Key Takeouts
Some ethical ETFs may include stocks that raise questions	Not all ethical exposures are created equal	BetaShares’ ethical ETFs employ stringent screening processes and an additional layer of oversight
The portfolios of some ASX-traded ethical ETFs include stocks that ethical investors may have concerns about.	There can be significant differences in the methodologies and screening processes employed by ethical ETFs.	BetaShares’ four ethical ETFs apply strict sustainability and ethical standards and have an additional layer of oversight by our Responsible Investment Committee.

Lessons from Wirecard – not all ethical ETFs pass the pub test

In late June, German payments giant Wirecard filed for insolvency, owing creditors almost $5.8 billion. The company’s collapse came a week after its auditor, Ernst and Young, found a $3.1 billion hole in its books, and refused to sign off on the company’s 2019 accounts, saying there were indications of an “elaborate and sophisticated fraud involving multiple parties around the world”¹.

Wirecard’s implosion is a stunning fall from grace for a company that was once seen as a champion of the European technology industry.

So how is the demise of a German fintech company relevant to Australian investors?

While it’s likely that relatively few Australian investors will have had direct exposure to Wirecard, it’s possible that significantly more had exposure via a managed fund or ETF.

The holders of broad sharemarket funds may be relatively sanguine about an event such as this, accepting that broad sharemarket exposure inevitably involves ‘taking the bad with the good’.

However, for ethical investors, investing their money in businesses whose environmental, social and governance (ESG) standards are beyond reproach is non-negotiable. A true-to-label ethical exposure is one of the most important factors to be considered in their investment choices.

About Wirecard

Wirecard offers products and services in the areas of mobile payments, e-commerce, digitisation and finance technology. It is also one of the popular options consumers can use to gamble online. In a report by the Financial Times², Wirecard acknowledged that up to 10% of its payment volumes “relate to lottery, gambling, dating, adult entertainment and associated business models”.

In its Responsible Investment Benchmark Report 2019, the Responsible Investment Association Australasia (RIAA) found that 82% of the responsible investment managers surveyed said they screened investments for gambling (see figure below).

Source: Responsible Investment Benchmark Report 2019, RIAA.

True-to-label ethical exposure

BetaShares’ market-leading global equities-focused ethical ETF, the Global Sustainability Leaders ETF (ASX: ETHI), aims to track an index that applies limits to the percentage of a company’s revenue that can be derived from activities deemed inconsistent with responsible investment considerations. These exposure limit guidelines include a limit of 0% for casinos and manufacture of gaming products, and 5% for distribution of gambling products.

Due to its involvement in gambling, Wirecard did not pass ETHI’s index screening process and was not included in its portfolio. It was estimated that well over 5% of Wirecard’s revenue was derived from providing payment services to online gambling, poker tournaments, and sports betting platforms.

Wirecard was also excluded from a number of other ASX-traded ethical ETFs – but not all.

Not all ethical exposures are created equal

For investors who are concerned about the true-to-label exposure of their ethical investments, it’s essential to have confidence that an ethical fund is screening out investments that do not align with their values.

As of 30 June 2020, the ~$1.25 billion in funds under management (FuM) in BetaShares’ ethical ETFs accounted for more than 70% of total FuM in ethical ETFs traded on the ASX. BetaShares ethical ETFs have also accounted for 70% of the ~$1.5 billion in net inflows into ethical ETFs since 1 January 2017.

The performance of BetaShares’ equity-focused ETFs has been strong. For example, from its inception in January 2017 to 30 June 2020, ETHI returned 20.7% p.a.³

However, we believe that one of the primary reasons that investors (both institutional and individual) have favoured our ethical funds is the integrity and quality of the investment methodology our funds employ. The figure below illustrates ETHI’s screening process.

The screening process for both ETHI and FAIR (the BetaShares Australian Sustainability Leaders ETF), considers a company’s exposure to a range of industries/activities deemed inconsistent with responsible investment considerations. The percentage of the company’s revenue derived from each industry/activity is assessed against a specified threshold.

These limits are set out below.

