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Can We as Investors Make a Difference?

At the Social Enterprise Conference on March 4th, Peter Kinder, President of KLD Research & Analytics and Cheryl Smith, Executive Vice President and Senior Portfolio Manager at Trillium Asset Management shared their insights on Socially Responsible Investing (SRI).

Peter Kinder defines Socially Responsible Investing (SRI) as the “incorporation of ethical, religious, social and moral values in investment decision making.” It is based on a human impulse-the desire for consistency. It begs the question “why own something that’s inconsistent with your values?.” Kinder cited the LA Times article which criticized the Gates foundation for investing in companies ranked as top U.S. pollutants. The article highlighted inconsistencies between the healthcare aspirations of the Gates foundation to mitigate health problems in the Nigerian Delta and the foundation’s investment in an oil company contributing to pollution in the region. Is there a problem when 5% of assets used for charitable endeavors are funded by 95% of investments which support companies that violate environmental guidelines? Kinder asks, what does it imply when 95% of assets are “undoing” the good done by the 5%?

Although SRI has not reached the mainstream mutual fund offerings, the movement is gaining new ground. Cheryl Smith shared the evolution of SRI from its roots 35 years ago when the movement began to address concerns about apartheid in South Africa. At its early stage, SRI was exclusionary-screening companies involved in producing weapons and tobacco, and operating in countries with questionable human rights practices. The focus was on removing companies that did not fit socially responsible values. SRI evolved to become more inclusive, searching for positive attributes from companies during peace time, thus addressing concerns such as the environment and employment diversity. Later, the movement extended to shareholder advocacy-using the voice of investors for constructive engagement to produce meaningful changes in the way companies operate. Much of the improvement in public company disclosure could be attributed to these efforts. Companies are now more transparent about their equal employment opportunity policies. They also improved consistency in reporting results from global operations and provide details on sustainable sources of inputs in their production process.

The audience erupted in laughter as Peter Kinder shared: “the first activist investor was not KKR, it was a nun”. Kinder expects the renewed interest in global warming to continue to spur the growth in SRI. As well, the inclusion of environmental and social impact as risk factors in the UN’s Environmental Finance Initiative decision making process is a triumph for SRI.

So what’s the catch? How much do we have to give up in order to “do good”? Do investors necessarily have to give up returns?

Cheryl Smith emphatically says, “No”. Experience has shown that SRI funds, which use social screening and activism, have performed competitively against their benchmarks over long periods of time. SRI funds have been negatively portrayed in the press for underperforming because several news sources lump together results from multiple SRI funds to calculate a “blended SRI return” which they then compare to the broader market index. Smith argues that this exercise is certain to mislead investors as returns are naturally dominated by the investment style, and SRI funds using a certain strategy (i.e. value/growth, market cap) have to be measured against comparable indexes.

Other critics point to the limited universe of stocks passing socially responsible criteria as a possible contributor to underperformance. Smith likens this to playing with half a card deck. Her solution: “Well then, we’ll throw away the 2’s and keep the best cards”. Smith explains that companies who have evaluated the environmental impact of their projects have found this improved their competitive advantage. In addition, companies who treat workers well have experienced less turnover and less equipment sabotage. Outsourcing to Sri Lanka had reputational risk for companies as customers avoided purchasing products made from the region. Smith reiterates that SRI’s goals are not an “either/or”, it is viewed as “above/and”-that is, earning above a competitive return and providing socially beneficial outcome.

So why aren’t SRI funds more available? SRI has largely targeted high net worth individuals because there is insufficient demand from large mutual fund complexes. Peter Kinder encourages retail investors to demand SRI products as investment consultants and institutions respond to consumer demand. Marketing expenses are a huge drag on performance, especially for smaller funds that do not have the scale and it’s up to us as retail investors to drive the change.

March 26, 2007
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