Anyone who has studied to be a professional accountant should appreciate the concept of 'materiality' well. Simply put materiality is that while a number may be incorrect it is not of sufficient size to worry about and spend time on and so is just left. I remember really struggling with this in the early days as an accountant. Surely if it is wrong it is wrong?! But what about for ethics and ethical investors? It seems reading the Guardian yesterday that materiality is also a concept that ethical investors and IFAs need to get their heads around if they want to use ethical investment funds which screen out stocks.
Green in nature?
Why am I writing about this? It is because yesterday the Guardian printed an article which implied that ethical funds do not use the concept of materiality in their process.
John Ditchfield, Chairman of the Ethical Investment Assocation, was quoted yesterday in the Guardian as saying:
"It's ridiculous that Ecclesiastical can win an award like that (Moneyfacts award for Best Ethical Investment Provider) at the same time as having a 10% screen that allows it to invest in tobacco firms and arms. That's the letter but not in the spirit of what ethical investors want to achieve. Investors don't want to be a bit ethical, in the same way that you can't be a bit pregnant."
In defence of John by "stirring up debate" as he told me on the phone today, perhaps we will all, through the mire, understand a little better the ethical investment market. And no one can deny his PR off the back of it! But, this statement together with one on engagement (which perhaps needs another blog) needs some follow up so that investors and advisers don't go barking up the wrong tree.
Ethical materiality at work
Nearly all ethical funds use materiality of turnover in their ethical screening criteria. Equally they are all explicit about it and it is not a big secret or myth that needs to be exploded. John points to Ecclesiastical's 10% screen on tobacco and armaments. Today I met with AXA and reading from their sheet in front of me I can tell you that they apply a 10% criteria on gambling and tobacco, but on military sales the revenue generated needs to be under $100m. I could go on an exhaustive list through all the ethical funds on how each ethical fund does this, but I would waste a lot of my time for no net benefit. This is not a 'ridiculous' approach as John was quoted as saying, but industry standard because 'materiality' is a very practical way of dealing with difficult issues.
The key for investors if they are very worried about a particular issue is to look at the ethical criteria being applied by each firm. The criteria are not wrong, but simply each firm's way of dealing with an issue.
Later in the same article John points to the holding of GE by the Ecclesiastical Amity International. He objects to the fact that GE supplies engines to the military and that this derives for GE a turnover of $830m. There are a number of positive reasons why GE might be included in an ethical portfolio which Neville White points out. My point is that as an IFA and investor if this upsets you so much you need to simply pick another fund. It is not an issue upon which to beat the Investment House over the head with, because materiality is a fact of life and it needs to be built into everything that we do.
PR and not News
Just from the simple analysis of two ethical funds above you can see that GE could not be bought by the AXA Ethical fund, but can be bought by Ecclesiastical Amity International. If supplying engines to the military is a particular worry of yours then consider AXA Ethical over Ecclesiastical Amity. In my opinion an ethical investor might consider other issues higher on the agenda, but that is my opinion and ethics are a personal thing.
In my dealings with Ecclesiastical and in particular Ketan Patel, one of their research analysts, I can easily see why Ecclesiastical won Moneyfacts Best Ethical Investment Provider of the year. John Ditchfield can be eyed with jeolousy for his marketing coup and coverage in the Guardian, but materiality is a fact of life and IFAs and investors should treat yesterday's Guardian article
as a PR story, not a news story.