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Mike Murray on watching for the changing narrative

Mike Murray is Head of Domestic Equities at Australian Ethical, which manages over $6 billion in Australian equities and multi-asset funds. Australian Ethical has launched its first ETF, the High Conviction Fund (ticker: AEAE).

 

GH: After a long history of funds in the unlisted space, what has motivated the launch of an active ETF and why this particular fund?

MM: There’s been a huge growth in demand for ethical investments and people want something that's true to label and ultimately it needs to be accessible. That’s where the ETF comes in. It’s a good product in terms of the ease of use and not having to fill out all the paperwork that typically goes with a managed fund. And while there have been a lot of fund launches in the sustainability space, there aren't a lot of true domestic ethical active managers in the ETF space. So we thought there was a bit of a gap there.

GH: You've chosen the High Conviction version, what was behind that?

MM: High Conviction means a more concentrated strategy than some of our other strategies. It aligns with our ethical charter and active management, looking for sustainable business models but it also plays a bit higher up the market capitalisation curve. It holds some small caps but it is a bit more overweight some of the mid caps and larger cap stocks, and that gives it a bit more dividend yield. It's not really reinventing the wheel. It's an extension of what we're already doing.

GH: What will be the maximum weighting allowed in any one stock?

MM: Up to 10% in an individual name but that's unlikely in practice, we'd expect 5% to 7% would be a typical position for a larger capitalisation stock.

GH: ESG and sustainable investing is pretty much mainstream now, you hardly find a fund manager who doesn't claim to operate under these principles. How does Australian Ethical maintain a point of difference?

MM: It’s a good thing that it’s mainstream, but we've got an ethical charter that's really unchanged for 30 years, and we only do one thing. Probably a slightly more nuanced point is that we don't think ethical investing is exactly the same as ESG. Ethical investment goes deeper, it's more about values, aligning the portfolio with the values of the client. We think some things have inherent value, creating a positive impact on people, the planet and animals. Those things have inherent value that we can't necessarily measure in risk and return.

GH: You've been at Australian Ethical since 2016. What's been your best investment decision over that time?

MM: A company that's done very well in the last five years is Fisher & Paykel Healthcare, a very innovative company and that's one of the keys to their success. They had a core technology relating to humidification of ventilated air in hospitals and so they benefited from making a positive impact in the COVID setting. They moved into CPAP and the nasal high flow, which is a type of oxygen therapy. The share price over five or six years has gone from $10 to $30. We're not actively adding to the position but we like the management, its organic growth profile and the business model.

GH: And on the other side of the ledger, is there a stock that you sold recently that's made you think about your investment process and how you analyse investments?

MM: Well, not a company that we've sold recently but it's under takeover. One that hasn't gone according to plan is Australian Pharmaceutical Industries, API, the pharmaceutical wholesaler and they also own the Priceline franchise business. We believed in the Priceline footprint and the company met our ethical hurdles as well. But shortly after investing in the company, the management changed and became more focused on acquisitions rather than organic growth, some outside their core competency. It hasn't really delivered in terms of earnings. The lesson is to watch for changing narratives in companies when you're meeting with them. When a company starts acquiring outside its core, sometimes it tells you something about their core business and the growth profile.

A slightly more nuanced thing is that we have done much better at product-oriented companies than service- oriented companies. A case in point is aged care, which was a hot sector for a while but it hasn't really delivered, it hasn't scaled, and we think product-oriented businesses scale better than personal services.

GH: Do you own a stock that you expect to keep for a long time, maybe 10 years?

MM: We are very patient providers of capital but when you're a fund manager, a lot of things change in 10 years, you might even see two or three CEOs. You can see companies get very overvalued or very undervalued in that period and if a company becomes very overvalued, we would sell it. Cochlear is another company we've held for a long time, it's a market leader and the business does tremendous social good and their markets are under penetrated. They've got a high gross margin. They probably raised too much capital during COVID which was very conservative as business bounced back much quicker than people expected. They’ve ended up with $500 million of cash on the balance sheets, they’re conservatively geared. So you pay a high PE but over a 10-year period that will come down, given the strong growth rate.

GH: And a good business to own for the previous 10 years as well. Can I delve into your ethical process a bit more? When you're assessing a stock like Coles or Woolworths, which both sell tobacco, alcohol, sugary products, which are on the negative side of the ethical ledger. How would you weigh up owning a stock like that?

MM: That’s a really good question. We distinguish between companies that are direct producers of some of those harmful products … and we do think they’re harmful, there’s no real debate about that. In this case, they are retailers, we would not classify them as direct producers, they are indirect participants in those markets. The second part is: are they selling more than their natural share of those products and are they strategically involved in those industries? We don’t think those companies have an overweighting in those areas.

And then we ask if there are other positives in the business, and we think the answer is yes. Both those businesses are important in the overall economy. Coles is held in the High Conviction strategy and is committed to 100% renewables by 2025. They are signatories to the alcohol beverage advertising code, we can see quite a lot of positives. None of these companies is perfect so we're always making these judgements.

GH: Do you own any stocks now which may not have passed your ethical screens, say five years ago?

MM: We’ve seen both sides. We no longer invest in Tasmanian salmon producers for ethical reasons. But on the other hand, a company like Downer moved out of the mining contracting space into more of a light footprint, urban contracting business with a big role to play in energy transition. In building, there is a commitment from some businesses to a lower footprint and newer technologies, such as Fletcher Building and Boral. And in other cases, the end use of a product has changed, such as with lithium. Traditionally, we would not invest in mining companies but they are important for batteries and decarbonisation.

GH: Finally, any new developments at Australian Ethical coming this year?

MM: There's enough going on in the field of ethical investment to keep us occupied. You should expect us to stick to our knitting. We don't have a big presence in active international equities at the moment. That's something with some very interesting technology addressing society's problems. And more ETFs as we look across our product suite, they are on the radar.

 

Graham Hand is Managing Editor of Firstlinks. Michael Murray is Head of Domestic Equities at Australian Ethical, a sponsor of Firstlinks. This information is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs.

For more articles and papers from Australian Ethical, please click here.

 

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