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Investment Ideas: Australian Ethical Australian Shares Fund

One of The SMSF Investor’s key points of differentiation with other investment newsletters and websites is Lonsec’s depth of research coverage in managed investments. Further to this has been the addition in recent years of in-house expertise in the area of ‘Sustainable Investing’.

With more and more investors considering sustainability in their investment decision making, the difficulty has been in how this can be measured and compared. Enter Lonsec’s “Sustainability Score”, which is a quantitative estimate of the ‘net goodness’ of a managed fund’s portfolio, and has been designed to help investors more easily make investment decisions with these issues in mind.

A Sustainability Score of “five bees” is the highest a fund can achieve. This signifies that the fund’s holdings are ranked within the top 10% of peer universe, on a net ‘goodness’ basis.

One of the funds that has achieved this high score is the subject of our “Investment Ideas” piece today, the Australian Ethical Australian Shares Fund.

What is it ?

The Australian Ethical Australian Shares Fund (the ‘Fund’) is a long only, Australian equity product that focuses on companies that meet its Ethical Charter. The Fund employs a benchmark unaware approach to actively seek out companies that are contributing positively to society and the environment, and avoiding those involved in harmful activities. The Fund aims to outperform the S&P/ASX 300 Accumulation Index (the ‘Benchmark’) after fees over rolling three to five-year periods.

The investment universe of Australian Ethical (the ‘Manager’) is defined by its Ethical Charter, and combines both positive and negative screens for portfolio construction. The list of excluded industries is extensive and considered among the most rigorous responsible investment practitioners in the peer group. As a result of the screening process, the investment universe of allowable stocks is highly constrained relative to most peers.

The Fund’s all-cap approach provides exposure to both large and small cap Australian equities. Notably, only about 40% of the S&P/ASX 50 Index has been assessed to be aligned with the Manager’s Ethical Charter. Given the constraints, the Fund typically maintains a bias towards smaller market cap companies relative to peers. The Fund can also invest up to 5% in unlisted companies.

The Manager seeks to construct a portfolio of around 60 stocks from the screened universe with portfolio turnover typically around 30% p.a. While the Manager does not favour either growth or value stocks, a mild GARP style tends to be a residual of the process i.e. the Manager will tend to hold growth stocks as an outlay of the screening process but manage the portfolio with a value approach.

As per the PDS dated 2 October 2018, the fee disclosure for the Fund is as follows – management costs of 1.10% p.a. During the financial year ended 30 June 2018, the net transaction costs for the Fund were estimated at 0.04% of the NAV of the Fund. Net transaction costs are costs incurred in managing the Fund (including explicit and implicit costs of buying and selling assets, the cost of hedging/protection strategies and/or when there are applications or redemptions of fund units by investors) that are not covered by the buy/sell spread. Buy/sell spreads are subject to change depending on market conditions. Refer to the Manager for current buy/sell spreads.


The investment team comprises nine members led by CIO David Macri. Lonsec believes the team to be high quality, passionate responsible investors, boasting an average 21 years of industry experience. Lonsec takes comfort in Macri’s familiarity with all Australian Ethical products and his ongoing engagement in the Fund in an oversight capacity. Despite covering both large and small caps, Lonsec considers the team to be reasonably well-resourced, highlighting the Manager’s investment universe is highly constrained relative to some peers which somewhat moderates the stock responsibilities of each Analyst.

Lonsec considers Portfolio Manager Andy Gracey to be a highly capable investment professional with 25 years of industry experience, albeit with a high portfolio workload as he is also responsible for the Manager’s dedicated micro-cap strategy. Notwithstanding the high degree of overlap in stock holdings which should aid Gracey’s portfolio responsibilities, Lonsec will continue to test his workload and engagement with the Fund in future reviews.

Notably, Lonsec has provided research on the Manager for a number of years and observed a distinct corporate culture relative to traditional investment management firms. Lonsec is a firm believer that favourable investment outcomes are more likely to eventuate where experienced and motivated investors have a stable and supportive investment backdrop. Lonsec is pleased to note the consistency of the Manager’s adherence to its ethical investment process. This philosophical commitment is viewed as a key strength of the Manager.

In addition to the investment team, Lonsec considers the resourcing and focus of the Ethics Research Team, led by Dr Stuart Palmer, a key component of maintaining the Manager’s responsible investment culture, process and branding of the Fund. Lonsec believes Palmer to be a highly valuable and passionate member of the responsible investment community.

Investment approach

Lonsec considers the Manager’s research process to be well-structured, logical and repeatable with several standardised elements (e.g. common research templates, knowledge management and research retention). While the investable universe is highly constrained relative to traditional managers owing to the impact of ethical screens, the Manager is focused on bottom-up stock picking in its research approach to uncover investment ideas and determine a company’s fundamental intrinsic value. The Manager is willing to pursue ideas across the market cap spectrum and consider some less well-covered companies in the universe.

