Do Australians want an army of social engineers to control their investments?
Clearly some do, as shown by the existence of so-called ethical funds. But then, most investors -- over 99 per cent -- do not.
Well, they are about to lose their choice and be forced into the hands of the social engineers.
The Financial Services Reform Act, passed in the dying hours of the last Government, imposes disclosure requirements on all funds managers which will, in effect, force them to inquire into the labour, environmental, social and ethical standards of the Australian corporate sector.
At first sight, the legislation appears relatively innocuous. Who could object to disclosure on labour, environmental, social and ethical matters? No doubt the Minister was persuaded that the amendment was harmless and would even aid "transparency".
Upon closer examination, however, the legislation is much more intrusive than it seems. And the transparency is more apparent than real. In practical terms, disclosure requires the institutions to formulate and express its attitudes and practices on four matters which range from difficult to impossible to define.
Institutions will be forced to decide what is an ethical activity. Ethical funds have for example commonly declared armament manufacturers such as Boeing to be unethical. Yet these funds have frequently invested heavily in the computer manufacturers that provide the guidance systems for Boeing's missles. They also over-looked the fact the missiles manufactured by Boeing protect the lives of many innocent people. The funds will be forced to decide what constitutue good labour standards. For example, whether it is adquate to follow the laws of the land or follow the dictates of the union movement. They will be forced to decide and measure environmental standards -- not just those required under law, as every firm does that, but above-the-law standards.
In theory, businesses could state that they do not take these matters into account thereby avoiding scrutiny and the subsequent paper chase. In practice, however, no institution will state that it does not take such matters into account, in part because if it did, pressure groups would label it as unethical or anti-social. Silence would be treated as guilt. In any case, it is a reality of business that those matters are almost always "taken into account" in some degree, so a nil return would, in most cases, be misleading. The normal investment selection processes involve winnowing out unethical or high risk actions.
In short, the legislation gives the pretence of voluntarism but not the reality. And it goes well beyond mere reporting.
If proof were needed of the likely impact, we can turn to the UK where similar but milder, legislation came into effect two years ago. Over 50 per cent of UK pension fund trustees are now pursuing on-financial objectives, not because they believe that they are interest of their unit-holders, but rather to protect their good names from attack by activists.
Contrary to the claims of the ethical lobby these provision will cost investors.
The ethical lobby's sales pitch is that investors can "do well by doing good". That is thery can pursue non-financial goals at no financial cost. Indeed some even claim to have the secret to beating the market by being clean, green and union friendly.
Over the 1990s ethical investments were often able to match the market. Some even were even able to beat the market. This is now, however, proving to be another mirage of a bubble economy.
Ethical funds have tended to invest in blue chip companies, in growing industries which, in the 1990s, tended to be socially "acceptable" industries, such as dotcoms, telcoms, and services. In short, they have tended to invest in the leading firms in the fastest growing segments of the market.
The leading firms of the 1990s are now leading the market down and the old economy stocks are the stars. As a result most ethical funds are struggling. Ironically despite their ethical screens, ethical funds have been some the largest losers from recent corporate collapses including Enron, WorldCom, Ansett and HIH.
Ethical funds are also more costly to manage. They not only need a team of financial analysts, but a team of social engineers, ethicists, environmental scientists and labour market analysts, to screen for good behaviour among the stock chosen by the financial people. Recent research found that ethical funds have expense ratios (management costs as share of funds invested) of between 1.5 and 2.5 per cent which compares very poorly with the average expense ratio of non-ethical funds of about 1 per cent.
In short, ethical funds cost more to manage, adopt higher levels of risk and yield lower returns than funds that adopt strictly financial criteria. This should surprise no one.
Forcing unnecessary and costly investment criteria on the investors is not only a breach of their rights but a serious threat to their future.
The Government needs to go back to the drawing board and give us our freedom back.
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