Rachel Crossley discusses the progress made in the field of socially responsible investment and how fund management groups can work alongside companies towards the introduction of more socially aware working practices
Just over a year has passed since a new regulation came into force requiring all occupational pension funds to disclose in their Statement of Investment Principles, 'the extent to which, if at all, social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments'.
Although this change to the regulation does not directly affect investments such as unit trusts and Isas, it has caused a ripple effect, spreading an interest in Socially Responsible Investment (SRI) across all product areas. As a result, according to Hindsight, there are now 101 different ethical funds from which to choose, with a total value of £3.8bn (EIRIS, 2001).
The term ethical investment is generally used to describe funds that use negative and positive screens to determine which companies to exclude from their investment portfolios, such as those that produce or sell tobacco or military and nuclear products or that use animal testing. The first such product, the Stewardship fund, launched in 1984 by Friends Provident, now has around £1.3bn in funds under management.
Over the past couple of years, several new types of ethical funds have evolved, which offer investors more choice. The term socially responsible investment is now commonly used, as it reflects the fact that these funds also take into account environmental and social issues in their investment strategy. Today, SRI is one of the fastest growing and most exciting segments of the market.
Investing with principles
Some 51 of the 100 largest global economies are now multinational corporations; only 49 are countries. With business taking on the leading role in the world economy, parliamentarians, the media, the public, pressure groups, academia and investors ' almost everyone in fact ' are beginning to demand that businesses do more to reduce their environmental impacts and improve the contribution that they make to society.
As a consequence, investors are starting to ask for investment products that allow them to take these concerns into account in their investment decisions.
Many recent studies show that companies can do well by doing good. Thus, by extension, investing in the most socially responsible companies yields good financial returns. Conversely, ignoring environmental and social issues can be disastrous for a company's reputation and have an immediate damaging impact on the bottom line.
Examples of this are widespread. Serious misjudgements by Monsanto killed the company's ambitions in the genetic modification game and brought it to its knees financially. The share price of Talisman Energy, a Canadian Oil company, fell 15% following allegations of involvement in human rights violations in Sudan. In the UK, Railtrack's recent share collapse underlines why business must take its broader social responsibilities seriously.
Several ethical indices have recently been launched, which builds on the belief and experience that more responsible companies perform better financially. The FTSE4Good Index, launched in July 2001, is the first index that selects its constituents based solely on their social responsibility. Close Brothers has launched a passive retail fund based on the FTSE4Good index and others are expected to follow suit. The popularity of other indices, such as the Dow Jones Global Sustainability Index and the Arese 'ASPI Eurozone', all demonstrate the growing global interest in SRI.
One of the most significant developments in the SRI world of late is the availability of funds taking a very different approach to screening ' that of engagement. Engagement simply means entering into a constructive dialogue with companies in which a fund invests, in order to encourage the company to more effectively address its environmental and social impacts.
Fund managers will typically meet with company management to raise concerns about how they address critical issues such as climate change, human rights, sweatshops or forestry. Bad management of these issues can be a major risk to corporate reputations and their future success. They will also make recommendations to companies on ways of reducing their environmental and social impacts and risks. Some fund managers have also made commitments to use their votes at AGMs to strengthen their messages on these issues.
Engagement can be used as a complementary strategy to screening. For example, funds can first screen companies out of portfolios using traditional screens and then engage with those companies allowed into the portfolios. Alternatively, engagement can be used as the fund's primary means of achieving its socially responsible investment objectives. The Stewardship funds, for example, operate a very extensive range of strict traditional screens but also engage with companies that are held in the portfolios.
Some are understandably sceptical about the effectiveness of engagement. Will companies really listen to investors and be willing to make the changes that they recommend?
In 2000, Friends Ivory & Sime announced that it would apply its socially responsible investment policy to all of the group's equity investments, currently totalling around £16bn. The engagement approach has had a number of notable successes, demonstrating the benefits of engagement as either a stand-alone or complementary SRI investment strategy. The company has a team of 10 professionals in its Governance and Socially Responsible Investment Team. It is their job to engage with companies on five different engagement programmes: human rights, labour standards, climate change, environmental management and reporting and forestry.
On labour standards issues, Friends Ivory & Sime has engaged with companies in the clothing sector. In November 1999, it wrote to 11 clothing retailers requesting information about the ethical standards they set for the factories they source from around the world.
Of the initial 11 companies, only three that wrote back had a Code of Conduct covering issues such as child labour and working conditions that we judged to meet established best practice standards. The rest had inadequate practices in this area.
However, as a result of discussions between Friends Ivory & Sime and those companies over the following year, the other seven companies have significantly improved their approach to these issues by introducing Board-approved Codes of Conduct or doing ethical audits of the factories from which they source.
One company in particular, Peacocks, a clothing and home textile company with 300 stores in the UK, has worked closely with Friends Ivory & Sime to improve its policy on labour standards and working conditions in the thousands of factories it sources from around the world. The company has adopted a formal policy on pursuing more ethical sourcing and has trained its buyers to check that factories are complying with these standards.
George Cruickshanks, quality assurance manager for Peacocks, said that as a result of policies Friends Ivory & Sime helped develop, his company has not had to terminate any relationships with its suppliers. 'This work has given us a more focused and detailed approach to all of the issues contained within ethical sourcing,' said Cruickshanks, 'such as enabling us to question suppliers on working hours, rates of pay and conditions, and not just the more easily recognisable issues such as child labour.'
SRI is an exciting and rapidly growing segment of the investment market. A number of surveys have shown that customers increasingly want to be able to take social and environmental issues into account in their investment choices.
Customers can now choose from a wide range of funds that offer traditional ethical screening, engagement, or both. Engagement offers a particularly positive and effective way of enabling investors to pursue their oft-stated desire to 'make a difference' through their investments.
SRI also has a financial upside. Through engagement with companies, investment houses can protect and enhance the value of their customers' investments. Gaining insight into more than just a company's financial performance can enable houses to identify the potential environmental and social risks that they face early and then advise them on better ways of managing those risks.
• Ethical investment usually means funds that use negative and positive screens to exclude companies from their portfolio.
• 51 of the 100 largest global economies are now multinational corporations.
• Several ethical indices have recently been launched, including the FTSE4Good.
Head of UK intermediary distribution
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