Good Honest Dollar $$

Few investors who entrust their money to fund managers of any form would want to see their funds directed toward companies which are complicit in terms of mass genocide in countries in which they operate.

In this regard, a March 26 announcement by TIAA-CREF, a large investment firm in America, that it is stepping up efforts to combat genocide in Darfur, represents a positive initiative which should be welcomed within the investment community.

 
The announcement 
Targeting five specific companies in which it holds stock, TIAA-CREF has demanded that the companies concerned:

(a) engage in constructive dialogue with the TIAA-CREF, in which the investment firm will encourage them to take proactive and meaningful steps toward the objective of eliminating genocide and suffering within the Darfur region; and

(b) demonstrate an acceptable level of achievement on an ongoing basis with respect to the above goal.

According to the announcement, the fund manager intends to divest itself of holdings in any of the target companies whose response is not satisfactory with respect to either step.

(The five firms being targeted are PetroChina, CPNC Hong Kong, Oil and Natural Gas Corporation, Sinopec and PETRONAS)

TIAA-CREF is not demanding that the firms in question necessary discontinue their operations in Sudan, although that is one option available for target firms that wish to avoid divestment.  As an alternative, target firms that wish to continue operations in the country can still avoid divestment by undertaking reasonable steps to ease the suffering of the Sudanese people.

 
Do companies take these requests seriously?
Apparently so.

Since 2006, TIAA-CREF has engaged twenty-two firms in discussions in order to encourage them to avoid any form of complicit support with respect to the genocidal Sudanese government.

These discussions have produced results – ten of the companies involved have since either ceased operations in Sudan or committed to appropriate humanitarian initiatives.

As a (nearly) $400billion financial services company, it appears that TIAA-CREF has quite an impact, and that its investee firms sit up and take notice when it makes demands about social responsibility.

 
Shouldn’t funds pressure companies to leave Sudan altogether?
I don’t think so, although there is a fair case for it.

On one hand, by continuing to operate in Sudan, and thus paying taxes (and no doubt bribes) to the Sudanese government, companies are effectively helping to fund a regime that sponsors genocide and other human rights abuses on an unbelievably massive scale.

By discontinuing operations, the companies concerned would no longer contribute funding to such an appalling regime.

On the other hand, it is difficult to see how leaving Sudan would help ease human suffering. After all, the regime is hardly likely to stop genocide just because a few companies discontinue operations, not to mention the plight of workers, who would suffer from loss of employment (admittedly a highly exploitative employment arrangement).

Rather than leaving the region, I would have thought that by undertaking humanitarian initiatives within the region, companies would have a more positive impact upon the lives of those who suffer from the appalling situation there. It is easy to see how programs to help improve education, health and water supplies have a direct positive impact upon the lives of people in Darfur.

In contrast, any benefit which the people of Darfur would derive from companies divesting in Sudan is less clear.

 
Summary
TIAA-CREF’s announcement represents a positive initiative in terms of the contribution of the global investment community toward the goal of eliminating genocide and suffering in Darfur, and should be warmly welcomed by the global investment community?

 
Over to you
Do you think fund managers should pressure companies in which they invest to cease operations in Sudan altogether? Or is requiring such firms to contribute toward humanitarian initiatives an even better idea?

(Image provided by Hugh Beauchamp)

This is the final post in the series on socially responsible investing (SRI).

Today, I would like to outline some basic principles as to how to actually go about becoming a socially responsible investor.

But before I get into that, let me stress two important points.

Firstly, I do not intend to provide a complete guide toward ethical investment – such a guide would be beyond the scope of this discussion and I intend to simply outline a few common sense basic principles. Readers are encouraged to add any thoughts of their own.

Second, I am not a qualified financial planner. As such, I cannot, and will not, recommend specific investment strategies, and the information presented here is intended for general discussion purposes only.

Indeed, this brings me to my first point:

  
• Consult a qualified financial planner.

