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Moving towards the mainstreamThe past five years have seen socially responsible investment
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The tech-heavy NASDAQ proved a boon and a
bust for many SRI funds
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Both SRI indexes and disclosure have remained major themes in the years since 1999, but performance has been less consistent. The technology bubble burst in 2000, and the world equity markets have had a difficult few years – focusing attention back to the debate around a ‘sustainability premium’ (see box 2). Despite this, assets under SRI management have grown over the past five years and new markets have opened up, especially in Asia (see box 3).
At first glance, the total amount of assets under management in the largest SRI market, the US, appears to have increased only modestly. The latest figures from the US Social Investment Forum (SIF) show a total volume of $2,164 billion for 2003, up only $5 billion from 1999, although SRI still represents a ninth of all professionally managed assets in the US (albeit with the very broad definition of SRI that SIF employs).
However, the withdrawal of a large pension fund from shareholder advocacy in the intervening years dragged the 2003 total down, masking an increase of $646 billion in the assets managed in screened funds, from $1,497 billion in 1999 to $2,143 billion.
Similarly, the figures on assets under management in Europe vary depending on the definitions used and the sector of the market being looked at. The SiRi Group, an alliance of SRI research companies, suggests that there has been a slight increase in assets in retail “green, social and ethical funds” to €12.2 billion ($15.1 billion) in 2003, from €11.1 billion at the end of 1999, but that the figure peaked at €14.4 billion in 2001. Fluctuations in world equity markets have to be taken into consideration when looking at these figures, but SiRi also finds the number of funds almost doubled over the same period, to 313 from 159.
By comparison, a 2003 survey by the European Social Investment Forum (Eurosif) of institutional investment in Austria, France, Germany, Italy, the Netherlands, Spain, Switzerland and the UK found that €34 billion was invested in ‘core’ SRI funds, which it defines as those using either positive or negative screens in stock selection. Fifty-four per cent of these assets were under management in the Netherlands and 44% in the UK, illustrating the differing rates of SRI development across Europe.
But of perhaps more significance than the growth in assets, the past five years have seen a growing awareness and acceptance of SRI among investors. In a survey commissioned this year by Friends Provident, a major UK pensions provider, two thirds of retail investors said they would consider investing their money ethically. US observers also note a growing familiarity with SRI among retail investors, and use by US-based ‘mainstream’ institutional investors of some of the same tools as the SRI industry.
Many argue that the UK pension reform – which came into force in 2000 – brought social and environmental considerations into the realm of mainstream investment, and set the ball rolling on fund management disclosure. Similar regulations have since been put in place in Australia, France, Germany and Italy. Indeed, Sweden went even further in a 2001 reform of its state-run pension funds, including a requirement that they consider “ethics and the environment in investment activities, without compromising the overall goal of a high return”.
However, despite its promise, the UK reform, and similar reforms elsewhere, have not seen a wholesale shift of assets into SRI portfolios.
A key reason, analysts say, is the interpretation of ‘fiduciary duty’ – the legal trust of care that the fund manager has for the savings which he or she manages. Many believe that excluding stocks for non-financial reasons could impact their funds’ financial performance. Considering social and environmental risks should arguably improve performance over the long term, but the evidence remains mixed.
Most of the earliest SRI funds used negative screening, by which companies or whole sectors engaged in environmentally or socially risky activities are excluded from investment portfolios. While still popular among many investors, especially those in the US and southern European countries who choose to avoid certain stocks for religious reasons, this form of management reduces the overall universe of stocks in which to invest. This can cause performance to fluctuate along very different cycles to benchmark indexes, giving a high tracking error. But this doesn’t preclude outperformance: the oldest SRI fund in the UK, Friends Provident’s Stewardship Fund, has returned 664.64% since its launch in 1984, compared to 607.53% for the median UK fund.
One attempt to overcome concerns about performance generated by negative screens is positive screening. This includes taking a ‘best-in-class’ approach, whereby the most environmentally and socially sustainable companies in each sector are selected for inclusion in a portfolio – allowing investors access to a broader range of stocks.
