Features, October 1999 Dow initiative ignites debate Sustainable investing has taken a giant stride towards the mainstream with the launch of the Dow Jones Sustainability Group Indexes. But, as Mark Nicholls finds, the methodology has proved controversial. Most analysts, consultants and environmental fund managers have warmly welcomed the September launch of Dow Jones' new family of sustainable indexes. The heavyweight US index provider, they say, brings kudos and publicity to the sustainable investing debate. But behind the broad expressions of approval, the company has run into criticism for the methodology it has chosen to calculate the indexes - highlighting just how controversial the rating of companies for sustainability remains. "They've done a good job, given the current state of the art," says David Coles, head of the sustainability advisory services group at consultants KPMG in London. "That isn't to say that the methodology won't need to be substantially improved. There's currently not enough information [on sustainability] in the public domain." "My first reaction is that I support the initiative," says Matthew Kiernan, executive managing director of Innovest Strategic Value Advisors, a New York-based investment research firm, which offers clients an alternative eco-rating methodology. "But I'm mildly surprised that Dow Jones would build a methodology that is so open to question." Kiernan, and others, have questioned the objectivity and reliability of the data used to select the 229 companies that make up the flagship Dow Jones Sustainability Group Index (DJSGI). The New York-based president of Dow Jones Indexes, David Moran, is not slow to acknowledge the difficulties in formulating an index of this type. "The sustainability concept is not static - there's always going to be a certain amount of subjectivity in component selection. But after a period of consultation, we've decided that [the approach Dow Jones has taken] is sufficiently analytically rigorous." To produce the indexes, Dow Jones has entered into a partnership with the Zurich-based SAM Sustainability Group, to form Dow Jones Sustainability Group Indexes GmbH, also headquartered in Zurich. SAM, which specialises in corporate sustainability assessment, has provided the methodology and the research behind the indexes. The process is based on questionnaires sent to the 2000 largest components of the Dow Jones Global Index. Their responses are cross-checked against company reports, regulatory filings and an ongoing media review. The DJSGI index family consists of one global, one US, and three regional (North America, Europe and Asia-Pacific) indexes. Four specialised indexes are also calculated for each of these geographical regions excluding alcohol, gambling, and tobacco stocks, and all of the above. Over the last five years, the US dollar global DJSGI returned 137%, compared to 96% for the Dow Jones Global Index. The US sustainable index, however, returned a staggering 290%, compared to 194% for its mainstream equivalent. Dow Jones is reluctant to make too much of this, pointing out that backtesting indexes is notoriously unreliable. The returns will, however, give heart to those investors who believe sustainable investing makes good financial sense. Returns aside, criticisms have centred on the indexes' reliance on questionnaires for assessment of each company. "You have to be a little cautious about questionnaires. They're useful, but you need independent verification," says Mark Mansley, at London-based Claros Consulting, which specialises in ethical and environmental investing. Alois Flatz, head of sustainability research at SAM in Zurich, vigorously defends the methodology. He says that the media review can often pick up on the less-than honest. "Some companies that claimed that they weren't involved in corruption cases were automatically excluded from the index when press reports showed large numbers of violations." Flatz adds that because the questionnaires are signed by senior company managers, there would be "legal implications" in providing incorrect information to DJSGI GmbH, as this could amount to misinforming shareholders. Dow Jones and SAM have also come under fire for their lack of company visits to verify the information they receive. "I'm old fashioned," says Kiernan. "I like to visit the companies we rate." But the drawback with company visits, says Flatz, is that they would add another layer of subjectivity to the assessment process. Unless SAM was to visit all of the sites of all of the companies they analyse, then they would be unable to assess companies fairly, he says. This would also be prohibitively expensive, he adds. And Flatz argues that it is possible to attempt to collect too much information from companies. One of SAM's competitors, he says, recently sent a 36 page questionnaire to a German bank. The bank - which told Flatz that it struggled to complete the 14 page questionnaire sent by DJSGI GmbH - simply declined to respond. "You can ask 150 questions or 1000," he says, "and you will most likely see the same companies leading." Many observers agree that SAM and Dow Jones were forced down the questionnaire path by the paucity of third party information available on sustainability issues. Outside the US, where companies have a legal obligation to provide certain information to regulatory bodies, it can be extremely difficult to access data without going directly to the company itself, they say. But Kiernan also questions how SAM has weighted the relative importance of the various factors that it has chosen to ask about. "The number of environmental audits and the amount of carbon dioxide produced by a company do not have the same financial impact," he argues. Equally, the very choice of questions asked of companies - particularly in the industry specific sections - is subjective, say some analysts. Flatz says that DJSGI GmbH has made every effort to reach some sort of consensus, involving external consultants and industry experts. Some companies themselves were asked to comment on draft questionnaires. "At the end of the day, it will always be subjective. We've tried to limit this as much as possible," he says. The process also involves standards where they exist, such as the United Nations Environment Programme standards on environmental reporting. "What is important is that we treat all the companies in the same way," he says. Moran also points out that the judgements made in assessing sustainability criteria are not set in stone. "We're only making judgements on the relative sustainability prospects of a particular company in a particular industry at a particular point in time. As the sustainability concept develops and changes, I hope we can take that into account as we review the index components on an ongoing basis," he says. Leslie Christian, president of Seattle-based asset management company, Progressive Investment Management, believes that all definitions of sustainability are subjective. "The index's perceived subjectivity is no reason to dismiss it. It's wonderful that there's this much focus on sustainability from a company like Dow Jones." Adrian Henriques, head of corporate accountability at London-based pressure group, consultancy and auditors New Economics, believes that the index should encourage companies to provide 'harder' information on sustainability: "Given that it's not easy to get this kind of information, it's better that this index exists than not. But I'd like to know how Dow Jones intends to develop it, to influence companies to provide objective, verified information." KPMG's Coles believes that the very existence of the index will push companies in the direction of a greater emphasis on sustainability issues, and towards greater accountability. "The great plus with this index is that it will put pressure on companies to address sustainability." FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE