Exclusion of sectors by newly launched index has baffled some in SRI marketwho believe this reduces their chances of persuading companies to change
UK ethical funds are becoming more difficult to differentiate from other UK All Company portfolios due to the catch-all mandates of some ethical funds and the adoption of socially responsible principles by more mainstream portfolios.
Ethical isn't even a word that is widely used to describe these portfolios anymore ' instead most use the term socially responsible investing or SRI. Fading fast is also the premise of blanket exclusion of unacceptable sectors, such as tobacco or oil companies. Replacing it is the notion of responsible shareholders, using the weight of the fund's stake in a business in order to force and push through positive changes, such as non-discriminatory hiring practices and recycling projects.
This change in gears is represented in the recent launch of the FTSE4Good index, an index consisting of FTSE All-Share constituents that are deemed, socially responsible companies. This will enable people to be able to buy ethical trackers, giving another investment choice to passive and SRI investors alike.
The surprise in its construction came from which companies it chose to include and exclude from its lists of members: oil giants Shell and BP were included whereas some retailers, such as Tesco, were excluded.
Still, many SRI funds hold shares in the excluded Tesco, which suggests that its environmental policy is at least no worse than other supermarkets, according to Ryan Smith, SRI researcher at Aegon Asset Management.
He said: 'I know for a fact that they have made significant inroads into improving their environmental policy, it is not clear to me why they have been excluded.'
Amanda Forsyth, investment director at Standard Life Investments and UK Growth manager, said the FTSE4Good index does not have a clear direction. She said: 'It falls between two stalls, it has chosen to exclude certain areas automatically but it includes companies that we avoid like BP and Shell, which work in countries with human rights abuses.'
The exclusion of sectors is also considered strange in that UK SRI policy trend has been towards inclusion with the idea of changing the way the companies are run.
John Paul Maytum, of the Co-operative Insurance Society (CIS), said: 'By ruling people out of the index you are letting them go. You may find that by excluding them you won't have any effect on their behaviour and you lose the ability to engage with them.'
There have been notable victories for ethical investment argued Guy Jubb, corporate governance director at Standard Life. He cited the highly publicised changes in policy direction by Shell. A particular example of where socially responsible investors persuaded the company to change its behaviour was where it withdrew its American subsidiary as a member in the Global Climate Forum because of concerns it had become a political lobbying organisation rather than one which aimed to stop long term changes in global climate.
Another victory for the movement highlighted by the Ethical Investment Research Service (Eiris) was the recent decision by drug companies to drop their court case against the government of South Africa over intellectual property rights.
Eiris claimed that it was pressure from SRI investment houses caused the companies to stop their action. Stephen Hine, head of international relations at Eiris, said: 'The decision of the companies followed a campaign by eight investing institutions which urged GlaxoSmithKline to develop its policy on the accessibility of drugs in poor counties.'
But others are wary of claiming the credit for changes for the SRI movement. Charles Henderson, head of SRI research at Aegon, said: 'It is a bit presumptuous to claim that the SRI movement was instrumental in making the changes. There are a number of stakeholders involved that change corporate behaviour including government and NGOs as well as investors.'
James Giuseppi SRI communications manager at Hendersons which has 23 ethical funds explained that typically industries were excluded for historical reasons. He said that the ethical movement came out of the Church, so areas like alcohol and gambling were excluded from many funds because they were frowned upon by religious authorities.
He said: 'There is growing concern about issues of sustainability, the environment is becoming much more important in the eyes of investors. There is now more of a positive focus so the funds are looking to invest in areas which are involved in sustainable development.'
Aegon's Ethical fund has changed its criteria for exclusion to reflect shifts in consumer attitudes since it was launched in 1989. Henderson said: 'The changes we are making provide a neat snapshot of shifts in consumer attitudes over the last 12 years.'
The group has excluded companies researching and promoting GM foods and new media companies that sell pornography. It has also excluded companies that operate in countries in which slave or child labour exist and where the company is doing nothing to tackle the issue. The fund has also turned from 'vegetarian to vegan' by excluding retailers of all dairy products, according to Henderson.
The introduction of SRI funds where there is positive engagement with companies who participate in activities traditionally seen as unethical has opened it up to charges that it has become little more than a marketing ploy. Charles Mesquita, charities specialist at fund managers Carr Sheppards Crosthwaite, said: 'You should not have to jump on the marketing bandwagon, if you invest in a green fund you should be aware of what that means and understand why your money is being invested where it is.'
It is now law for pension funds to state if they have any ethical criteria in their investment process and some are taking an active part in the decision making process. Recently, eight leading pension funds and fund management firms have come together to write to 750 quoted UK companies asking them to give shareholders an annual vote in the size of their directors pay packets.
But it is still unclear to what extent pension funds take SRI as an important factor. Mesquita said that it is difficult to make a decision on behalf of a pension fund that has a large number of stakeholders. He said: 'How do you represent everybody's views and how do you get a consensus, should the decision about what not to invest in come from the trustees or the pensioners?'