Alongside positive screening, there has been an increasing trend over the past five years towards engagement, whereby investors enter into a dialogue with companies to try to improve their environmental and social behaviour. Investors can also use their rights as shareholders to put pressure on companies at annual general meetings (AGMs) and put forward proxy resolutions. This approach allows them to remain fully invested in a stock market index while still demonstrating a willingness to address social and environmental issues.
Some fund managers now carry out engagement on all their holdings, often employing organisations, such as the Investor Responsibility Research Centre in the US and Manifest in the UK, to provide proxy-voting services. The Eurosif 2003 analysis mentioned above found that, while the amount invested in core SRI funds by institutional investors was €34 billion, if those using some type of engagement strategy are added, the total soars to €336 billion.
In the US, where socially responsible investors have a longer tradition of shareholder activism, the growth in filing proxy resolutions is clearest, rising in number from 220 in 1999 to 310 in 2003, according to figures from SIF. Last year, shareholders pressed a number of US utilities – including American Electric Power, Southern Company and TXU – to review their vulnerability to climate change and report back to investors.
This trend towards more active shareholding has been driven in part by the scandals at Enron, Parmalat and others, which have pushed the issue of corporate transparency further up the agenda, and made corporate governance a major concern for sustainability investors. Disclosure of social, ethical and environmental policies among companies is now obligatory in France, and will be in the UK next year, for issues that affect company performance. In the US, the Sarbanes–Oxley Act may also lead to more comprehensive disclosure of social and environmental issues in future.
Besides legislation, a number of initiatives have also been set up to encourage greater transparency – ranging from international programmes to individual meetings between companies and investors. Possibly the most noteworthy of these is the Carbon Disclosure Project (CDP), the result of collaboration between an initial 35 institutional investors, holding $4.5 trillion between them. Launched in 2002, the investors collectively asked companies in the Fortune 500 for information on their carbon dioxide emissions. The number of investors involved has now increased to 95, representing over $10 trillion of assets.
In response to the growing emphasis on transparency, there has been an increase in voluntary disclosure of non-financial performance in the form of corporate social responsibility (CSR) reports. CorporateRegister.com, an online directory of CSR reports, records 269 electronic and 533 hard copy reports as having been produced by companies for 1999. By 2003, this had risen to 1,246 electronic and 545 hard copy reports.
These reports are, however, not always as informative – and certainly not as standardised – as SRI analysts would like. Companies have also complained that, despite producing CSR reports, they are inundated by requests for information from index providers and research companies. One solution to this problem is the promotion of standardised reporting guidelines, such as those of the Global Reporting Initiative (GRI). Originally established in 1997 by the US-based Coalition for Environmentally Responsible Economies, but now independent, the GRI provides a widely applicable set of guidelines and boasts 500 users.
Other solutions to the problem of ‘survey fatigue’ are also beginning to appear: this year has seen the launch of two services – OneReport from SRI World and the Corporate Responsibility Exchange from the London Stock Exchange – enabling companies to log questionnaire answers at a single source.
The very fact that survey fatigue is now considered a problem shows the extent to which investors consider social, environmental and ethical considerations to be important. With conventional funds adopting engagement strategies and pension funds beginning to look at long-term risks such as climate change, SRI and mainstream investment have shown some convergence. But the extent to which this continues is linked to the debate about the profitability of SRI, and even whether profitability matters.
These are arguments that were raging in 1999 and, while SRI has grown up in the intervening years, they are still to be resolved. EF
The announcement, in 1999, that Dow Jones was to put its name to a socially responsible investment (SRI) index family developed by SAM Sustainable Asset Management, a Zurich-based research firm, was greeted with excitement in the SRI world. It was an acknowledgement that SRI had come of age, and heralded another step towards the investment mainstream.
Rival FTSE International followed in 2001, with its FTSE4Good family of indexes. The two index providers take different approaches to selecting index members. The Dow Jones Sustainability Indexes (DJSI) include the top 10% of companies, in sustainability terms, chosen from the 2,500 stocks in the Dow Jones Global Indexes.
FTSE4Good, meanwhile, is open to any company in the UK FTSE-All Share or the global FTSE All-World Developed indexes (apart from those in the tobacco, weapons, and nuclear sectors) that meet steadily rising environmental and social criteria. As such, it is more ‘inclusive’ than the DJSI.
