Socially responsible investing is growing, but share prices aren't keeping pace.
Invest in socially responsible companies and get
better returns. So says a slew of recent studies and reports. You
almost can't get away from the tenets of socially responsible investing
these days.
It's based in ethics: How to do the right thing, be a good corporate
citizen-for society, for shareholders. That may mean being more
environmentally friendly. Or it may mean paying better attention to
shareholder proposals. In any case, socially responsible investing is
changing the way corporations act.
Goldman Sachs announced in December that it is
"going green," embracing a policy that will promote and support
environmental awareness. General Electric announced that it will more
than double its investment, to more than $1.5 billion over the next
four years, in technologies that will provide cleaner energy plants,
hybrid power and reductions in the amount of water and pesticides used
in the agricultural sector. The effort is part of GE's new business
unit, Ecoimagination, from which it expects double-digit earnings
growth over the same period. These companies are leaders in a new Earth
Day dawning on Wall Street.
Already there's more than $2 trillion earmarked for
socially responsible investments, according to the Social Investment
Forum in Washington, D.C. The money is mostly in separately managed
accounts ($1.99 trillion) and mutual funds ($151 billion) that seek out
either shareholder advocacy policies or community investing
initiatives. But much more clout and dollars are being promised.
Pension funds and rating agencies are getting into the SRI act, calling
for companies to take on new standards or face divestment and, in some
cases, rating downgrades.
"We are seeing an explosion of commitment by
companies to corporate social responsibility, and I've been fascinated
by the thousands of companies doing CR (corporate responsibility)
reporting," says Tim Smith, chairman of the Social Investment Forum and
director of socially responsive investing for Walden Asset Management
in Boston. Assets under management in this area have grown 40% per year
for the last ten years, according to the Social Investment
Forum-outpacing growth in all other forms of financial assets, the
group claims.
People, from individual investors to hedge fund
managers, seem to be getting the lowdown that ethical companies perform
better. It isn't just that these companies recycle or embrace fair
labor standards-they are entirely changing their corporate cultures.
"What companies have figured out is that the central
driver to their success is culture," says Dov Seidman, chief executive
of LRN in Westwood, Calif. LRN teaches companies how to change their
cultures to effect ethical change.
Seidman says this can be quantified in revenue
because it inspires employees to do more while constraining and
containing unwanted behavior. "Chuck Prince [chief executive of
Citigroup] says he is going to spend half his time on culture. There's
a reason for that."
That reason, he says, is the pervasiveness of the
cultural ethic in everything from day-to-day transactions to management
and new business development.
Operationalizing ethics is one thing, but
translating that into capital appreciation is another. Even though
professional consultants like Seidman and academic studies say CSR
(corporate social responsibility) makes companies perform better, the
evidence is scant. Take this: Fannie Mae for years made the list of the
top ethical companies in the country. Then an accounting scandal broke,
its CEO and CFO were ousted and the quasi-governmental mortgage finance
company became the bane of regulators trying to tighten the screws on
oversight control.
Now, of course it's easy to take pot shots at
companies that have fallen: Tyco, Worldcom, Enron, Adelphia, etc. But
the flip side is to take another look at companies held in high esteem.
Do-good companies, The Economist magazine said last
year, aren't doing any one any good. In a sweeping CSR indictment, it
said: "All things considered, there is much to be said for leaving
social and economic policy to governments. They, at least, are
accountable to voters. Managers lack the time for such endeavors, or
should."
In others words, companies should seek to make
profits - period. There certainly is an argument for that. The
performance of "sin stocks" can't really be argued either. (Oil,
tobacco, alcohol, gaming have all been on a tear.) Check out the Vice
Fund: its share price has climbed over the past two years from less
than 10 to more than 16. That beats the pants off most of the
goody-two-shoes mutual funds out there.
Indeed, in a special Journal of Investing report
published last fall, several academics made a compelling case for
investing in "antisocially conscious sectors," going so far as to say
that "financial advisors have a duty to inform clients" that funds
which aren't socially conscious perform better.