Industry/Activity	Exposure limit guidelines (% of total revenue)	Explanatory notes
Fossil Fuels – direct	0%	Companies which have fossil fuel reserves, fossil fuel infrastructure, or involved in the mining, extraction, burning of fossil fuels.
Fossil Fuels – indirect	5% for products and services. Excludes the largest global financers of fossil fuels, and financers of significant fossil fuel infrastructure.	Companies which provide products, services or finance which is specific to and significant for the fossil fuel industry; as well as companies with very high use of fossil fuels*. *Except where more than 50% of company revenue is derived from renewable energy, resource efficiency, environmental solutions or energy efficiency products and services.
Gambling	0% for casinos and manufacture of gaming products 5% for distribution of gambling products
Tobacco	0% for production or manufacture 5% for sale of tobacco products
Uranium and Nuclear Energy	0% for uranium mining and nuclear energy 5% for products and services to nuclear energy
Armaments and Militarism	0% for manufacture of armaments and weapons 5% for specific and significant services to military and armaments manufacture
Destruction of Valuable Environments	0%	Companies which have direct negative impact on recognised World Heritage and High Conservation areas.
Animal Cruelty	0%	Companies involved in live animal export, animal testing for cosmetic purposes, factory farming, or controversial animal products (ivory, foie gras etc).
Chemicals of Concern	0%	FAIR: Companies which produce or use chemicals of concern recognised by UN Environmental Program, producers of agricultural chemicals. ETHI: Companies which produce or use chemicals of concern recognised by UN Environmental Program, Gold and Silver miners.
Mandatory Detention of Asylum Seekers	0%	Companies which operate detention centres.
Alcohol	20%	Production or sale of alcohol.
Junk Foods	33%	Production or sale of junk foods.
Pornography	0% for production of pornography 5% for sale of pornography
Human Rights	n/a	Evidence of human rights violations including child labour, forced labour, sweatshops, bribery and corruption.
Board Diversity	n/a	No women on board of directors.
Payday Lending (FAIR only)	0%

In addition, the BetaShares Responsible Investment Committee may, applying the ESG-related screening criteria, exclude a company exposed to significant ESG-related reputational risk or controversy, if it considers that its inclusion would be inconsistent with the values of the underlying index.

Not all ethical funds apply such rigorous standards. The strictness of screening processes can vary between ethical ETFs, and many ethical ETFs rely on off-the-shelf indices without the kind of additional oversight that our Responsible Investment Committee provides.

This can result in stock inclusions that may not pass the ethical ‘pub test’ and would be out of place for many investors seeking an ethical exposure.

A comparison of ETHI’s portfolio with those of two other global ethical ETFs traded on the ASX is instructive. Companies screened out of ETHI’s portfolio, but held within one or both of the competitor global equities ethical ETFs included⁴:

• Fossil fuel exposure: Marsh & McLennan – global insurance broker that has been acting for Adani mining since 2015, helping to facilitate the Carmichael coal mine in Queensland’s Galilee basin.
• Animal cruelty: French beauty giant L’Oréal – conducts animal testing for cosmetic purposes and has received a “Fail” grade from the influential Ethical Consumer Guide.
• Junk Food: Yum! Brands – the American fast food franchiser behind global brands such as KFC, Pizza Hut and Taco Bell.
• Armaments and militarism: Analog Devices – builds missile targeting, guidance and other precision munitions-integrated products and solutions.

Fund performance

Both ETHI and FAIR have significantly outperformed their respective broad sharemarket indices since inception in 2017, while the indices the two funds aim to track have outperformed over a longer timeframe. Over the five years to 30 June 2020:

• The index ETHI aims to track outperformed the MSCI World ex-Aust Index (AUD) by 6.1% p.a.
• The index FAIR aims to track outperformed the S&P/ASX 200 Index by 4.9% p.a.⁵

Currency-hedged global equities ethical exposure

On 23 July, BetaShares launched the BetaShares Global Sustainability Leaders ETF – Currency Hedged (ASX: HETH). HETH is the currency-hedged version of ETHI, and gives investors a choice – to remain exposed to exchange rate movements as another source of potential returns, or to seek to minimise the impact of currency fluctuations. HETH currently obtains its investment exposure by investing in ETHI, with the currency exposure hedged back to the Australian Dollar.

Summary

The Wirecard episode demonstrates the importance of understanding what lies ‘under the hood’ of an ethical ETF. There can be significant differences between fund methodologies, and as a consequence, in the ability of different funds to deliver on their promise of offering ethically-screened portfolios that align with the values of ethical investors.

For more information about the BetaShares ethical ETFs, please refer to the fund pages for:

• the BetaShares Global Sustainability Leaders ETF (ASX: ETHI)
• the BetaShares Global Sustainability Leaders ETF – Currency Hedged (ASX: HETH)
• the BetaShares Australian Sustainability Leaders ETF (ASX: FAIR)
• the BetaShares Sustainability Leaders Diversified Bond ETF – Currency Hedged (ASX: GBND)

 

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Investment risks include market risk, international investment risk, non-traditional index methodology risk and foreign exchange risk (for ETHI and GBND), as well as interest rate risk and credit risk (for GBND). For more information on risks and other features of each Fund, please see the Product Disclosure Statement.

Licensed adviser use only. Not for distribution to retail clients.

1. Source: Bloomberg.
2. https://www.ft.com/content/cd12395e-4fb7-11e9-b401-8d9ef1626294
3. Source: Bloomberg. Does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance is not an indication of future performance of the index or the ETF.
4. Based on information publicly available as at 24 July 2020.
5. Source: Bloomberg. Does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance is not an indication of future performance of the index or the ETF.