For those with a substantial sum of money to invest, obtaining professional advice prior to making any form of investment decision is a prudent course of action.

Ethical investing is no exception – there are a considerable range of options available and your financial planner is in the best position to provide advice in relation to the strategies which are most appropriate for your individual circumstances.

In addition, should you choose to invest via an SRI fund, your financial adviser can also advise you as to which funds are considered to be the most reputable.

  
• Learn about ethical investing.

Notwithstanding the point above, conducting your own independent research is also a good idea.

In particular, you would want to gain a basic understanding in the following areas;

(1) Investing in general – how share, property and bond markets work, along with the basic workings of managed funds and retirement accounts.

(2) Ethical investment – the nature of ethical investment, the range of approaches available, and the workings of SRI funds.

(3) The corporate reputation of any prospective investee companies as well as any key ethical issues confronting the industry in which they operate (only relevant for those who purchase shares directly, as opposed to community investment or investment through an SRI fund).

  
• Determine your core ethical principles.

There are many, many issues which could be considered within the ethical investment process. Just to name a few, these could include – environmental management, labor rights, world poverty, legal compliance, corporate governance, technological advancement, legal justice, education, public health, transparency, corruption, war, political & religious freedom, product safety, resource management, ethical sales and marketing practices.

It is most unlikely that there are any investment options which satisfy every possible ethical issue, and therefore it is important to focus upon the core issues about which you feel most strongly.

My suggestion – choose five core issues and/or principles, and focus primarily upon these during the decision making process.

  
• Determine your ‘style’

One issue which will have an impact upon determining the approach which is most appropriate for you is your investment style  – in particular, your appetite for risk and whether or not you wish to take an active or passive approach toward the management of your investments.

Those who are most comfortable with a more passive approach, for example, may be best suited toward investing through as SRI fund. Community investing may also be an option.

In contrast, those wishing to take a more active approach may prefer to select their own investment portfolio via direct investments in the share, property or bond markets. Such investors may also consider becoming involved in some form of shareholder advocacy.

Finally, those with a particular burning passion, who are willing to undertake a considerable level of risk, may wish to invest their financial and/or time resources into some form of social entrepreneurial type project.

  
• Determine your financial goals, objectives, and priorities.

Ethical investment decisions must be consistent with two core items – your ethical investment priorities and your financial investment priorities.

Your financial priorities should guide your decisions in terms of determining an appropriate growth profile of prospective investments as well as an appropriate risk profile.

My suggestion – make a list of financial goals, for the next one, three and five years. Depending on your circumstances, it may be appropriate to set even longer term goals, particularly if you are in the process of planning for retirement. But I would think that five years would be an appropriate time horizon at a minimum for the majority of investments.

  
• Act.

Once the due diligence process is complete, it’s time to act, and to enjoy the satisfaction of knowing that however large or small, your investments are having a positive impact upon the world in which we live.

A desire on the part of investors for their money to be invested in a socially responsible fashion has fuelled exceptional growth rates within the Socially Responsible Investment (SRI) industry in recent years.

But can we actually verify that SRI funds are as ‘responsible’ as they claim?

Potentially not, commentators such as Paul Hawken claim, due to a lack of transparency within the industry, which they see as a serious impediment to informed decision making from prospective investors.

 
What does my fund invest in?

One of the key problems, according to Hawken, is a failure on behalf of many SRI funds to provide adequate disclosure about specific holdings within their portfolio.

The majority of funds explain the broad principles which they follow in relation to how ethical issues are taken into account during the investment selection process. However, many fail to provide specific details in relation to individual companies which are included within the portfolio.

As a result, prospective investors are unable to determine for themselves which specific companies these funds invest in. This, in turn, results in two adverse consequences:

• it makes it difficult for investors to determine with any degree of certainly whether or not such investments are compatible with their personal values; and

• it means that prospective investors have no way by which to verify or substantiate claims made by fund managers in relation to the overall social responsibility of the portfolio. 

