to both clients. Regnan’s analysis recognised that the impact of retail industry practices on people working in the garment supply chain was significant. However, this impact was asymmetrical; the impact on Australian retail companies of labour conditions in their supply chain was not.

Many providers claim their approach does both simultaneously. This is possible (though rare) with a disciplined approach that handles each strand separately. Just as often, this claim is a combination of spin and wishful thinking. Fortunately, it is easy to test.

When considering strategies, products, frameworks or providers, funds should ask for examples of responsible investment decisions that were made; drill down on the reasons for these decisions (for example, a decision to sell down a stock) and focus most on the cases where value and values angles differ (such as the garment worker safety example, above). Then consider:

  • does the rationale include a statement of a clear moral position? If this statement is vague, weak or ambiguous, values credentials are likely overstated.
  • if the rationale is an economic one, how strong is the risk, return or business case analysis that underpins it? If the goal is better investment performance, mere mention of these isn’t enough – they need to be able to withstand professional scrutiny.



Where a strategy is only about investment performance, it will integrate ESG information into its financial analysis, rather than using a rule to apply directly within the portfolio. In practice, many funds now use ESG as an additional way to monitor their managers to avoid risks accumulating in the portfolio.

In contrast, where a values-basis is used, the rules must be clear and independent of any financial case.For instance, in the example above about excluded tobacco companies, the criteria could instead:

  • filter for inclusions (such as a Sustainability Leaders Fund)
  • respond to company behaviours (exclude companies recently fined for a safety breach)
  • use relative instead of absolute criteria (include/exclude companies that are the best/worst in their sector relative to peers, rather than exclude an entire sector).

For that matter, the rules can apply to:

  • transactions instead of holdings (“only these stocks are cleared to buy”), or
  • the portfolio as a whole (“the portfolio’s carbon footprint cannot exceed that of the benchmark”).

Responsible investment strategies are as varied as their clients, and it is important for funds to ensure they understand how the approach is consistent with their objectives.

Best practice fiduciaries need to be responsible in their investment approach. Knowing how well your internal investment teams and your external fund managers understand the impacts on long-term value, as well as any ‘values’ you want applied, is vital to effective responsible investment governance. It is also critical to ensuring you are able to secure the best retirement outcomes for fund members.


This was originally published in Superfunds Magazine.


Regnan Global Equity Impact Solutions Fund

This fund is distributed in Australia via Pendal and in the UK, Europe and other countries via J O Hambro Capital Management.

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