Portfolio construction and assigned stock weights broadly reflect the Manager’s assessment of each individual stock’s risk and reward characteristics. The Portfolio Manager considers a variety of criteria in assessing the attractiveness of each stock and assigning target weights. These include qualitative considerations, valuation metrics, diversification and liquidity. Lonsec believes this judgement based approach to portfolio construction is one which requires a significant level of investment skill and market knowledge. In this instance, Lonsec is supportive of the methodology given the extensive experience of Andy Gracey as Portfolio Manager.

The resultant portfolio is broadly diversified with large active weights given the benchmark unaware approach, notwithstanding the Manager does not consider relative weights when assigning target weights to each stock. Lonsec has observed a clear linkage between the Manager’s best ideas and portfolio positioning.

Lonsec is pleased to observe appropriate governance framework surrounding the ethical classification process. The Ethics Research Team assists the investment team to ensure investment ideas comply with the Manager’s Ethical Charter. Pleasingly in recent reviews with the Manager, Lonsec has observed a willingness and commitment by the Manger to ensure its Ethical Charter remains relevant and aligned with investors by reviewing its proprietary sector frameworks as its ethical philosophy evolves.


The Fund aims to outperform the S&P/ASX 300 Accumulation Index after fees over rolling three to five-year periods. Over the three years to 31 December 2020, the Fund has met this objective by returning 14.65% p.a. (after fees) versus the index benchmark which returned 6.87% p.a. The Fund has also met this objective over five years returning 12.72% p.a. versus the index benchmark which returned 8.84% p.a. The one year return has been particularly strong at 21.01% vs 1.73% for the index benchmark.

The Fund has shown a strong level of defensiveness, outperforming in at least 50% of down markets over all periods assessed. Relative to peers, the Fund has also exhibited similar or lower levels of volatility (as measured by standard deviation). As expected due to the Manager’s benchmark unaware approach and ethical screens, tracking error is considerably higher than peers.

Risk management

The Manager’s benchmark unaware approach is reflected in the relatively loose portfolio risk limits, with risk management embedded within the fundamental, bottom-up research process. While not as sophisticated as some more well-resourced peers, Lonsec believes the Manager to have adequate risk management processes in place.

Lonsec notes the maximum single stock limits of 7.5% is seldom used, and it has been rare for the Manager to hold a single stock beyond a 5% portfolio weight. The portfolio is also unconstrained by sector and industries, and in line with the ethical screens, the Fund may have more exposure in sectors such as IT, Healthcare and Industrials and less in Consumer Discretionary, Consumer Staples and Real Estate relative to peers.

Using this fund in a portfolio

The Fund is a long only Australian equity product which will be predominately invested in the Australian equity market. Investors should be aware that the Fund is structured to avoid investment in an extensive array of excluded industries. This may appeal to those investors motivated by strong ethical considerations. Lonsec recommends that equity investments are suitable for investors with an investment time horizon of at least five years.

The Fund is structured more in line with the traditional ethical end of the Ethical/SRI decision making spectrum (i.e. avoid companies involved in harmful activities and include companies that are contributing positively to society and the environment). The Fund’s high level of screening will significantly limit its investable universe and challenge the Manager’s ability to diversify the portfolio either through sector and/or stock selection.

The Fund is subject to equity market risks, and movements (both positive and negative) in the prices of the underlying securities will impact the portfolio. Investors should therefore be aware of and comfortable with the potential for the Fund to experience periods of negative returns, which result in capital losses being incurred on their investment. As such, the Fund will generally sit within the growth component of a diversified investment portfolio.

How to access

Investment in this Fund can be accessed directly via the fund manager, Australian Ethical. Note that the mFund option (buying units in managed funds via the ASX’s mFund platform with a broker account) was closed to new investors back on 2nd October 2018.


The Fund has retained its ’Recommended’ rating at the most recent review. Lonsec maintains a strong level of conviction in Australian Ethical’s specialist investment team who are deeply committed to their ethical investment approach led by experienced Portfolio Manager Andy Gracey. Furthermore, Lonsec believes the support provided by Dr Stuart Palmer and the Ethics Research Team to be invaluable, providing real-time detailed research and engagement with companies on ethical matters.

Given the Manager’s strict ethical screening process, the Fund is particularly suited for investors seeking to minimise exposure to fossil fuels while gaining exposure to leading sustainability sectors such as healthcare, education and renewable energy. That said, investors should be cognisant of the Manager’s benchmark unaware approach, and the Fund’s potentially small and micro-cap exposures, which at times may produce a considerably differentiated return profile relative to more benchmark aware peers.


Important Notice: Issued by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec). Lonsec receives a fee from the fund manager or financial product issuer(s) for researching the financial product(s), using objective criteria and for services including research subscriptions. Lonsec’s fee is not linked to the rating(s) outcome. Lonsec Investment Solutions Pty Ltd ABN 95 608 837 583 CAR (CAR: 001236821) of Lonsec receives fees under separate arrangement for providing investment consulting advice to clients, which includes model portfolios, approved product lists and other financial advice and may receive fees from this fund manager or financial product issuer for providing investment consulting services. Refer to the Conflicts of Interest Policy at:  Lonsec does not hold the financial product(s) referred to in this document. Lonsec’s representatives and/or their associates may hold the financial product(s) referred to in this document, but details of these holdings are not known to the Analyst(s).
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