SRI is more than just a fair-weather strategy
Environmental, social and governance issues more important in downturn
The decision by Calstrs, the $169bn (€109bn) California teachers’ pension fund, to consider allowing tobacco stocks back into its portfolios after shunning them for eight years suggests socially responsible approaches to investment may be threatened by an economic downturn.
In the benign markets of the past half-decade, an impressive job has been done of heightening the profile of socially responsible investing and introducing it into institutional mandates. Climate change and demographic trends have become widely accepted orthodoxies even in the US and China, which arguably have the most to lose by accepting these problems need to be tackled.
The US Census Bureau estimates the world’s population will grow 50% to nine billion by 2042, increasing pressure on natural resources such as water, energy and food and resulting in a dramatically different profile of consumption preferences: few would argue that this is unlikely to impact long-term investment returns.
But while many have bought into the strategic case for SRI, Calstrs’ swing towards tobacco shows that, in harsh economic conditions, SRI considerations may be mutually exclusive to the fiduciary duties of pension fund trustees. Calstrs estimates its anti-tobacco stance cost the fund $1bn in potential returns. As so often with institutional investment, long and short-term aims can become misaligned.
Jane Goodland, investment consultant at Watson Wyatt, said that for investors, there is no evidence that SRI considerations will fall by the wayside: “Sustainable investing is a long-term investment theme, regardless of where we are in the economic cycle. In a downturn, risk awareness is heightened, including business risks arising from sustainability issues.”
Research by Julie Hudson, analyst at UBS, suggests the SRI sector could shrink in the short term as “firms under pressure may go into survival mode, de-emphasising anything that is not relevant to immediate survival”. Hudson counters this with a long-term view that SRI issues such as climate change, resource constraints, food scarcity, the energy challenge, and corporate control are driven by politics, public opinion, and consumer behaviour rather than market volatility.
Hudson said: “SRI investors don’t abandon their values in a downturn. When markets are volatile and visibility is clouded, all investors cast around for other inputs to help them understand companies better.”
Seb Beloe, head of sustainable and responsible investing research at Henderson Global Investors, agrees that how companies are run and what they focus on are differentials that signal the strength of a company: “Looking at corporate responsibility is a way to identify better companies in which to invest.”
SRI’s origins as an exclusionary approach that limited the investment universe have lead to the misconception that it automatically translates to underperformance. But as environmental, social and governance factors have a growing impact on a company’s risk management profile, they become a means by which to seek pockets of better performance, and investors that do not take these issues into account could lose compared to those that do.
Beloe added: “Many corporate leaders understand the sustainability agenda, but the financial community is behind. Fiduciary concerns have perhaps acted as a brake on pension funds. Change is always challenging, but increasingly not taking SRI issues into account is seen as a dereliction of fiduciary duty.”
There is some evidence of outperformance. According to Style Research, in partnership with environmental research firm Trucost, global utilities stocks with the greenest credentials have outperformed the average by 0.5% since the start of 2006. Oil and gas stocks which pollute the least outperformed by 0.9%. Robert Schwob, chief executive of Style Research, believes this is significant and will lead to a change in behaviour by consultants and pension scheme trustees in the selection of their mainstream portfolio constituents.
Interest has been growing. Socially responsible investing in the US grew 18% to $2.7 trillion from 2005 to last year, a period during which all investment assets under management increased by 3% and the global economy boomed, according to the Social Investment Forum, a US SRI industry association. A survey from the UK SIF found that three quarters of UK corporate pension funds have a responsible investment policy.
Asset managers are responding in kind. Goldman Sachs Asset Management and Threadneedle are the latest to launch funds to tap into escalating concern over energy and the environment. GSAM has been developing a sustainable fund after the success of Generation Asset Management, led by David Blood, its former chief executive, and Al Gore, former US Vice-President and environmental activist.
A study by law firm Freshfields Bruckhaus Deringer for the United Nations Environmental Program’s Finance Initiative in October 2005 found: “The links between environmental, social and governance factors and financial performance are increasingly being recognised. On that basis, integrating these considerations into an investment analysis is clearly permissible and is arguably required.”
Jason Josefs, head of research for the sustainable and responsible investing team at Aviva Investors, formerly Morley Fund Management, works with the United Nations Asset Management Working Group on integrating SRI issues into investment analysis. He said: “SRI is an area to be in for the long term because the world rewards companies which generate more sustainable growth with higher valuations. The majority of a company’s value comes from its long term cash flows.”
Josefs strongly believes while there has been a shift to more sustainable economic development in the market in response to environmental and demographic issues, the future change will be much larger and faster than is widely accepted.
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