SRI managers use various strategies to select companies that meet their ethical criteria, but by targeting companies that do not come up to scratch, managers themselves could act as agents for change
Although global markets have been experiencing some of the worst performance seen in the last 30 years, the conditions for increasing the assets managed in socially responsible investment funds would seem to be extremely favourable.
For its part, the government has been encouraging investors to embrace the socially responsible investments (SRI) market while at the same time encouraging companies to improve their environmental and social reporting. In 2000, the pensions legislation urged all pension funds which were administered by a board of trustees to offer an SRI option to their members. It seems that more than half of such funds have now introduced this option. Subsequently, Prime Minister Tony Blair introduced an element of moral persuasion to encourage all the largest UK companies to compile and publish a report on their social and environmental targets and activities.
drivers for change
The movement to achieve greater clarity in corporate disclosure was taken up by the European Commission which published its Green Paper on Corporate Social Responsibility (CSR) in July 2001, later reissued as a White Paper. The French authorities have gone one step further by insisting that all large companies in the benchmark CAC Index publish a report on their social and environmental activities in the near future. Other European governments are contemplating similar legislation but this has yet to be introduced. These developments are 'positive' catalysts for change and support an expanded market for SRI through the dissemination of better information to investors.
However, perhaps some of the most important drivers for change could be categorised as 'negative.' Included in this field are the revelations of manipulation and accounting fraud which have overwhelmed WorldCom and other major global companies, and begged the question 'for whose benefit were these companies being managed?' The need for honesty in operating procedures and clarity in reporting of operations and earnings has been gaining great prominence since the revelations of fraud first hit the press and created the impression that many firms considered the 'off balance sheet' methods employed to be legitimate practice.This will undoubtedly change.
The combination of this negative wall of corporate news, coming at the same time as the market as a whole was trying to digest the impact of the collapse in global growth and earnings, dealt confidence a serious blow and has probably turned many private investors who joined the bull market of the 1980s and 1990s away from stocks and shares for good.
The terrorist attacks of September 2001 were another factor which has contributed to a change of view of the investment markets and what they should be seeking to achieve. WorldCom and other companies with similar accounting irregularities have focused attention on corporate governance, with respect to board composition as well as management and reporting procedures. Good corporate governance is essential to the rebuilding of investor confidence and time will be required for this to be achieved. These issues are germane to the analysis conducted by SRI portfolio managers.
SRI managers have followed various strategies to select companies which will meet their criteria: some use an exclusionary process focusing on negative screening ' removing those companies which are involved, for example, in the production of tobacco, alcohol or nuclear weapons. Others will look for positive aspects in corporate behaviour such as community involvement or charitable giving. A third approach will consider each industrial sector in some detail and select the best representative (best of sector) while another manager will invest a portfolio on its fundamental (financial) merits alone and then assess the constituent's quality in SRI terms, raising issues with company management where they assess the company falls short of best practice.
This is the 'engagement' approach. Within these categories there will also be sub-categories where the manager may focus on a specific aspect when making their investments such as 'the environment' or 'corporate sustainability.' The latter researches all a company's activities to calculate the long-term impact on individuals and the environment, and will focus investments on companies which will have a positive impact, or, failing that, the smallest negative impact. All these approaches involve a degree of 'corporate activism' in the sense of contacting a company, building a relationship with management and using that relationship to encourage change in the corporation's philosophy or processes.
SRI investment has been greatly helped by companies that embrace the need for fuller reporting, particularly those which have produced corporate social responsibility (CSR) reports. The mere fact a company produces a CSR report indicates that it has taken the trouble to document its social and environmental impact. You can have confidence that management take the issues seriously and are intent on improving their conduct.
The CSR report will also provide useful information to stimulate a deeper dialogue with the company and provide a broader range of topics which can be explored. In most cases these reports will be the outcome of a positive decision by management to adopt a tool which can enhance their control of a company, but in a minority of cases it will be used as a means to keep the new army of SRI analysts at bay.
Over the past two years SRI investors have been subject to the collapse in growth stocks since most SRI portfolios had an overweight exposure to growth stocks to counterbalance the underweight in 'old economy' dirty or heavy industrial companies. Growth companies, including technology and telecom groups generated strong returns prior to their collapse in 2001. With the shift in performance to value stocks, and certain defensive companies such as tobacco and alcohol, the pressure increased on SRI investors. Portfolios had to be restructured to avoid the damage of the technology collapse and the thrust of this move was into cyclical companies which would respond to the improvement in the global economy. This is the strategy which investors have adopted in recent months.
Since the beginning of 2003, the war in Iraq and more recently, the outbreak of the severe acute respiratory syndrome (SARS) which has spread from China to North America and Europe, have disrupted global travel and are expected to impact growth by as much as 0.5% to 1% this year. This will delay once more a recovery in the fortunes of 'growth' companies but there were signs that investors were beginning to sense this recovery coming through in the first quarter of 2003.
In the future there will be more changes which favour SRI investors. Corporate policy is being perceived in terms potential risk and risk can be mitigated by focus on corporate conduct via CSR policies. CSR is bound up with definitions of corporate sustainability. So managers are approaching the issues from a variety of angles. Ultimately, we believe we are seeking companies which have strong fundamentals and are well managed, whichever way we conduct our screens.
Perhaps the way of the future then will be to move away from an investment process which screens out companies on negative grounds to a process which focuses on the best-managed, and fundamentally sound companies and then considers how these companies stack up in terms of their social and environmental record. Thus, the key feature in the SRI process will shift to engagement or corporate activism. We believe this is the way forward ' we must be invested in a company to be in the position to initiate change. If you turn your back on the company and disinvest, you can no longer be an agent for change.
We invest across the broadest range of companies available but then assess those companies to see which have strong environmental, social and human rights policies. Those companies which fall short of our mean will become targets for engagement in a systematic process. This process will be logical to investors as it will be to investee companies. We believe this can achieve results and initiate change. And this is what we are about.
The case for socially responsible investment has been driven by both positive and negative catalysts.
SRI investment has been greatly helped by companies that have produced corporate social responsibility reports.
Going forward there may be a move away from screening out the negatives, to investing in the positives and then instigating changes from within.
Joined as head of strategy, multi asset, in June
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