Does SRI Pay?

A number of recent regulatory initiatives are going to force businesses to look social and environmental issues straight in the eye. To lag behind competitors could be perilous, as socially responsible investment (SRI) may develop from an undercurrent into a critical investment process.

In the early 1980s when the first ethical fund was launched by Friends Provident, industry commentators were dismissive and expected the market to be saturated at £500m. Figures released in August 2001 by EIRIS, the independent ethical investment research service, showed that there are now 60 SRI funds to choose from, representing £4bn funds under management. Almost all UK fund managers have had to consider the environmental and social impacts of the companies that they have invested in and many have recruited green teams.

Focus has often fallen on the perceived under-performance of SRI funds, on the basis that they do not invest in the entire index of companies. But SRI specialists argue that, in selecting companies that take environmental and social risks seriously, they are choosing those that are best placed to grow.

Bozena Jankowska, head of SRI research at Dresdner RCM Global Investors, believes that companies must have an effective corporate social responsibility (CSR) strategy in place, as the growth in public knowledge of social issues has heightened investors’ awareness.

To minimise risk, it is important that companies are transparent and are able to respond quickly to events, avoiding last minute panics. Toby Belsom, SRI analyst at Morley Fund Management, believes that companies must be proactive in protecting their brand value. For example, Cadbury Schweppes was recently associated with poor working conditions in west Africa, with resulting bad publicity. Luckily for the group, the effect did not snowball - but it did threaten the brand.

Increasing value
Examples of mismanagement of social issues leading to plunging share prices are two-a-penny, but does it pay to manage these issues well? There are growing seedlings of research to indicate that companies who go beyond compliance can indeed harvest higher returns. Belsom points to a study by management consultants and think-tank SustainAbility. He explains: “The research found that environmentally superior products can lead to increased shareholder value by differentiating products and developing and strengthening customer loyalty for those brands.

UK retailer Iceland has been cited as an example of a company whose wide-ranging and sometimes high risk environmental initiatives saw its share price grow by 400% over four years. However, mainstream analysts are yet to be convinced. A survey by Business in the Environment (BiE) last year found that only 3% of City analysts believe that social and environmental issues are significant in a company’s performance figures.

The tide is about to turn, according to Ted Scott, director of the Stewardship Funds at Friends Ivory and Sime. Scott says: “At the moment there is a lack of general awareness. There is a key gap in boardroom meetings with mainstream analysts. Social issues are not raised, even though some companies pile resources into environmental programmes.

However, he stresses that CSR will come under the spotlight in the UK, subsequent to the legislation of July 2000, which required trustees of pension funds to disclose to what extent, if any, they took account of social responsibility considerations in their investment strategy. This was followed by investment guidelines drawn up by the Association of British Insurers (ABI), asking to see social and environmental policy in company annual reports.

Scott continues: “The ABI covers half the investment market. This means that all companies are taking this extremely seriously.” But he admits that at present it is difficult to see that CSR has an effect on share price performance inside individual sectors. “For a stock analyst an important factor for BP is the price of oil but, with mandatory reporting, the difference in shareholder value will clearly be seen between BP and say Shell.

It does not seem that those investing ethically are losing out. According to figures from Standard and Poor’s as at 1 December 2001, the three month percentage change for UK ethical and ecological unit trusts and OEICS was -2.40 compared to the FTSE all share at -2.41. However, analysts must struggle with inadequate data because of the subjective nature of ethical funds.

How green?
Such funds can be categorised as light green or dark green, with the older dark green funds only investing in the most ethically sound companies and the lighter green taking a more progressive stance. Charlie Thomas, assistant fund manager overseeing SRI funds at Jupiter Asset Management, says that he takes two approaches.

“Our Ecology Fund, mainly holds companies that will benefit from international environmental legislation. An example of this is a Canadian company, Ballard Power Systems, which is researching the development of fuel cells to enable cars to run on hydrogen. Secondly, there is a best in class within each sector - an approach we use predominantly in our Environmental Opportunities Fund. We pick stocks such as CGNU, Abbey National and Vodafone, which have environmental issues high on their agenda.

A key development in plugging the gap of performance measurement was the launch last year of the FTSE4Good index. But criticism has been levelled at the FTSE4Good, as it focuses on companies’ management processes and policies, rather than outcomes. Scott comments: “Ethical funds’ negative screening leads them to exclude many larger companies such as most pharmaceutical and financial services companies as well as major polluters. The FTSE4Good does not.”

Emma Howard Boyd, head of Jupiter’s environmental research unit, sits on the advisory committee for the FTSE4Good and is keen to stress that the new index is not set in stone. “Part of what we are doing is developing the criteria for the index. These are going to change over time from policy-related issues to performance. Companies are going to be warned about any changes they need to make to satisfy the CSR criteria to stay in the index.”

While most fund managers agree that it is difficult to link positive environmental processes with higher profits despite increasing empirical evidence, a more probing political, legal and social environment may make it difficult to brush these issues under the carpet. Such trends may well transform environmental issues from relatively minor factors in corporate decision making to ones that are integral to competitiveness in the 21st century.

Fiona Dunlop is a freelance journalist

EUROPEAN INITIATIVE
November 2001 saw the launch of Eurosif, the European Sustainable and Responsible Investment Forum, at the EU Belgian Presidency Conference on Corporate Social Responsibility in Brussels. Eurosif is a pan-European network for promoting and developing SRI. Its creation was driven by the growth of interest in SRI across Europe.

Eurosif is an initiative of five European Social Investment Forums (SIFs) from France, the German speaking countries, Italy, the Netherlands and the UK, with strong support from the EU. Founding members range from investment institutions to research providers. It aims to promote the development and convergence of SRI across Europe.

Specifically, it intends to: