Australia’s leading independent ethical investment manager Australian Ethical Investment Limited (ASX: AEF) this morning reported a net profit of $3 million on revenues of $23 million for the full year ending June 30 2016. The profit and revenues are up 53 per cent and and 8.8 per cent over the prior year.

The group delivered basic earnings per share of $2.82 and paid $3 in dividends per share. As at year end total funds under management stood at $1.56 billion with net inflows of $319 million approaching double the $179 million of net inflows logged in the prior year.

Competition

The strong FUM flows demonstrate the increasing popularity of ethical investing with most mainstream banks like Commonwealth Bank of Australia (ASX: CBA) and asset managers like AMP Limited (ASX: AMP) or BT Investment Management Ltd (ASX: BTT) all now also offering ethical investment funds. This is not because the big end of town has suddenly discovered an ethical conscience and desire to sacrifice profits for the greater good, but because money managers realise there’s profits to be made within the ethical investing industry due to increased investor demand.

Australian Ethical’s advantage over its mainstream rivals is its independent status and marketing pitch that it’s genuinely ethically and focused on issues such as the environment and philanthropy that are important to its investors.

As a result its fees are slightly higher than your average super fund manager with AEF’s super fund charging 0.72% per annum as an investment fee plus 0.41% per annum as an administration fee in addition to other fixed costs. This compares to the 0.55% per annum plus a 0.10% performance fee charged by the “Socially Aware” investment option offered by industry fund Australian Super.

Looking under the carpet

Embarrassingly, AEF also admitted in its full year report that a provision of $0.9 million had been recorded as a result of unit pricing errors that are believed to have affected members of its super fund. Operational cock-ups like this can slaughter reputations due to the theory that there’s normally more than one cockroach in the kitchen when it comes to operational messes. The company reported that an investigation is underway into the issue, with an update to be provided to the market in the first half of FY17.

Growing FUM

Nearly 70 per cent of the money Australian Ethical manages is superannuation with 78 per cent of total funds under management coming via direct channels rather than advisory distribution networks. This suggests the company has plenty of opportunity to grow its distribution networks, while its efforts to promote itself directly via channels such as social media and other direct digital marketing continue to pay dividends.

Investment performance has also been reasonably strong with the Smaller Companies fund being the star performer in delivering an average return of 13.8 per cent per year over the past five years.

Ethical funds generally have thumped their benchmarks over the last 24 months as some serendipity means they are mandated to avoid stocks in the cratering resources sector that has been universally pummeled on the back of crashing commodity prices.

Outlook

This morning the stock is selling for $81.51 per share on around 29x trailing earnings with a dividend yield in the region of 3.6 per cent. The company has some tailwinds although it will need to stick with competitive fees given the ethical investing space has virtually no barriers to entry and the company has no real moat.

For me at these prices the stock looks too expensive, although I continue to believe it is one of the more attractive small-cap investment managers on the ASX alongside Wilson’s WAM Capital Limited (ASX: WAM).

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.