He questions the whole concept of deciding what is socially responsible or ethical. He said: 'I feel strongly about the environment but it is not clear how I should translate that into my investment decisions. If I stop investing in UK companies that are regarded as polluting, US companies will take their place. This could create a social problem in the UK where people are laid off.' The proper way for things to get changed in a democratic society, said Mesquita, is by modifying the laws. He said that laying the blame for society's ills at the feet of companies is wrong and that people should be taking more responsibility for their own actions.
Like Hendersons, Credit Suisse uses an advisory committee to decide which industries to exclude. Suzie Kemp , fund manager of the Ethical Fund said that although an independent panel made the final choice, investors have a real say in deciding the make up of the fund. She said: 'Ethical investors are definitely a lot more involved than those who hold conventional funds. We have a lot of contact with the public who feed into the decision making process where the areas of investment get voted on three times a year by the panel.' She acknowledged that this can make the decision making process somewhat faddish but argued that with areas like genetically modified organisms, it is right to hold out on investing in them until it is clear what their impact will be.
The growing importance of SRI, in its lighter green shade, is now also being taken into account by fund managers who do not run any ethical funds. Jupiter has added a light green screen to its entire fund range while Zurich Scudder has incorporated SRI factors into all of its funds to take account of issues which can affect investments across the board. George Latham, a fund manager on the UK equities team, explained that looking into SRI factors can reveal both threats and opportunities. He said: 'In some areas it is managing risk, the analysis can help us to spot legislative trends that may hit a company, for example.'
One area of risk that Latham identified was problems in the supply chain of a company. Companies have suffered because they did not take sufficient account of all parts of that chain, he noted. Latham added: 'Nike suffered a serious loss of reputation because they had not adequately investigated the companies who supplied them and it was too late when they discovered they were treating their workers badly.' SRI analysis is able to spot this kind of risk and help investors get out of a company before problems arise, said Latham.
But he stressed that investors can also use SRI analysis to spot opportunities in different industries. Latham said: 'The fuel cell industry is developing means of providing fuel for cars and homes, this environmental technology is still in the early stages of development but it has had an impact on share price. SRI analysis has helped enabled us to companies which produce them like Johnson Matthey.'
Zurich Scudder recently mandated research from Innovest, a research company that rates companies on environmental factors. It has a system, which rates companies from AAA to CCC using 60 to 80 variables to assess environmental performance. It has found that there is a strong empirical correlation between stock price performance and ethical performance, according to managing director of the recently set up UK operation, Simon Brown.
He claimed that there has been a sharp increase in the level of interest from the fund management industry. He said that Innovest had just landed a $185m mandate from one of the world's largest pension funds, ABP as well as the US fund manager T Rowe Price.
This emphasis on SRI resulting in good returns from performance was also stressed by Maytum at CIS. He pointed to successes in curbing excessive director remuneration as a good example of where having a socially aware, engaged attitude towards investment has had a positive impact on the management of a company. He reported that pressure from investors like CIS had a direct impact on getting Luc Van de Velde, the chief executive of Marks & Spencer, to postpone his performance related bonus. Similarly he argued that it was pressure from engaged investors that persuaded BSkyB to put properly independent non executive directors on its board.
Ian Pitfield, director at Phillips & Drew also sees a parallel between corporate governance and socially responsible investment. He said: 'SRI is at the stage now that corporate governance was a few years ago - there is not enough information available to make definitive judgements but investors are starting to ask companies questions.' Martin Clarke, CIS general manager, said that people's attitudes towards companies are just as important to SRI as performance. He said: 'SRI is not only an important part of our mainstream investment strategy to provide the best long-term returns for our policyholders, but also reflects their ethics and aspirations.' Maytum at CIS said that research it had carried out has shown that people are increasingly concerned about how the companies they invest in behave. He added: 'Of the people we interviewed, 20% wanted active screening of ethical companies while a further 51% wanted their investment to be used to lobby for improved business practices.'
Guy Jubb, corporate governance director at Standard Life Investments divides the SRI sector into three broad categories:
The ethical investment approach excludes companies which do not meet the client's ethical criteria. He said that there were difficulties in benchmarking and that investors have felt uneasy about excluding certain types of investment when they have the potential to produce very good returns.
The second way of running money is in a socially responsible way that Gubb defines as the sustainable investment approach. He stated that this involves investing in portfolios comprising only companies which are ˜best in class' when measured against a balanced scorecard of socially responsible issues. He argued that this sustainable investment is closely correlated with sustained outperformance in the long term. He said that this method of investment is relatively new and the introduction of the FTSE4Good index could be the catalyst to get more people interested in this type of investment.
The third method of SRI investment that Jubb outlined was the inclusive SRI portfolio approach. This form of investment does not exclude any category of company but encourages active engagement with companies. This form of engagement, he believes, will account for more and more mainstream investment in the future.
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