Thursday 10 November 2016

Simple investing weren't so simple

I wanted a low-fees market-tracking Kiwisaver provider. Simplicity started up recently. Their low-fees model just had funds going into a selection of Vanguard funds to track the market, with conservative, balanced and growth options. 

Then they announced that their investments were flipping into Vanguard's ethical funds. Simplicity noted there would be no effect on their charged fees. But they didn't note that Vanguard's ethical funds have had middling to low returns compared to other Vanguard large-cap funds. They've done well over the past 5 years, but less well this year, and  poorly over the longer term.

Here's the ethical funds against some of the other large-cap Vanguard funds.

Average annual performance—quarter end
Vanguard Large-Cap Index Fund AdmVanguard FTSE Social Index InvVanguard 500 Index Fund AdmVanguard Diversified Equity InvVanguard Dividend Growth Fund
YTD as-of date09/30/201609/30/201609/30/201609/30/201609/30/2016
1-, 3-, 5-, 10-year as-of date09/30/201609/30/201609/30/201609/30/201609/30/2016
Since inception7.70%3.33%5.05%7.30%8.17%
Inception date02/02/200405/31/200011/13/200006/10/200505/15/1992
SEC yield2.09% B   1.76% B   2.13% B   1.26% B   1.99% B   
SEC yield as-of date11/04/201611/04/201611/04/201611/04/201611/04/2016
If I had already flipped over, I would be annoyed. Past performance doesn't predict future returns and all, but any fund that prioritises things other than performance seems unlikely to do better on average than funds prioritising performance.

Everyone has a different idea of what's ethical anyway. My ethical investment choices would be rather different from anybody else's.

Happy to eschew landmines, but not the company whose landmines help keep North Korea from crossing the DMZ. Those are good landmines. Landmines that make the world a better and safer place. Can I invest only in the companies making those landmines?

I'm happier investing in tobacco stocks than in whatever company is doing the meth testing in NZ state houses while simultaneously providing cleaning services their testing shows is necessary. Nobody forces anybody to smoke, but lots of people were forced out of state houses because of those meth tests.

I'm also happier investing in nuclear weapons companies than in whoever is selling drugs to state governments for use in lethal injection. I'd also want to divest from the manufacturers of the flash-bang grenades used by American police departments. There are plenty of countries that shouldn't have nukes; companies that trade on stock exchanges can be barred from dealing with them.

Ultimately, the whole thing is too fraught. My ethical preferences are idiosyncratic.

And this statement from Simplicity was a bit worrying:
The debate on ethical change will not go away, and it shouldn't. There should be an ongoing discussion on what is right and wrong to invest in, and the debate will evolve. It will never be fast enough for some, but it's clear that investors are becoming more aware of what they invest in, and they should be.

In the case of the investments we have eliminated, there are no 'rights' about them. But in other areas, the argument is much more complex.

Take fossil fuels as an example. We have been asked a few times why fossil fuels weren't included in the exclusion list, and it's a very legitimate question. There are several reasons why.

Primarily, it's not what the vast majority of our members want. Demands to remove fossil fuel companies is low, because it would also remove investment in a large number of global companies which also produce things like plastics, food, electronic components, roading materials, and many other things now considered essential to modern living.

Secondly, it would have resulted in a much smaller, and more expensive, fund. Other managers would have likely shunned it, making it more expensive to run. To reduce fees, KiwiSaver managers need economies of scale too. Our primary goal is to increase your retirement savings via the lowest fees. If we can eliminate sin stocks in the process, we will do so, because it's the right thing to do. However, most of our members would resent us passing judgement on fossil fuels, and charging them more for doing so. That's also democracy in action.
Popular moods change. Would I want my investment portfolio divested of oil stocks if a majority of other investors in the fund decided they didn't like oil?

In grad school, my friend Ed Stringham talked about setting up a Vice Fund. If ethical investors have non-return preferences over portfolio allocations, that should mean lower returns in ethical funds as compared to the companies seeing divestment by ethical investors - and opportunity for others. Turns out there now is a Vice Fund. The picture below tracks VICEX against other benchmarks, and the Vanguard social investment fund.

The vice fund the ethical fund over that long period, but the fund has pretty high fees and is beaten by the ethical fund over some periods too. Catch Jim Rose on the topic as well.

I was pretty enthusiastic about Simplicity's simple model. But if you don't necessarily mind your stocks runnin' with the devil, the simple life ain't so simple.

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