John Woods CFA is responsible for asset allocation at Australian Ethical, which manages more than $ 6 billion based on the principles of its ethics charter. Multi-asset funds are balanced, high growth and diversified stocks.
GH: John, let’s start with a personal question about your beginnings in fund management.
JW: It was a roundabout path. I started my career as a software engineer, working in industrial automation and business intelligence. I found the best data to be in the financial industry, so I started looking for companies, initially in the telecom industry, which matched my background. As I expanded into other industries, I became an Asian strategist focused on emerging markets. I focused more on macroeconomic research then multi-asset roles. At Australian Ethical, I put everything in place based not only on the financial impact, but also on an ethical perspective.
GH: What if you could talk to your 25 year old self who could start this journey, what lesson would you teach yourself?
JW: There are many, but perhaps the most important thing is to keep an open mind. Predicting the future is really difficult. For example, if you recognized the potential of 3D printing at an early stage, there were a lot of companies involved, but you would have been better off investing with the big established tech companies. It’s not that you couldn’t see a trend happening, but the difficult question is how to take advantage of that trend.
GH: So even if you identify a theme, the next thing you need to do is determine how it translates into financial performance?
JW: Yes, and economies are at a time of transformation, where the world is pivoting towards more sustainable and climate-related outcomes. It’s fantastic for the planet and for potential investments, but you need to be open-minded about how you implement it. It might not be as obvious as buying the new idea.
GH: In your asset allocation role, what changes have you made recently and in particular, how do you deal with defensive allocations with such low interest rates?
JW: The major change is that we are increasing the level of alternative assets. Defensive assets have lost some of their diversification advantages, but we keep in mind that the primary role of fixed income assets is to protect capital. The income component comes second. It was great when defensive assets paid you to hold them, but we haven’t been in that environment for quite some time. Fixed income securities will continue to protect portfolios during massive equity sales.
But we also need to protect ourselves against the real interest rate hikes that permeate multiple asset classes. We manage the need for diversification by bringing in new things, such as alternative assets. They present different equity risks than the rest of the portfolio, such as global companies with a reasonable equity risk premium.
GH: What are the specific examples of alternatives and why do they have the right defensive characteristics?
JW: The alternatives for us are areas like private equity, infrastructure and venture capital. We are specific about how we implement them to justify bringing illiquidity into the portfolio. The institutions that bring us these investments must find assets that we cannot find on the listed markets, in particular in the venture capital space. Many emerging technologies, such as tackling climate change or providing food, are found in this venture capital space with different drivers than the broader stock market. They still have an equity risk premium, but we need to determine if entrepreneurs are able to take the business from one start-up to the next phase.
GH: Are you exposed to infrastructure via managers specializing in the asset class?
JW: Yes, and in line with our values, such as agricultural infrastructure or medical infrastructure.
GH: Besides the trends for which Australian Ethical is known, such as climate change and ethical investing, are there any other market trends that you particularly support at the moment?
JW: Well, more of a topic we try to solve in a high growth portfolio is managing inflation over long periods of time. A traditional response might be to invest in energy, but a sector like oil may not have much of a future. So we focus on other ways to capture exposure to inflation, such as carbon pricing. If carbon becomes a cost of energy production, we protect ourselves by owning assets in the natural capital space.
GH: What do you mean by “natural capital”?
JW: Assets such as water, forests and clean air. Natural capital is a way of looking at nature as a stock that provides benefits to people and the economy. While researching a business, we check their water use, greenhouse gas emissions and other factors that can harm the natural environment. We are looking at a report that deals with all of the “six capitals”: not only financial and manufactured, but also intellectual, human, social and environmental capital.
GH: Is there a part of your equity portfolio that differs significantly from the index?
JW: The market overlooks many opportunities, especially as many asset managers as benchmarks. We try to look where others don’t. For example, our portfolio does not only include the top four banks, as we are overweight in BOQ and Auswide. In telecommunications, we have Macquarie Telecom and Telecom New Zealand rather than Telstra.
GH: One of your venture capital exposures relates to CSIRO’s venture capital business, Main Sequence. What attracted you and how does it fit into a multi-asset portfolio?
JW: When a lot of people think of venture capital, it seems high risk. Now, every individual investment backed by venture capitalists can be high risk, but when you build a portfolio, those idiosyncratic risks are diversified. What attracted us to Main Sequence was the high level of alignment. The types of issues they are trying to solve are the problems we are trying to solve.
But every venture capital investment I’ve ever considered sounds fantastic and exciting, but it’s hard to find a group of people who can actually sift through this excitement with real knowledge. And this is where the connection with CSIRO is unique. They have some of the best scientists in Australia who can answer some of these really tough questions. In a world awash with cash, we need this discipline to make sure we don’t overpay our assets. Main Sequence builds businesses to solve problems from scratch, paying for a startup’s capital expenses rather than a high valuation multiple. It is a powerful differentiator.
JW: It’s good to see other managers taking ESG into account, it’s a positive trend for the company. But inevitably there will be more greenwash, so we encourage investors to engage with the impact they want from their investments. Serious ethical investing creates different portfolios from traditional funds with different risks. We have been doing this for over 30 years, with ethics and frameworks integrated into our investment philosophy.
GH: So how do your diversified funds differ from others?
JW: Our high growth fund is designed for investors who are considering a much longer period. We recommend a minimum investment period of 10 years and more. We want to take advantage of early impact investments and more illiquid investments in private equity and venture capital. So this is a 100% growth asset fund and the way we manage risk is to diversify these asset classes. It’s still multi-asset, like a balancing fund, but it has a more singular focus on capital growth over a very long period of time.
GH: Let’s finish with what keeps you from sleeping at night.
JW: Inflation worries me at the moment but I also think about risk management knowing that with every risk there is an opportunity. For example, being invested in the world’s largest stock market, the United States, has produced some great returns, but will we see this cycle repeat itself in the same stocks? I doubt. We are seeing a proliferation of new technologies entering the market and we have the opportunity to sift through them to deliver good returns, missing those opportunities keeps me awake.
Graham Hand is editor-in-chief of Firstlinks. John Woods is Head of Asset Allocation at Australian ethical investing, a sponsor of Firstlinks. This information is general in nature and is not intended to provide you with financial advice or to take into account your personal goals, financial situation or needs.
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Press Release, November 29, 2021 – Australian Ethical Doubles Climate and Technology Solutions with First Visionary Grants 2021, via the Australian Ethical Foundation.