Ethical to focus on sustainability with new index fund

(October 5, 2004) Vancouver-based socially-responsible investing specialist Ethical Funds is changing gears slightly, moving towards a focus on sustainability, as it launches a new index fund based on the S&P/TSX Composite Index.

The Ethical Canadian Index Fund, launched October 1, seeks to match the performance of the TSX, but will remove stocks that don’t meet the fund firm’s sustainability screens, says Ethical investment product strategist Wusooq Khaleeli.

However, that knocks out only about 20 of the TSX’s 224 stocks, representing about 7% of the index’s market cap. That includes mostly companies whose primary activities involve tobacco, military production, or nuclear energy.

But Ethical has also implemented a corporate sustainability scorecard that ranks companies in different industries, adds Carol Boutin, Ethical’s marketing communications manager.

The scorecard is based on as many as 120 key performance indicators, such as the environment, stakeholder relations and human rights. Companies are graded from a high of “A” for industry leaders down to “E,” which are viewed as non-compliant and excluded from the index fund. Companies considered borderline would become candidates for Ethical’s shareholder engagement program, but would remain in the index fund, which uses the same weightings as Standard & Poor’s.

The new fund will have a low management expense ratio (MER), around 1%, Khaleeli says, but is not available in a DSC version. However, he says he still expects some interest from the advisor channel. “A fair number of advisors have a small proportion of their clients’ money in an exchange-traded fund or an index fund,” he says. “The majority of clients, their money will be in actively managed money, but they will have a small proportion in passive management as well. They recognize they won’t make as much on trailers and commissions, but they would place some percentage of clients’ money there.”

Khaleeli notes that backtesting has shown that the while there will be periods of underperformance and outperformance compared to the TSX, that’s really just a function of market cycles, pointing out that oils and golds, some of which might be excluded by Ethical’s screens, usually do better in a bear market.

“But in the first six months of this year we outperformed, so everything should balance out,” he explains. “The amounts involved are not material. On average, it’s been within a half a per cent a year, which is not really meaningful.”

“That’s the other message we’re trying to get across, that you don’t have to sacrifice performance to invest in an SRI fund,” Boutin adds.

Ethical is not the first Canadian SRI firm to launch an index fund. Meritas introduced the Meritas Jantzi Social Index Fund three years ago, based on the Jantzi Social Index, a basket of about 60 stocks that pass a series of broad social and environmental screens.

Khaleeli says Ethical is encouraged by the success of the Meritas index offering, but notes there are significant differences between the two funds. “[The Jantzi index] is based on the S&P/TSX 60 so it’s got a narrower focus on large-cap companies. We cover a much broader spectrum of the marketplace. The Jantzi index also removes and replaces companies; we don’t do that. We just remove companies and we’re left with the rest of the universe.”

Ethical’s fund has a different pricing structure, he adds, noting that the MER on the Meritas fund is “significantly higher than ours. We’re looking at around a shade over 1%. We want to make sure it stays in that range.”

Meritas CEO Gary Hawton points out that his company does not include gambling, pornography or alcohol companies in its portfolios and has tighter guidelines on some other screens. “If both companies took the same index and screened it, we would likely end up with significantly fewer companies in our portfolio. I think that SRI investors and advisors who serve this market need to look at what their clients are trying to accomplish (or avoid) and then look for the best SRI fund to meet these objectives.”

With respect to fees, Hawton says the Meritas funds all have “reasonable” MERs in relation to the firm’s distribution strategy. “From this we pay full commissions and trailer fees to advisors who recommend our funds. In fact, our commissions for the Meritas Jantzi Social Index Fund are fully twice that which would be paid for a comparable sale of the new Ethical fund and our trailers are no less than 150% of that which would be paid.”

As for Ethical’s new spotlight on sustainability, that doesn’t mean the firm is abandoning the socially responsible investing concept, Boutin insists. “We’re trying to focus SRI. We can add more value to investors if we put a long-term sustainable focus in the marketplace. We’re not the first SRI investor to do that, perhaps we’re the first in Canada, but around the world, this is something that we’re seeing more and more.”

“We’re not getting away from SRI, we’re just focusing on long-term sustainability,” she says.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com

(10/05/04)

Doug Watt