Hugh Ferrand describes recent developments in socially responsible investing and his own company's response to the challenge
UK trustees of pension funds are now required to incorporate their policy on socially responsible investing (SRI) in their Statement of Investment Principles (SIP). Pensions Minister Jeff Rooker has defined socially responsible companies as those "with sensible corporate governance policies, environmental policies, mission statements that respect the rights of workers - whatever country they operate in. Companies that welcome engagement by fund managers and provide the sort of information that will enable trustees and their agents to determine and verify factors that are important to them."
Using the markets to achieve social ends is very much in accordance with New Labour philosophy. The government's approach to SRI involves engagement, corporate governance, sustainability and the environment. It does not focus on negative screening. Rooker encourages trustees to adopt a positive stance towards SRI, as companies adopting progressive environmental, ethical and social standards are likely to perform well in the markets. He warns that trustees who ignore SRLmay fail in their fiduciary duties. Supporting SRI and implementing a corresponding policy are expected to limit the likelihood of legal action. However, the primary responsibility of trustees must lie with their fiduciary duties to pension scheme members and employers who incur the costs of managing the scheme.
Participating organisations
One of the leading promoters of SRI, the UK Social Investment Forum (SIF), defines it as combining "investors' financial objectives with their commitment to concerns such as social justice, economic development, peace, or a healthy environment". Managers seeking to achieve SRI may fall into four categories:
SIF expects many defined benefit schemes to adopt an engagement policy, with the results of this approach feeding into stock selection. The positive selection of certain stocks, where socially responsible criteria have been considered, will provide scheme members with both financial and non-financial performance benefits. However, the onus is on fund managers to prove in their investment process their support of the SRI policy outlined in the trustees' SIP.
Pensions Investment Research Consultants (PIR< provide a clear view of how closely companies are following best practice. Their approach to corporate social responsibility is based on monitoring five issues - environment, employment, human rights, community policy and corporate governance
The National Association of Pension Funds' (NAPF) Voting Issues Service (VIS) plans to extend its corporate governance service into an "engagement partnership". This service covers 350 UK companies and addresses environmental engagement and socially responsible issues.
Trustees' attitudes
The trustees of British Telecom's pension scheme were among the first to make public their propose amendments to the company's SIP. This now incoi porates its stance on SRI. The statement, outlined below, provides a useful benchmark for trustees. "The letters of appointment of every investment manager of the scheme instruct the appointee, in i investment policy, to consider the following when selecting the shares in which they invest the scheme's assets: a company run in the long-term interests of its shareholders will need to manage effectively relationships with its employees, suppliers and customers, to behave ethically and to have regard for the environment and society as a whole."
The letter of appointment also requests the fund manager to endeavour fully to exercise the voting rights associated with their shareholdings.
BT's announcement followed the Universities Superannuation Scheme's (USS) decision to commit itself to adopting an ethical, social and environmental investment policy. The USS aims to follow an active engagement policy in order to encourage corporate bodies to behave in a socially responsible manner. Ithas also decided to publish all of its holdings on its web site, implying that knowledge of individual holdings is the providence of the beneficiaries. It has also made two appointments to monitor how closely its managers are adhering to its SRI commitments.
The trustees of another large pension fund, on the other hand, have decided that, to achieve the best optimum return, they should not impose any restrictions on investment managers. In exercising their voting rights, the trustees require their fund managers to act in the best interests of shareholders and to be actively rather than passively involved.
More recently, trustees of the £2bn City of Edinburgh Pension Fund decided to pursue a policy of "constructive engagement". Lothian Pension Fund said its aim is to "promote corporate social responsibility among the companies in which it invests". The fund has requested four of its newly appointed fund managers to provide quarterly updates on their respective SRI strategies.
In general, trustees appear to have gone down the route of giving the responsibility for SRI considerations to their investment managers, but with the caveat that beneficiaries should not be penalised financially. Thus a typical SIP might read: "The trustees consider that it is appropriate for investment managers to take account of social, environmental and ethical considerations insofar as they believe such considerations will benefit performance and reduce risk. The trustees have given the investment manager full discretion in the selection, retention and realisation of investments."
It seems that the implications of adopting an SRI policy depend on a client's specific SRI strategy. Many trustees have signalled their intention to pursue some form of active engagement which incorporates screening for sustainability and environmental factors as part of their analytical research process. It is unlikely from this that the tracking error will rise as in the first WM study (see Performance). Our view is that engagement will ultimately lead to a clearer earnings picture.
INVESCO's approach
We prefer to work with our clients to implement their SRI policies. We believe that clients should respond in a spirit of openness and transparency as we think that the impetus for SRI will, with government encouragement, continue to grow. While a statement saying that "we have no policy" is acceptable in the short term, it is unlikely to be so down the line. We recommend working closely with fund managers so that the eventual policy does not claim to do something that the fund manager does not carry out, or force the fund manager to alter what may be an attractive process. SRI is likely to have a greater impact if there is a recognisable degree of commonality in the approaches adopted by trustees throughout the industry. Our current statement on corporate governance states that our voting policies have three main objectives:
As part of these objectives, we consider that good director stewardship should include, where appro priate, disclosing each company's environmental and social policy in its annual report. We look at the corporate governance policies of the companies in which we invest for clients.
In addition, we implicitly include SRI issues as part of the normal assessment of those factors likely to affect a share price. Our process incorporates rigorous screening of financial data and a qualitative assessment of non-quantifiable information. Management capabilities come under this category. We are interested in management which plans into the future, helping to ensure that cash flow and earnings are predictable. We want to avoid downward earnings revisions as a result of litigation or any action against the company.
As a part of this due diligence, we look for management which is aware of its responsibilities to society and the environment. Of all the qualitative factors we study, we regard an understanding of management objectives and principles as perhaps the most important. This current analysis of management, and therefore the sustainability of future earnings streams, will be enhanced and improved by engaging with companies on SRI issues.
Only companies that adopt good corporate governance structures and manage their business in a socially responsible manner are likely to secure the long-term financial future of their business.
As recent developments have demonstrated, the industry can expect to witness a general increase in voting among pension funds. This will also include voting on SRI issues, a trend which can already be seen taking shape in the recent BP Amoco and Rio Tinto shareholder resolutions. Our ultimate objective is to exercise voting rights more widely and across all countries for all funds. As a first step, we are implementing a consistent policy for UK
equity holdings. We have appointed a corporate governance officer who has reviewed our own voting service and will ensure consistent voting responses. We are in the process of selecting a proxy voting service that will streamline the process and ensure that issues which require detailed consideration are flagged well in advance. We expect this to enable us to cast our votes in an efficient, consistent and timely fashion. It will also systematise record keeping. We anticipate shortly to be voting electronically.
Going forward, we intend to record consideration of SRI issues in a more explicit fashion as part of the normal analytical process. There are a number of organisations such as PIRC (Corporate Social Responsibility Service), Manifest (Greencard Service), NAPF (Voting Issues Service) and EIRIS (Ethical Investment Research Service), all of whom provide research that will enable us to assess the economic, environmental and social sustainability of the companies in which we invest.
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Hugh Ferrand is director - UK institutional division, INVESCO Asset Management Ltd.
