How our ethical process strengthens investment outcomes
Over 40 years, we've found our investment and ethics processes work hand in hand. The things that make businesses ethically sound are also the things we believe make them worth holding over time – accountable governance, long-term thinking, sustainable business practices, and products and services that contribute to, rather than work against, the world they operate in.
Rigorous ethical analysis functions as a risk management framework for us. It can help surface governance risks before they become headlines, identifying structural and regulatory pressures that can be reflected in share prices. It helps us see things that a purely financial lens might miss, as shown in the examples below.
Materials: Identifying structural transition risk
In the materials sector, our ethical process helps us distinguish between businesses positioned for long-term structural growth and those potentially facing structural decline. We want to invest in companies that have more of a long-term focus, after our ethical and investment assessment.
We don’t invest in companies which derive the majority of their revenue from fossil fuel extraction1 because we believe they face increasing regulatory, economic and competitive pressures as the global economy transitions toward lower-carbon energy sources. While this can create periods of short-term underperformance for our portfolios, we believe the structural headwinds facing fossil fuel businesses over time are well established.
Resources are finite, constrained by geology and tightening regulation as governments pursue science-based emissions targets. For these businesses, capital demands make growth cyclical and expensive. We invest selectively in businesses supplying what the energy transition genuinely requires.
Copper is essential to electrification, renewable infrastructure and battery storage. Lithium underpins electric vehicle batteries and grid-scale energy storage. Demand for these metals is structural rather than cyclical, driven by long-term shifts in energy and transport demands that we expect to strengthen regardless of near-term commodity price movements.
Materials stock example: Capstone Copper
We hold Capstone Copper, one of the few ASX-listed companies offering substantial pure-play copper exposure. The company has a diversified portfolio of copper assets across the Americas and is progressing a multi-year expansion programme expected to drive meaningful production growth, supported by a balance sheet capable of funding much of that growth internally.
Defence: Governance as an investment concern
We do not invest in companies involved in the manufacture of weapons and we restrict+ investment in companies involved in weapon components. Read about our view on investing in weapons and defence.
The values reason is clear, but also from an investment perspective, businesses with financial performance heavily dependent on government spending in unpredictable geopolitical conditions are inherently difficult to hold through a full market cycle.
We have observed that some areas of the market associated with emerging technologies can attract speculative capital, driving share price appreciation well ahead of underlying business fundamentals. This can create incentives for management teams and insiders that are not always aligned with the long-term interests of investors. We see these risks most often in sectors where short-term market enthusiasm is greatest and governance oversight is weakest. Our ethical process helps identify and avoid businesses where these issues may emerge before they affect shareholder outcomes.
Defence stock example: DroneShield
DroneShield is a company that offers an illustration of the governance issue we are describing here. The stock rose sharply as sentiment around defence technology ran strongly. What followed was a significant sale of stock by the chairman and board in a single day, concentrating the benefit of that price appreciation among insiders while leaving other investors exposed to the subsequent decline. The stock has not recovered to those levels.
Technology: Valuation and governance in the same frame
Technology is an area we invest in actively, with genuine preference for businesses that grow through software, data and scalable distribution.
Our portfolios naturally favour companies whose value is driven by future earnings, making valuation discipline particularly important. At the same time, our ethical process closely examines the concentrated ownership structures common across parts of the technology sector, where governance risks can remain hidden until they surface unexpectedly.
Technology stock example: WiseTech Global
WiseTech Global is a case in point. A logistics software business with genuinely differentiated technology and a strong competitive position, but one that faced serious governance concerns: misconduct allegations against its founder and Executive Chair, four independent board director resignations including the chair, and sustained investor pressure around leadership transition. We engaged directly with the company and did not see sufficient evidence of remediation that met our standards so we ruled the stock out of our investable universe.
Financials: Looking underneath the label
Sector labels can obscure more than they reveal. While we are overweight financials overall, our exposure to the major banks is significantly lower than the benchmark.
In fact, we currently hold less than half the benchmark weight in the major banks in our large cap active equities portfolios. In our assessment, they are trading at elevated multiples relative to their own history, and the near-term environment presents headwinds that current valuations don’t fully reflect.
Banks facilitate the flow of money and capital that underpins access to goods and services — which is why financials have a place in our investable universe. How a bank lends, and to whom, is central to our assessment, alongside business economics, governance quality and valuation rather than simply tracking benchmark weights.
Financials stock example: 
Small lenders and insurance companies
We look beyond the big banks that dominate the index, toward smaller lenders (like Pepper Money and Bendigo & Adelaide) and insurers (like QBE, IAG and NIB), where we see more attractive valuations and more resilient earnings. Insurance is cyclical by nature, and a business generating strong returns on equity through a soft part of the cycle carries meaningful earnings leverage when conditions improve. In our view, current prices reflect the headwind without pricing in the recovery — creating a more attractive entry point for investors with a medium to long-term horizon.
The consistent pattern
Across defence, materials, financials and technology, the same pattern emerges. The factors that raise ethical concerns often point to investment risks as well. Weak governance, dependence on structurally challenged resources, and short-term decision-making can all undermine a company's ability to create sustainable long-term value. As a result, our ethical and investment analysis frequently lead us to the same conclusion.
Forty years of applying this framework has shown us that the things that make a business ethically sound tend to be the same things that make it worth holding over time.
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1 There are limited circumstances where we may have indirect market exposure through derivatives. Derivatives used to obtain broad market exposure may reference companies, sectors or securities that have not been ethically approved or that are excluded under our Ethical Criteria.
Interests in the Australian Ethical Managed Funds are issued by Australian Ethical Investment Ltd (ABN 47 003 188 930, AFSL 229949), the Responsible Entity of the Australian Ethical Managed Funds.
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Australian Ethical Investment Ltd does not guarantee the performance of any fund or the return of an investor’s capital; past performance is not a reliable indicator of future performance.
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Investing ethically and sustainably means that the investment universe will generally be more limited than non-ethical, non-sustainable portfolios in similar asset classes. This means that the portfolio(s) may not have exposure to specific assets which over or underperform over the investment cycle, and so the returns and volatility of the portfolio(s) may be higher or lower than non-ethical, non-sustainable portfolios over all investment time frames.
+ Our investment restrictions include some thresholds. Thresholds may be in the form of an amount of revenue that a business derives from a particular activity, but there are other tolerance thresholds we can use depending on the nature of the investment. We apply a range of qualitative and quantitative analysis to the way we apply thresholds. For example, we may make an investment where we assess that the positive aspects of the investment outweigh its negative aspects. For information on how we make these assessments for a range of investment sectors and issues such as fossil fuels, nuclear power, gambling, tobacco, human rights, and many others, please read our Ethical Guide.
