The expectations that Australians place on the financial services industry are changing fast and traditional ways of managing and advising on investments need to evolve to keep up with these changes. More clients are asking for a responsible and ethical approach to how their money is managed, from retail through to institutional investors.
The industry is responding. Today in Australia, nearly one in every two dollars is being invested with a commitment to responsible investing, taking into account environmental, social, governance (ESG), or ethical considerations into investment decision-making.
The drivers of the ethical investing trend
This proportion reflects a quadrupling over the past three years, largely driven by the growing acknowledgement within the industry that ESG factors contribute to valuations, both positive and negative. For example, earlier this year, Bank of America Merrill Lynch stated that ESG has become the most important signal of future risk and “a better signal of future earnings volatility than any other measure”.
But another driver has emerged which many in financial services have overlooked. Australians expect their investments are managed in a way that is consistent with what’s important in their own lives. They hold views on ‘what matters’ and what is ‘right’, as demonstrated by the charities they chose to donate to, the businesses they prefer to shop at and the type of world they feel they are contributing to for their children and grandchildren.
The Responsible Investment Association Australasia (RIAA) recently launched new consumer research underscoring this expectation, with 9 out of 10 Australians stating that they expect their superannuation and other investments to be invested responsibly and ethically.
Lessons from across the Tasman
We witnessed a resoundingly clear example of what this expectation means in practice in the New Zealand market last year when front page reports in the national broadsheet and radio networks exposed that the default pension funds (KiwiSaver funds) across the country were holding investments in tobacco, cluster munitions, land mines, and nuclear weapons. This resulted in a significant outcry by the community and politicians, followed by New Zealand police investigations. The majority of KiwiSaver providers dumped stocks across these most controversial industries within a matter of weeks in order to retain clients and hose down the reputational damage.
While only around 4% of Kiwis had opted in to ‘ethical’ funds, the vast majority of people expected their retirement savings to be invested, at a bare minimum, in ways that avoided the most harmful of industries. Within a few months, responsible investment assets under management moved from 4% to 60% of the industry with ‘ethical’ negative screenings in place. This is a cautionary tale for the Australian financial services industry, where portfolio holdings are much less transparent than KiwiSaver funds, but where the stated expectations of Australians are clear.
Notably, our research also showed that this expectation of responsible and ethical investment is supported by a willingness of Australians to switch funds. Four out of five surveyed stated they would consider switching their super or other investments to another provider if their current fund engaged in activities inconsistent with their own values. Some 24% indicated they are likely to consider investing in ethical funds in the next 12 months, and over 50% said they would consider it over the next one to five years.
The money is already moving, with a doubling of funds flowing into traditional ethical investments over the past two years, reaching $65 billion in AUM at the end of 2016. Indeed the fastest growing super fund in 2016 according to KPMG was Australian Ethical.
It’s no longer just our largest banks and listed companies that face the scrutiny of the public and elevated expectations of transparency. Insurance, banking, superannuation, financial advice and fund managers are being examined much more closely than ever before. It’s no longer sufficient to deliver strong returns. An army of small online funds, investing platforms, P2P lenders and boutiques are moving in to capitalise on this shift, and are already nibbling away at market share of the bigger institutions.
The three things to keep in mind
First, our biggest challenge in this industry has been to achieve deeper engagement with our client base. Responsible and ethical investing provides a means to connect more deeply with clients, around issues they care deeply about, and through this, build more loyal clients. If managers want clients to open their emails and letters, connect returns and distributions to a discussion about the issues the clients care about.
Second, our communications need to modernise and move into the digital age. Many of the new cohort are primarily based online, communicating online, signing up new clients online. It is much easier today to move between super funds, managed funds, and banks, and to attract new members through websites and apps.
Third, Millennials count, but data regarding the financial preferences of Australian Millennials has been scant on the ground. RIAA’s research dug deeper and confirmed the elevated propensity of Millennials to invest in line with their values: 88% are considering investing in ethical funds in the future or already doing it, compared with 65% of Baby Boomers and 73% of Gen X. Furthermore, 9 in 10 Millennials would change providers if they were engaged in activities that are not consistent with their values (compared with 68% of Baby Boomers and 77% of Gen X).
It’s time we reconsidered how we deliver on some of the core principles that underpin the finance industry – notions of best interests, fiduciary duties, and ‘know your clients’.
The ability to explore and align people’s values with their investments is what will distinguish the leaders in wealth management from their robo-competition over the coming decade.
Simon O’Connor is Chief Executive Officer of the Responsible Investment Association Australasia (RIAA).
As further evidence of the rising significance of ESG investing, The Sydney Morning Herald this week reported how big investors are warning major polluters to recognise implications of climate change.