Three Reasons Why Ethical Income Doesn't Mean Compromising On Yield

28 February 2019

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Investors don’t want to choose between their values and income – and we believe they shouldn’t have to. In this viewpoint, we discuss why we believe the track record of our Ethical Income Strategy, launched three years ago, has demonstrated investors no longer need to compromise.

The Martin Currie Australia Ethical Income strategy was launched in December 2015, with the aim of providing investors – such as charities, foundations and not-for-profit organisations – with a version of our high-quality, low-risk Australian Equity Income solution. Importantly, this strategy was to be both consistent with a client’s own ethical values but without forfeiting its ability to generate an attractive income stream.

Despite our client’s stringent Ethical and ESG Impact screens1, we have been able to maintain our focus on income, because of our disciplined portfolio-construction methodology.

Below we highlight three of the key ways we can help investors achieve their objectives:

1. Income is complementary to values

We focus on sustainable and low-risk income sources for all our income strategies.

As such, highly risky stocks of questionable Quality2 are already excluded. ESG forms an integral part of our Quality assessment process, and any flags for ESG issues are doubled in terms of magnitude when compared to any other investment factor.

A poor ESG score will be reflected in a lower Quality score by our analysts, and a Quality 5 rating excludes the stock completely from the investable universe.

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High Quality companies also tend to generate high free cash flows, which in turn generate attractive Sustainable Dividends3 Payout ratios alone are not a good indicator of sustainability, and our analysts fundamentally assess the free cash flow generation of companies through different stages of the economic cycle and look through any financial engineering that may artificially boost headline or near-term dividends. Companies with poor Sustainable Dividends are excluded from all income portfolios.

Chart 1 below highlights the positive skew towards Quality 1 and 2 stocks for our Ethical Income portfolio and the standard Equity Income portfolio (where there are no Ethical and ESG Impact screens in place)4.

Chart 1: Portfolio Quality Distribution (%)

Source: Martin Currie Australia, Factset; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. This strategy is not constrained by a benchmark, however for comparison purposes the composite is shown against the S&P/ASX 200 Accumulation Index.

Due to our emphasis on Quality and Sustainable Dividends, the universe of around 120 securities that pass the grade for our income strategies is already constructed in a way that is already complementary to the needs of an ethical portfolio.

Ethical reasons aside, a resources company like BHP tend not to be included in our income strategies given the volatility of their earnings and poor Sustainable Dividend assessment.

In fact, only 19 securities are currently excluded by the Ethical and ESG Impact screens (see diagram 1). And of these, only five would be found in a standard Equity Income portfolio5.

Diagram 1: Screening for our client's ethical values

Ethical screens (5% of revenue)

  • Alcohol
    • Coca Cola Amatil*
    • Coles
    • Woolworths
  • Fur
    • Myer
    • Premier Investments
  • Gambling
    • Aristocrat Leisure
    • Crown Resorts
    • Skycity Entertainment
    • Star Entertainment
    • Tabcorp
  • Tobacco
    • Amcor
    • Metcash
  • Adult entertainment
  • Defense and entertainment
  • Genetically modified crops
  • Nuclear power

ESG impact screens

  • Thermal coal power generation and mining (20% of EBITDA)
    • AGL*
    • Whitehaven coal
  • 'Red flag' for very severe ESG impact on stakeholders
    • BHP

Additional Ethical Values with Income screen**

  • Catholic Values
    • Healthscope
    • Primary Health Care
    • Ramsay Health Care
    • Vitrus Health

The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
*Forms part of a representative Equity Income portfolio
**The additional Ethical Values with Income screen is based on Catholic Health Australia Code of Ethical Standards and is used for the Legg Mason Martin Currie Ethical Values with Income Fund only


2. Ethical substitutes are available

For some of the five stocks which are excluded from the Ethical Income portfolio, we have been able to replace them with similar companies which do not breach the client-driven ethical screens.

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One example is AGL, which is excluded from the Ethical Income strategy due to its reliance on thermal coal in its energy production. In its place, the breadth of our research team enables an investable universe to substitute utilities exposure into cleaner renewable energy, in the form of the New Zealand integrated electricity utilities Contact Energy, Genesis Energy and Meridian Energy.

Meridian Energy is a great example of an electricity utility that doesn’t need to rely on thermal coal to generate electricity, and predominately uses cleaner renewable hydro power.

Its high Quality rating is based on both its strong Environmental credentials, and its above average business strength & market share, making it appealing for the strategy from both a values and sustainable low-risk income perspective.

We find that the New Zealand utilities can also greatly assist in actively lowering the overall carbon footprint of the portfolio relative to both the index and Equity Income portfolio, while still contributing to the income and quality objectives of the strategy6 (as seen in chart 2).

Chart 2: Ethical Carbon Footprint

Source: Martin Currie Australia, MSCI; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. Based on Portfolio investment of $1,000,000,000 and Benchmark investment of $1,000,000,000 for securities where data is available. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Index.

3. Diversification is the key

The consumer sector is the only sector in which the exclusions of high-quality securities do cause a material sector weight difference relative to our Equity Income portfolio. These include Woolworths, Coles and Coca- Cola Amatil (on alcohol or tobacco-revenue grounds), and Tabcorp (because of its gambling revenue).

