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ESG Focus: Helping Pengana To Sell The ESG Message

ESG Focus | May 20 2019

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

This story was originally published as part of Weekly Insights on May 10, 2019. Upon re-publication to include it in FNArena's dedicated ESG Focus news section, additional information provided by Pengana has been added (see further below). 

Helping Pengana Selling The ESG Message

By Rudi Filapek-Vandyck, Editor FNArena

Peter Hall, the driving force behind what once was one of Australia's successful and leading ethical investors, Hunter Hall, saw his career abruptly cut short when a too confident bet on local biotech Syrtex turned sour. Since June 2017 Pengana Capital Group is managing the fund renamed Pengana International Equities ((PIA)), which still operates within an ethical framework but solely in international markets.

The new managers in charge have deliberately scaled back the volatility in the fund's performance, and made its dividends to shareholders more reliable and stable, but, nearly two years after taking control, one niggling problem remains unaddressed: a severe lack in liquidity means the ASX-listed shares continue to trade well below the fund's Net Tangible Assets (NTA) valuation, to just about every stakeholder's frustration.

And there doesn't seem to be an easy solution at hand either, with the fund's attempt to increase total shares count via the issuance of options likely to prove futile. It's back to the drawing board thus.

In the meantime, the fund managers are touring Australia in a bid to communicate with shareholders, explain their strategy and ask for understanding as far as the heavy discount is concerned that remains embedded in the share price.

Not completely unexpected, the recent shareholders gathering in Sydney elicited mostly questions about Labor's intended franking policy, its potential impact for retirees living off income from investments and what Pengana can possibly do to cushion any negative consequences.

Questions were also asked as to how the manager's ethically oriented investment process could possibly be to shareholder's best interest, and here, on my observation, the fund managers found it rather difficult to state their case in an overly convincing manner. Which is a shame, because ethical investment is not a guaranteed pathway to subpar investment returns (even though PIA's total returns to date have fallen short of the benchmark and of competitors).

Plenty of international academic research supports the notion that ethical investing over time generates superior returns, irrespective of the observation that stocks with inferior qualities can temporarily rally to the moon and back, as we all know. Instead of trying to argue the point that missing out on a temporary rally in, say, oil and gas stocks does not matter long term, I think the managers of PIA can make a much more attractive, and convincing case by referring to what should be missing in their portfolio.

Take Retail Food Group ((RFG)), for example. For years its shares had been a solid performer on the ASX, until the central holding company was exposed for what it is; a badly managed, profits-above-everything, let's squeeze the franchisers to their last breath kind of operation that, in hindsight, was always going to come unstuck at some point.

It's somewhat hard to believe today, but the shares were exchanging hands on the ASX at a price tag of around $7.50 a piece as recently as March 2015. Today, Retail Food Group shares are trading around 21.5c and they almost certainly are not going anywhere in a hurry.

Meanwhile, the negative news flow simply keeps on generating more revelations. If ever Hamlet's statement about something being rotten at the core applied to one company on the ASX, it must be this one.

The point here is that any scrutiny from an ethical or ESG filter perspective should have prevented fund managers such as Pengana (or Hunter Hall in its previous existence) to go anywhere near an investment in Retail Food Group, irrespective of the company's immediate prospects and general popularity at that time.

This is, in essence, the most valuable aspect of using ESG (ethical, social & governance) as a filter in the investment process. Badly managed companies are most likely to attract bad news flow and operational disasters, and badly managed companies score badly on ESG score cards.

A similar case can be made for past assessment of investing in AMP ((AMP)), IOOF ((IFL)), and even the Big Four Banks (though I doubt whether anyone would have scored the banks accurately on ESG measures pre-Royal Commission). Since PIA does not invest in the Australian share market, there should be plenty of suitable examples on offshore exchanges.

I remember reading how the Deepwater Horizon oil spill in 2010 had been preceded by numerous indications BP was not the world's most prudent and risk-conscious operator, to put it mildly. And it certainly seems the bad news flow, and potential financial ramifications from the 737 Max plane disasters for Boeing is nowhere near its end.

Stringently applied ESG filters should keep such disasters out of the portfolio; a message that will be understood by every kind of investor, irrespective whether they have experienced portfolio disaster first hand or not.


The story below is an example of how the managers of Pengana International Equities use ESG filters and considerations in their investment process.

Ethics focus: Axon Enterprises

With unmatched market dominance, a compound annual growth rate of 16% over the last seven years  and a mission statement to “obsolete the bullet”, Axon Enterprises appeared on our potential investment opportunity radar recently.

The manufacturer of TASER, a conducted energy weapon, Axon recognised a gap in law enforcement for ‘non-lethal’ weapons back in 1993 . Today, 17,000 out of 18,000 US police agencies procure TASER devices , and the company is quickly expanding globally, with TASERs deployed as far field as Mexico, the UK and Australia.

Not content with global product expansion, Axon has been developing an end to end integrated law enforcement solution. Axon already offers digital evidence management and the ability for officers to capture public safety videos through Axon’s body cameras. In the near future, Axon will be expanding its product range to include police agency records management systems and computer-aided dispatch software.

While Axon boasts impressive financial fundamentals, the ethics of investing in such a business aren’t as clear.

Axon describes TASER as "an alternative far superior to using firearms in many contexts”. According to the company, TASERs have saved nearly 200,000 lives, with over 3.7 million uses in the field worldwide.

But research to back such claims is, at best, inconclusive. Described by the United Nations Committee Against Torture as “a form of torture…that in certain cases could also cause death” , labelling TASER a 'non-lethal weapon' is a misnomer.  In the US alone, reportedly over 1,000 deaths have occurred following the police use of TASERS , and there is growing evidence of the risk of cardiac failure from TASER use.

Research by the University of Chicago found that the Chicago Police Department's adoption of TASER resulted in a reduction in officer injury but no effect on firearm use by law enforcement. The study found that "police injuries fell, but neither injury rates nor the number of injuries to civilians were affected."

Further ethical and privacy issues present themselves from Axon’s shift to data capture, management and retention. Live-streaming of incidents and real time facial recognition, tracking and matching technology is less of a technology challenge than an ethical one.

Although Axon has established an Artificial Intelligence Ethics Board to help guide the development of Axon's AI-powered devices and services, its members include law enforcement representatives, the very sector that faces growing scrutiny over how it uses Axon products.

Ultimately, these unresolved ethical issues surrounding Axon led us to the decision not to add the company to the portfolio.

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