Discovering the true value of SRI

In April 2010 an explosion on the Deepwater Horizon oil rig in the Gulf of Mexico claimed 11 lives and generated the worst oil spill in US history. It also decimated BP, the company operating it. Between April and June the oil giant saw more than 50% of its value wiped out and costs for the clean-up operation stood at $2.3bn (£1.57bn), in addition to a fund of $20bn (£13.5bn) set aside to compensate victims of the disaster.

BP’s corporate reputation will take years to recover but it wasn't the only company affected. Pension funds all over the world had huge sums invested in the multinational business, on the back of rising expectations of another surge in oil prices. The incident highlighted not only the reputational damage that can be done to companies and fund managers that fail to conduct thorough due diligence on the businesses in which they invest, but also the possible financial consequences.

“If anything positive is to come of the current environmental crisis in the Gulf of Mexico, it must surely be further support for the integration of environmental, social and governance risks in company analysis and investment decisions,” says Barbara Evans, sustainability research analyst at RCM. “Reward should not be based on delivery at any cost.”

While Deepwater Horizon has brought the whole issue of socially responsible investment (SRI) into sharper focus, pressure on fund owners and managers has been growing for several years through government legislation, scheme members and a greater focus on reputational risk by companies.

A recent survey by Allianz Global Investors found a majority of European pension experts viewed public opinion as the single biggest driver, with reputational risk also a major issue.

The economic downturn has also furthered the cause for SRI by highlighting the need for responsible business practices. “It has brought industry attention to the issue of corporate governance and the role of shareholders in engaging with and challenging company management,” says Will Oulton, head of responsible investment at Mercer.

In the UK, the debate around the process of active ownership and prudent stewardship of assets is currently being debated through the Financial Reporting Council’s consultation on a “stewardship code” for institutional investors.

“Asset owners and investment managers have actually increased their commitment to SRI and sus-tainability investing in the wake of the financial crisis,” says Evans.

She points to the results of a 2009 UN Principles for Responsible Investment report, which found that not only had the number of signatories risen from 381 in 2008 to 560 in 2009, but that they were also more active in integrating such research into investment decision-making.

Interest in purely sustainable initiatives has suffered, however, says Gerhard Wagner, senior port-folio manager at Swisscanto. “The recent financial crisis was, as we know, a debt crisis,” he says. “A significant number of sustainable investments such as wind farms are financed with debt and, since this became more difficult to obtain, demand has suffered.”
The options available to pension funds and asset managers in terms of SRI have broadened considerably over the past decade. “Ten years ago it tended to focus on ethical investment, which was all about excluding certain sectors with which people weren’t happy, such as tobacco, gambling or armaments,” says Amanda Young, SRI officer at Newton Investment Management.

Now, businesses can choose to invest in dedicated funds which specialise in energy, water or agricultural conservation or only back organisations with a strong record in the area of corporate and social responsibility. Others may take more of an activist approach, says Young, and invest in those that have underperformed in this area up to now with the hope of influencing their future strategy.

“Socially responsible investing is not, and cannot be, the main target for trustees,” says Chris Armitage, head of UK at FourWinds Capital Management. “But we see it as an additional, not a substitute, investment tool. While undertaking due diligence on companies it makes sense to search out those with best practice initiatives in employee welfare and conditions, risk control and environmental concerns.

Good, well run businesses are more likely to enhance portfolio returns in the long run.”

Young says such a wide variety of options means it is impossible to generalise as to whether funds with a socially responsible element tend to fare better or worse than more conventional options. But a study
by Mercer in November 2009 found that specific environmental, social and corporate governance factors had a positive impact on portfolio returns in 10 out of 16 cases, with four showing a neutral relationship and only two compared negatively.

A separate report by risklab in November 2009 suggested that focusing on environmental, social and corporate governance issues can significantly reduce portfolio risk and also lead to enhanced returns. “This can be achieved by choosing equity investments where corporate management proactively mitigates these risk factors,” says Evans.

There is, however, more that can be done by the majority of pension funds and managers. “The largest and most sophisticated schemes are making socially responsible issues more of a priority but the majority of schemes are only willing to meet their compliance requirements and are currently still box-ticking,” says George Latham, head of sustainable and responsible investment funds at Henderson Global Investors. “A large proportion of the industry needs to catch up.”

There are also considerable variations throughout Europe. A survey by Allianz Global Investors found that a majority (60%) of pensions analysts believed SRI would play more of a part in their decisions in the future. But this hid huge regional variations, ranging from 90% in France and 80% in Italy, down to 54% in Germany and just 46% in Switzerland.

“The market for SRI has grown much faster in the countries where government agencies have taken a lead such as the Fonds de Réserve pour les Retraites in France, APG in the Netherlands and the Norwegian government fund,” says Latham. “There has also been more pan-European co-ordination through Eurosif and policy coming out of Brussels. The activity and momentum is currently focused in the north of Europe, with the south lagging a fair way behind.”

Other trends are emerging which may be of interest to fund owners and managers. In April, STOXX launched its Europe Christian index with the aim of allowing clients to invest according to their religious beliefs. “We don’t think that this is a flavour-of-the-week type of trend, but a new way of looking at investing, which a growing group of investors seems to favour,” says Hartmut Graf, chief executive officer.

Mercer, meanwhile, highlights environmental-themed strategies as a growth area for the future. “There is an increasing interest around sectors such as energy efficiency, water infrastructure and renewable energy,” says Oulton. “There is also a significant amount of research being undertaken on the investment opportunities potential arising from eco-systems, which includes areas such as forestry.”

Whether pension funds and managers act out of a newfound sense of moral accountability, as a response to public pressure or simply to make the biggest returns in a more secure framework, there can be little doubt that socially responsible investment is here to stay. Those that continue to ignore it will not only miss out on excellent investment opportunities but could also find themselves tarred with the same slicky, oil-tainted brush that is currently smearing BP’s reputation.

“Environmental and social issues have the potential to have a dispro-portionate effect on the reputation of a company,” concludes Young. "On a bit of paper these issues don't look so extreme but they can have a disproportionate effect on a company’s ability to operate and its reputation. You can’t ignore them.”

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