This is particularly troublesome given industry criticisms that some funds are not as ethical as they claim. Such concerns have been heightened by the recent case of Pax World Management Corp., a well known SRI fund which was found by a recent SEC examination to have invested in ten securities which violated its own stated rules of avoiding firms in the defense, alcohol, gambling and tobacco industries.

 
Hawken’s Solution
In order to have sufficient information upon which to make informed decisions relating to the selection of SRI funds, Hawken believes that prospective investors should be able access the following information online:

• a complete listing of the entire holdings of the portfolio in question; and
• a thorough analysis of the strengths, impacts and weaknesses of each firm within the portfolio from an ethical perspective.

 
My viewpoint
With respect, the above recommendations go too far in my view.

I agree that SRI funds need to move toward greater transparency and accountability. I also agree that prospective investors need a greater degree of visibility in terms of the investment portfolio of SRI funds.

Nevertheless, the value of such information must be weighed against the cost involved in its provision. Furthermore, provision of the extensive information which Hawken proposes would be a costly exercise, particularly given the need to continually update such information on a very frequent basis to account for changes in holdings of the portfolio.

These expenses would be paid for by investors, and whilst I can appreciate the benefits of this level of disclosure, I do not believe that such benefits would be sufficient in order to justify the additional costs involved.

 
My alternative suggestion
In my view, a less extensive disclosure regime is appropriate, and SRI funds should not be required to disclose their entire holdings.

Instead, investors should be able to go online and view:

• a list of the thirty most significant firms within the portfolio; and
• a plain English summary of the strengths and weaknesses, from an ethical viewpoint, of the firms in question.

The list need not be up to the minute, but should be updated on a frequent, periodic basis.

The above disclosure, in my view, should be sufficient to enable investors to make informed choices about whether or not the fund in question satisfies their requirements from an ethical viewpoint, without imposing an excessive level of administrative requirements on behalf of the fund.

Let’s explode one myth right now – ethical investing does not generally result in sub standard financial returns, as often claimed.

That said, it does not necessarily improve investment performance either.

The relationship between ethical investment strategies and investment performance has been the subject of considerable research over the past twenty years. Naturally, different studies, using different methodologies and approaches, have produced differing results. (Click here for a summary of the most significant studies)

Nevertheless, the majority of studies support the conclusion that investing in a socially responsible fashion does not have any material impact – positive or negative – upon anticipated financial returns over the longer term.

 
The evidence
To be sure, there are some studies which do appear to indicate that SRI funds may underperform to a small extent relative to the broader investment market. One such study, conducted in my home country of Australia, measured the performance of eighty-nine ethical funds over a twenty year period from 1986 until 2005. The study found that on a risk adjusted basis, ethical funds underperformed the broader market by an average of approximately 0.88% per year over the twenty year period. (click here to view PDF abstract)

But these results must be balanced against other studies, which tell a more positive story. A UK study, for instance, by independent investment consultants Jewson Associates, found that “UK and global ethical investment funds outperformed the market over one, three and seven year periods.” (refer Financial Times report)

Furthermore, in 2002, an award winning Dutch paper, which analyzed investment returns over an eleven year period in Germany, the UK and the U.S, concluded that “there seems to be no statistically significant difference in returns between SRI funds and conventional funds.”

 
Are ethical funds more risky?
However, the UK report mentioned above indicated that ethical funds carry a slightly greater amount of volatility and a higher risk profile when compared to conventional funds.

The primary reasons for this are two-fold. First, ethical funds tend to invest more heavily in smaller companies, particularly those which offer promising new technologies. Second, ethical funds tend to avoid some sectors which are considered to be ‘defensive’ such as the oil industry.

This would appear to make logical sense, and one could see why ethical funds may carry slightly greater risk than conventional funds for these reasons.