The performance of the indexes so far has proved disappointing for those who argue that SRI should lead to outperformance. Since its launch in 1999, the DJSI World Index has returned 85.19%, compared to 87.63% for its benchmark, the MSCI World. The FTSE4Good Global index has fared even worse, compared to its benchmark: it has returned 92.63%, compared to 97.60% for the FTSE All World.
However, of arguably as much importance as financial performance is the impact the indexes have had on corporate environmental and social performance. For many large companies, inclusion in the indexes is a badge of corporate pride – and more than one head of environmental affairs has had to explain to chief executives why they have failed to make – or been expelled from – one or other of the indexes.
Indeed, in May this year, FTSE claimed in a report that the tightening of its FTSE4Good criteria has helped bring about “a marked improvement” in companies’ social and environmental policies and disclosure.
As of mid-September, the Dow Jones boasted 44 licensees for the DJSI and its sister indexes, the DJSI Stoxx, with almost €3 billion ($3.7 billion) in assets under management. Meanwhile, FTSE4Good has 23 licensees.
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The debate over whether socially responsible investors outperform their ‘mainstream’ peers is as live now as it was five years ago. For many years, when screening out ‘dirty’ stocks was the name of the game, there was a case to be made that SRI could put a drag on performance, particularly when defensive sectors such as oil and gas or tobacco are in vogue. Conversely, the tech-led bull market of the late 1990s saw SRI funds, overweight in telecoms, media and technology stocks, outperform the broader market.
The rise of ‘best-in-class’ investing, whereby SRI investors choose the most sustainable stocks across all, or most, industry sectors, has shifted the debate. Its advocates argue – again, with some justification – that the additional layer of analysis into social and environmental issues carried out by social investors can help them spot risks and opportunities before their mainstream competitors. Many SRI analysts also argue that good environmental and social management is a proxy for good overall management.
Innovest Strategic Value Advisors, a New York-based SRI research firm, has carried out quantitative research showing a ‘sustainability premium’ from investing in a portfolio of companies that score above average against its methodology. Others have found less evidence, or argued that the costs of such analysis can reduce or eliminate any premium.
There is, however, a school of thought that argues that all this worrying about performance is beside the point. Responsible investment, they argue, is about doing the right thing – and should not have to be justified purely in financial terms.
Five years ago, Asia’s SRI market was exactly two months old. The region’s first sustainable fund – the Nikko Eco Fund – was launched in Japan in August 1999. It exceeded expectations spectacularly, attracting $1 billion of assets after six months, 20 times the figure expected.
Since then, in common with many western markets, SRI in Japan has had its ups and downs. It was hit badly by the equity-market downturn, but has since begun to bounce back – and recent interest among Japanese companies has prompted index provider FTSE to launch a Japanese version of its FTSE4Good index. According to the Association for Sustainable and Responsible Investment in Asia (ASrIA), the country now boasts 11 different sustainability funds, seven of which are domestic and four international.
Elsewhere in the region, interest in SRI is also growing – albeit from a low base. Six global SRI fund options are available in Hong Kong, including offerings from major international companies such as Henderson Global Investors and Friends Provident, and from domestic fund manager Kingsway Fund Management.
And other countries are beginning to catch up, as awareness and acceptance of SRI grows, says ASrIA. Indeed, ASrIA’s creation in 2001 is testament to this. Investors in Singapore can now put money in a global SRI fund run by Morley Fund Management or in a local fund, which invests in companies with a progressive attitude towards women. There is also a green fund in Korea, which invests in companies with good environmental management systems or eco-friendly products, a global eco-fund has been set up in Taiwan, and an ethical investment trust in Malaysia.
As in other regions, Asian SRI funds face their own set of challenges and have some unique characteristics. Reporting by companies in the region is traditionally somewhat limited, especially on social and environmental matters, meaning that fund managers have to rely on face-to-face meetings to a much greater extent. Investors’ concerns also differ, with tobacco, alcohol and gambling not considered ‘sins’ in Japan, as they are in some other countries.