July 2007


Issues such as climate change and corporate governance have brought SRI into the mainstream. But is is just a marketing gimmick? And what about other ethical issues? Fiona Rintoul investigates 07_07_ethical_invest Ethical investment used to be seen as a kind of nuts-in-May pursuit best left to hippies and sandal wearers. Ethical funds controlled a tiny segment of the market and serious investors weren’t interested in them. Then a slightly less touchy-feely term (with accompanying obscure acronym) was coined – socially responsible investment (SRI) – and a couple of things happened that made the market think again. First, Enron blew up, highlighting for even the most hard-nosed of investors the importance of good corporate governance. Secondly, public policy on climate change started to evolve in ways that were clearly going to have an impact on a company’s bottom line. Ever since the term SRI first appeared, there has been talk of responsible investment becoming a mainstream pursuit. Eventually, so the argument goes, investors will come to realise that investing in a responsible or sustainable way doesn’t just give you a warm glow, it also makes financial sense. As Hugh Cuthbert, investment manager at SVM Asset Management, puts it: “Why should our SRI fund not perform? It has the same investment process as our conventional funds, but we are adding to it this process of engaging on ethical, governance, environmental and social issues.” All talk?
Cuthbert cites the example of personnel. If workers aren’t taken as good care of as they should be, the company won’t get the most out of them, and, ultimately, its performance will suffer. With the huge amount of attention that has been given to the financial consequences of climate change over the past year, surely the time is ripe for arguments like these to be given serious attention? Is it finally time for SRI to enter the mainstream? Certainly, SRI practitioners see positive effects from the climate change debate. “Climate change is a theme that brings to the forefront everything we know under the name of SRI,” says Catherine Friedrich, head of SRI marketing and communication at Dexia Asset Management. “It creates an awareness that some criteria that are not purely financial may affect financial results.” But as to whether it is dragging SRI into the mainstream, the jury is still out. Some feel that while what is being said about SRI has changed, what is being done about it hasn’t much. Rory Sullivan, head of investor responsibility at Insight Investment, says that two to three years ago he would have expected to see convergence around responsible investment in the mainstream, but that it hasn’t happened. “There’s been a lot of rhetoric, but there hasn’t necessarily been delivery.” There’s also concern about ‘greenwashing’ – paying lip service to SRI because it’s a good marketing gimmick. “I do get worried about overlays and best in class; it’s not integral and if it’s not integral, it’s not adding to the investment approach,” says Cuthbert. His firm goes for the more proactive approach of investing in companies that do yet have optimal policies regarding SRI criteria and encouraging them to change, a stance which is in line with its general investment approach. Then again, perhaps some fudging around the edges is inevitable as SRI evolves, both among asset managers and in boardrooms. “There’s no doubt the Stern Review had a huge impact in many UK and European boardrooms,” says Emma Howard-Boyd, head of SRI at Jupiter Asset Management. “Some initiatives might seem quite simple, but if you look at consumer trends, ethical consumers account for 6-7% of the market. Policies might seem to be attacking low-hanging fruit, but they are reaching out to the 94% who haven’t been thinking about climate change.” Of course, any assessment of whether SRI in coming into the mainstream requires us to be able to measure the SRI segment of the asset management market. And that’s not easy. “Across Europe, we see signs of robust SRI strategies, increased mandates from institutional players and the growing involvement of more traditional financial services providers such as brokers,” says Matt Christensen, executive director of Eurosif in the Eurosif European SRI Study 2006. “What the growing mainstreaming of SRI also means is that the line between SRI and non-SRI becomes more challenging to define.” Eurosif has resolved this issue by dividing the SRI universe into ‘core’ and ‘broad’. Within ‘core’ it includes ethical exclusions and positive screens, including best-in-class and pioneer screening (for definitions, see diagram). ‘Broad’ comprises simple exclusions including norms-based screening, engagement and integration. Using these definitions, and with the proviso that collecting and comparing data in the SRI area is an imperfect science, Eurosif has come up with figures that put the European SRI market at e1.138 trillion (at 31 December 2005), of which e105 billion is core SRI and e1.033 trillion is broad SRI. That seems like quite a lot, but, as Eurosif itself concedes, these figures are “based on the self-reporting of asset managers and self-managed pension funds” and could therefore cover a multitude of sins. Engagement, in particular, which is the largest segment of broad SRI, can be a woolly area. It’s virtually impossible to measure objectively how much an asset manager is engaging with companies and what effect, if any, that engagement has had. Rules of engagement