Paradoxically, Professor Bauer, who conducted the Dutch study mentioned above, observes that ‘SRI funds seem to be a little less risky than conventional funds.” (No reason for this observation was given in the article which I read)

Accordingly, whilst ethical funds would appear to be more risky, agreement as to whether this is indeed the case is not uniform.

 
What does all this mean?
When it all boils down to it, the overwhelming majority of historical evidence suggests that ethical funds offer competitive investment performance when compared to their non-ethical counterparts.

Contrary to the assertions of many critics, ethical investment strategies in general appear to have little if any impact upon anticipated investment performance – either positive or negative.

Investors who wish to consider SRI funds can do so comfortably in the knowledge that such an approach does not generally diminish anticipated financial returns.

Ethical Investment Anyone?

Is it possible to invest ethically in casino operators, tobacco manufacturers, weapons manufacturers, fast food chains or makers of alcoholic beverages?

One school of thought says no – given the negative social impact of the operations of such firms, it is impossible for funds directed toward them to constitute socially responsible investments.

But another school of thought adopts a different perspective, and instead selects ethical investments based on a ‘best of sector’ approach.

Those who favor such an approach typically would not exclude firms in the above industries altogether. Instead, they would consider only the best (or least worst) behaved firms from such sectors.

A fast food chain, for example, may be considered if the firm in question has taken proactive measures to promote public health – such as the introduction of healthier menu options, the elimination of harmful ingredients from recipes and the sponsorship of health education programs.

So too might a manufacturer of alcoholic beverages which had been active in the promotion of responsible drinking behavior and/or taken measures to reduce the alcoholic content of its beverages.

 
Introducing the ‘Best of sector’ approach
Under the more traditional approach toward the construction of socially responsible investment portfolios, investors or fund managers seek to specifically include stocks from industries whose impact is considered to be positive from a social or environmental standpoint and/or specifically exclude those whose impact is considered to be negative.

In contrast, under a best of sector approach, fund managers typically select companies from a broad range of industries or sectors, sometimes regardless of the social impact of the industry or sector concerned. Instead, investment selections are restricted to individual firms whose corporate reputation is amongst the best within their industry or sector.

Under this approach, the critical factor which determines the suitability of an individual firm for inclusion in the portfolio is not so much the sector in which it operates, but rather the firm’s individual performance relative to its peers within the same industry.

 
The key advantage of  the ‘best of sector’ approach
The key advantage of the best of sector approach is that it provides an incentive for individual firms across all sectors to improve ethical performance, regardless of the industry or sector in which they operate.

Any industry, any sector – firms which adopt the most responsible corporate behavior are candidates to attract the ethical investment dollar – and the resultant benefits in capital markets (refer post).

Investors who adopt this approach believe that positive corporate behavior should be rewarded across all industries, not only those which are favored by the traditional SRI approach.

 
Arguments against
In my view, there are two key arguments against this approach:

• Any investment dollars which are allocated toward industries whose social impact is negative help to stimulate growth of such industries – not a desirable outcome no matter which firm is involved.

• Firms which are not sufficiently motivated to adopt positive corporate behavior due to other factors (e.g. public relations, government regulations) are unlikely to do so simply to appease the ethical investment community.

  
So, which approach is best?
In my view, the optimal approach toward SRI would involve a combination of the more traditional selection process as well as the best of sector approach.

Ethical investment portfolios should certainly be weighted to some extent so that more weight is given to industries or sectors whose social impact is positive, with less weight given to those whose impact is negative.

However, the performance of individual firms relative to their sector should also be considered, and any firms which demonstrate a proactive approach toward mitigating any negative social impact from their operations need not be excluded from SRI portfolios altogether.

Nevertheless, I do believe there are some industries where no particular firm has demonstrated sufficient behavior to warrant inclusion in SRI portfolios. These include the tobacco industry and the worst parts of the adult entertainment industry.

Firms in such industries have no place in SRI portfolios.