Socially responsible investment has proved to be as kind to the wallet as it has to the world, since by definition it avoids much political, environmental and 'boardroom' risk
In the current uncertain financial climate, you might be forgiven for thinking those investors brave enough to get their cheque books out ought to only be concerned about the traditional bottom line of corporate financial performance. After all, against the current backdrop of increasing geopolitical tensions, now is not the time to be worrying about environmental or social concerns. In fact, industrials such as tobacco and mining have been among the best performing equity sectors during this bear run, while the understandable volatility in the oil price does not help general market stability.
Deepening the gloom, accounting scandals in the US and Europe have further damaged markets desperate for any positive newsflow. Forced selling of equities by insurers covering their liabilities have reinforced this downward spiral as institutional and retail investors sought safer havens. It was no surprise then that this year's individual savings account (Isa) season was a non-event. And again, you might be forgiven for thinking that socially responsible investment (SRI) funds would have fared particularly poorly, and that perhaps the SRI bubble of the late 1990s had burst.
high fund ratings
But you would be wrong. New evidence from the US Social Investment Forum has indicated that SRI mutual funds in North America have, on average, outperformed their mainstream counterparts. In fact, on average SRI funds in the US have achieved higher fund ratings than their conventional mainstream counterparts.
Despite the lengthy bear market, the percentage of SRI mutual funds earning the two highest marks from either Lipper or Morningstar actually increased by the end of 2002, according to new data from the US Social Investment Forum.
Nearly two-thirds of the SRI funds tracked by the Forum earned one of the two highest rankings for performance from the ratings agencies. This compared with the 63% of all such funds getting top marks during 2002. During the same period, of the largest 18 SRI funds (those with over $100m under management) 72% received top performance marks. This new research also indicated SRI funds were more successful in achieving performance ratings than their conventional counterparts.
Perhaps the most surprising finding of the research was that as the rest of the investment industry experienced considerable contraction, SRI funds actually grew. According to Lipper, SRI funds experienced net inflows of $1.5bn at a time when the rest of the retail investment market saw outflows of nearly $10.5bn.
In the UK, SRI funds under management as reported by fund providers themselves, remained relatively stable at around the £4bn mark between 2000 and the end of 2002. Being mainly equity funds, they were not immune from equity market downturns during this period, indicating that very healthy levels of net cash inflows continued during this period. Even with last year's dash-for-value, SRI fund performance has been respectable, with one SRI fund a huge 15% ahead of its mainstream sector average over the past two years.
But how has this been possible? Avoiding companies who are exposed to serious environmental or social risk is clearly part of the answer. But more recently this has been complemented by the more proactive corporate governance criteria of leading SRI practitioners.
Previously one of the least glamourous areas of fund management, corporate governance is now a popular subject in the world's financial centres as it is increasingly realised that boardroom risk equates to shareholder risk.
Shareholders in WorldCom, Enron, Tyco and Ahold will, with hindsight no doubt agree. Many leading SRI funds had screened out companies such as Enron and WorldCom, providing a significant driver to relative outperformance during 2002.
However the core area of avoiding environmental and social risk remains, with a number of geopolitical, strategic and regulatory factors set to have serious financial impacts in the shorter term.
Assuming that the current period of political instability in the Gulf region continues, company management and sector analysts need to consider the potential fall-out of exposure to political risk. This is particularly relevant to the oil sector, as extractive companies are increasingly forced to consider operating in more marginal and technologically difficult areas. For investors, the dangers of operating in such political hotspots have been demonstrated by repeated disruptions to US mining company Freeport McMoran's Grasberg site, to ExxonMobil's operations in Aceh, and to Talisman Energy's operations in Sudan.
BP's experiences clearly illustrate the nature of the problem. Two of its five new profit centres ' as outlined in a public strategy presentation in February ' will be established in Azerbaijan and Indonesia ' areas that are not new to issues of political risk. However, BP's approach does seem to be relatively rigorous, with an extensive engagement programme with local communities to ensure economic benefits are properly distributed among local populations.
Another area of social, environmental and therefore shareholder and fund risk is that of genetically modified (GM) foods. The EU and US are increasingly likely to come to blows over Europe's refusal to approve any new GM crops since 1998.
The US believes the policy has no substantive scientific foundation and is threatening to make a legal challenge though the World Trade Organisation. Though the US will probably wait until after the Iraq scenario is resolved, the subject will resurface later in the year when the EU finalises a new directive on the traceability and labelling of GM foods.
The US response will depend upon whether the core of anti-GM countries ' such as France, Denmark and Italy ' soften their position towards using GM seeds. Retailers and food producers will soon have to work towards meeting some of the requirements of the proposed GM labelling directive ' with potential liability implications.
Other environmental and social issues that will impact upon corporate profits over the next decade include climate change and increased clean air acts throughout Europe and North America, and directives on fuel efficiency and emissions.
Company management in the retail sector can continue to expect sharp focus from pressure groups and NGOs on areas such as supply-chain management, human rights and issues of Fair Trade. Even McDonald's has realised ' after posting its first ever corporate loss ' that issues of obesity and healthy eating must be reflected in the food served in its restaurants.
Rather than eroding the SRI message, the current geopolitical world order actually reinforces it. Investors, now more than ever, are seeking to minimise as much of the downside risk as possible.
From an SRI perspective, managing your governance, environmental and social risks is just part of being an effective and prudent management team trying to maximise shareholder value through a responsible business strategy that recognises more than just the latest set of short-term financial results. Why should it be any different in the so-called 'conventional' investment market?
On average socially responsible investment funds in the US have achieved higher fund ratings than their mainstream counterparts.
SRI funds experienced net inflows of $1.5bn at a time when the rest of the retail investment market saw outflows of nearly $10.5bn.
Rather than eroding the SRI message, the current geopolitical world order instead reinforces it.
Follows Asset Management Market Study
To open in second half of 2019
Regular reminders and updates
9 December 2019 deadline
Joe McDonnell joins as head of portfolio solutions (EMEA)