“There’s perhaps 10-15% of assets with either engagement or investment integration,” says Sullivan. “But it’s self-reported. Relatively few asset managers do engagement really well and many don’t disclose what they’ve achieved on engagement.” Another problem is that there are almost as many ways of looking at SRI as there are potential investors. One man’s unethical behaviour is another man’s Saturday night – almost literally. Common exclusions for funds with negative screens are tobacco, alcohol and pornography. This diversity is reflected within institutional mandates in particular. “Clients will have specific screens they want to apply to their funds,” says Jamie Cumming, investment manager SRI at Aberdeen Asset Management. “There’s a whole range of screens covering different aspects.” Screens can also be applied with varying degrees of vigour. Aberdeen, for example, wouldn’t screen out Tesco from a portfolio with negative screens for tobacco and alcohol even though Tesco sells these products. “We look at it based on turnover,” says Cumming. “If a company gets less than 10% of its turnover from tobacco or alcohol, we don’t screen it out.” Someone else might do it differently, however. And while some managers are busily screening out baddies from their portfolio, or trying to identify the least worst in a particular sector if they take a best-of-breed approach, others, such as SVM Asset Management’s Cuthbert, see more value both from an investment and an ethical point of view in engaging with companies that haven’t yet resolved their approach to the environment or to their workforce. And sometimes exclusions simply aren’t practical. “As a mainstream asset manager, you have to invest across the market,” says Sullivan. “You don’t have a choice over not investing. Also if you don’t invest you lose influence.” SRI is a very variable commodity, then, and one that is hard to measure. The SRI issues that have attracted substantial investor attention are the ones that have become material, principally climate change and corporate governance. Beyond that, some feel, there may be a bit of a green haze but little has changed. All about the bottom line
“Because emissions have a cost, you would expect any half decent analyst to look at them,” says Sullivan. “Climate change is now a standard part of valuations. Corporate governance is also mainstream. When you strip those out, there’s a lot of noise, but it’s not clear that there’s been much change.” Basically, truly ethical funds remain a tiny percentage of the investment universe and the rest of the market reacts to social and environmental issues when they have a clear price tag. Similarly, investors are piling into clean tech at the moment because it’s performing well and because it’s seen as an alternative asset class. But their investment is not indicative of a commitment to energy efficiency; they will no doubt pile out again just as quickly if clean tech companies stop performing. It is, of course, understandable from an investment point of view that the bottom line is everything. A pension fund manager, for example, of course has a fiduciary duty to maximise the performance of their client’s portfolio. But this creates problems at a broader level and perhaps suggests a lack of foresight. Climate change is an example. In many ways, investors are reacting too late because they waited for the regulator to create tangible financial incentives. “Whatever we do now, there is going to be environmental damage,” says Sullivan. In the SRI department at Dexia Asset Management, they see sustainable management as “a double source of alpha”. The firm does a sustainability analysis first, then a more traditional financial analysis. “Our goal is no different from a traditional goal: good performance,” says Friedrich. “But we particularly target double alpha: short-term alpha from the financial analysis and long-term alpha from the sustainability analysis.” It’s an alluring prospect, but it’s hard to prove that taking SRI issues into account improves performance, and it would seem that most mainstream managers still have their eyes firmly fixed on short-term alpha. Commentators suggest that only around 5% of assets under management in Europe are managed with any kind of serious commitment to SRI criteria.“ Social investment is something every asset manager should be doing, but it’s quite easy to hide behind climate change,” says Sullivan. “HIV/Aids is an equally huge global problem and there are probably more people affected, but there has been nothing like the response from investors.” He also points out that within climate change it’s quite common for engagement to mean taking part in “collaborative initiatives that aren’t really doing very much”. It’s not for nothing that the Stern review highlighted a market failure with regard to climate change. “That’s been dealt with by putting in place pricing mechanisms,” says Howard-Boyd. The future is going to bring more of the same and not just in already mooted areas such as transportation. Howard-Boyd predicts that obesity, for example, could be a issue that will provoke regulation that will affect companies’ bottom lines. Meanwhile, asset managers focused on SRI remain a minority, but one that is both attracting substantial inflows from clients and leads where mainstream asset managers increasingly follow. “SRI is good at spotting emerging issues at an early stage,” says Howard-Boyd. “Then others pick them up.” © fe July 2007
 SRI definitions
 Strategy Definition
Ethical exclusions Exclusions where a large number of negative criteria and/or filters are applied (as opposed to just tobacco or weapons for example).
Positive screening Seeking to invest in companies with a commitment to responsible business practices, or that produce positive products and/or services. Includes best-in-breed and pioneer screening.
Best-in-class Approach where the leading companies with regard to SEE criteria from each individual sector or industry group are identified and included in the portfolio.
Pioneer screening/Thematic investment propositions          Thematic funds, based on ESG issues such as the transition to sustainable development and a low carbon economy. May focus on sectors such as water, energy etc.
Norms-based screening Negative screening of companies according to their compliance with international standards and norms such as those issued by OECD, ILO, UN, UNICEF etc.
Simple screens/simple exclusions An approach that excludes a single given sector from a fund (such as arms manufacturer, publication of pornography, tobacco, animal testing etc. Simple screens also include simple human rights screens (such as excluding Sudan or Myanmar) and norms-based screening.
Engagement Engagement is applied by some fund managers to encourage more responsible business practices and/or enhance investment returns. It relies on the influence of investors and the rights of ownership, and mainly takes the form of dialogue between investors and companies on issues of concern. Engagement may extend to voting practices.
Integration The explicit inclusion by asset managers of CG/SEE risk into traditional financial analysis.

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