However, despite the material difference in sector weights, we promote diversification by focusing on a low absolute concentration of security and sector weights:

  • We limit individual securities to a maximum 6% of the portfolio, meaning the portfolio’s total yield is not dominated by any one security. As such, removing any one security should not impact the overall yield characteristics. This contrasts with the highly concentrated S&P/ASX 200 index which has seven key securities that derive around 60% of total income.
  • The strategy can only own a maximum of 22% is any one economic sector, which means that the portfolio today is structurally and tactically underweight the banks.

Diversification of the strategy also ensures a steady growth in income and a yield significantly higher than the S&P/ASX 200 (as seen in chart 3). On a forward-looking basis, the Ethical Income strategy is expected to provide a franked dividend yield of 8.3% over the next 12 months, compared with the S&P/ASX 200 expected franked income yield of 6.7%. Conversely, the Equity Income strategy has an expected income yield of 8.3%7.

Chart 3: Next twelve month franked income yield

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Source: Martin Currie Australia, Factset; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. Next 12 Months (NTM) Income yield is calculated using the weighted average of broker consensus forecasts of each portfolio holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Assumes zero percent tax rate and full franking benefits realised in tax return. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Accumulation Index.

Income: The Ethical Way

Over the past three years since inception, the Ethical Income strategy had implemented disciplined portfolio construction methodologies, and has exceeded its income investment objectives of providing an after tax yield above the S&P/ASX 200 Index7, (as seen in chart 4). It has also performed in-line with the income generated by the standard Equity Income strategy. Our focus on Quality has also ensured a very consistent growth in the income stream since inception, of well above inflation8.

Chart 4: Exceeding income investment objectives

Source: Martin Currie Australia, Factset; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. Next 12 Months (NTM) Income yield is calculated using the weighted average of broker consensus forecasts of each portfolio holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Assumes zero percent tax rate and full franking benefits realised in tax return. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Accumulation Index.


Given the ongoing volatility in equity markets, we believe the high-quality, low-risk nature of the strategy will ensure that the Ethical Income strategy will continue to be well placed to deliver an attractive and growing income stream to investors focused on ethical values.



1 Client-driven Ethical screens that identify and assess business involvement in unethical industries, and ESG impact screen for poor corporate behaviour and severe business controversies.
2 Quality is based on MCA’s fundamental and quantitative assessment of business strength, management quality, environmental, social and governance (ESG) issues, balance-sheet strength, returns and earnings quality.
3 Sustainable Dividends are the dividends that MCA believe are payable based when earnings for a company are near the low point in the cycle.
4 Source: Martin Currie Australia, Factset; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. This strategy is not constrained by a benchmark, however for comparison purposes the composite is shown against the S&P/ASX 200 Accumulation Index.
5 Source: Martin Currie Australia; as at 31 December 2018. Screens for the Legg Mason Martin Currie Ethical Income Funds range. Custom screens are available for mandate clients. 
6 Source: Martin Currie Australia, MSCI; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. Based on Portfolio investment of $1,000,000,000 and Benchmark investment of $1,000,000,000 for securities where data is available. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Index.
7 Source: Martin Currie Australia, Factset; as at 31 December 2018. Data calculated for representative Martin Currie Australia Ethical Income and Equity Income account. Next 12 Months (NTM) Income yield is calculated using the weighted average of broker consensus forecasts of each portfolio holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Assumes zero percent tax rate and full franking benefits realised in tax return. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Accumulation Index.
8 Income growth calculations assume distributions are paid out rather than reinvested.


Important information

Past performance is not a guide to future returns.
The information contained in this presentation has been compiled with considerable care to ensure its accuracy. But no representation or warranty, express or implied, is made to its accuracy or completeness. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were or will prove to be profitable

Martin Currie has procured any research or analysis contained in this presentation for its own use. It is provided to you only incidentally, and any opinions expressed are subject to change without notice. The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds. Please note the information within this report has been produced internally using unaudited data and has not been independently verified. Whilst every effort has been made to ensure its accuracy, no guarantee can be given.

Some of the information provided in this document has been compiled using data from a representative account. This account has been chosen on the basis it is an existing account managed by Martin Currie, within the strategy referred to in this document. Representative accounts for each strategy have been chosen on the basis that they are the longest running account for the strategy. This data has been provided as an illustration only, the figures should not be relied upon as an indication of future performance. The data provided for this account may be different to other accounts following the same strategy. The information should not be considered as comprehensive and additional information and disclosure should be sought ahead of any planned investment. The distribution of specific products is restricted in certain jurisdictions, investors should be aware of these restrictions before requesting further specific information.

    Investors should also be aware of the following risk factors which may be applicable to the strategy shown in this document.
  • Investing in foreign markets introduces a risk where adverse movements in currency exchange rates could result in a decrease in the value of your investment.
  • This strategy may hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the strategy’s value than if it held a larger number of investments.
  • Smaller companies may be riskier and their shares may be less liquid than larger companies, meaning that their share price may be more volatile.
  • Income strategy charges are deducted from capital. Because of this, the level of income may be higher but the growth potential of the capital value of the investment may be reduced.