The problem for them, and many others, is the
hindering standards attached to socially responsible investments.
Graham Sinclair, research product manager at Boston-based KLD Research
& Analytics, which houses a database of indexes tracking companies
in the socially responsible space, says such ethical standards "prevent
underperformance, but have yet to prove outperformance." Still,
thousands of companies are embracing CSR standards and reporting. KLD
since 1993 has monitored companies providing CSR reports. They show a
steady rise, with better than half of the top companies in the world
now providing corporate responsibility reports to investors as opposed
to one-third in 2002.
The Bethesda, Md.-based Calvert Group, which
includes mutual funds and other investment vehicles, recently released
a study showing that two-thirds of investors want some type of social
screening for their investments.
That's all well and good, but is anyone listening?
"We give them [clients] some socially responsible funds in their
portfolio and use our normal, nonrestricted choices for the rest," says
Norman Boone, a certified financial planner with Mosaic Financial
Partners in San Francisco.
Boone's observation jibes with comments from a
half-dozen financial advisors: there simply isn't enough selection in
SRI funds or investment from which to choose. Jake Engle, of Engle
Planning in Seattle, pretty much nails it on the head: "I find many
clients requesting socially responsible investments. Unfortunately,
since I prefer passively managed, low-cost investments, there isn't
enough product to suggest to clients."
To be sure, there are SRI mutual funds and other
products being designed, but the pickings are indeed slim. (There are
some 200 SRI mutual funds compared to the more than 8,000 funds on the
market, and only of couple of hedge funds devoted to SRI.)
Innovest, on the other hand, says it can pop out
giant returns through its ethical hedge fund series of assessment
tools. The New York City-based firm puts about $1 billion toward
ethical companies. The tools are designed as value-added overlay, and
can be used as "a complement to, rather than a substitute for" existing
investment strategies. "It can, therefore, add value and risk-adjusted
performance benefits to a wide variety of investment styles and
products: active, passive, enhanced index, long-only, long-short,
value, growth, sector-focused, and others," Innovest claims.
But SRI really plays into the ethos that capital
appreciation can take on its other meaning as well. The movement began
with the divestment campaign from South Africa in the 1970s and 1980s.
In 1993, when apartheid fell, some investors saw the power of their
overseas lobbying and took it home, broadening investor activism to
other issues. Now screening, shareholder advocacy and community
investing all have become formal disciplines.
But it's hard to decipher just what makes an a
company "responsible." Sinclair says KLD and others are "on it as best
they can trying to identify patterns of corporate behavior." KLD rates
companies in seven areas: environment, community, corporate governance,
diversity, employee relations, human rights and product quality and
safety. Analysts then assign strength and concern ratings associated
with these issues, providing a social and environmental profile of
companies. Those ratings are then compiled and published separately or
as indexes.
But being "on it" also means having strong corporate
governance practices as a company. Yahoo has a new Corporate Governance
Quotient that lets you evaluate the strengths, deficiencies and risks
of a company's corporate governance practices and board of directors.
It focuses (and provides an easy percentage rating system) on the
efficiency of the board of directors, audit procedures, anti-takeover
provisions and executive and director compensation. Moody's, Fitch and
Standard & Poor's have their own systems of evaluation as well.
This begs the question of whether companies are just
showcasing CSR reports to avoid negative investment sentiment.
"There are as many reasons for doing this as
companies," observes Michael Connor, publisher of Business Ethics
magazine. "Companies are increasingly realizing that they are, if not
legally liable, they have a real ethical liability."
The teeth behind this bark are shown in court.
Obesity is an example, he says. Smoking is an example, he says. "PR
problems may not remain PR problems forever," Conner says. "They can
turn into legal problems."
This is where the long-term view of SRI has to take
shape. Other vehicles and companies that are not socially responsible
can claim they outperform, but for how long? Moreover, CSR standards
often point to, well, good companies. Solid leadership, management and
oversight usually engender positive results and prevent bad things from
happening.
There's a way to look for it, too.
Mark Feldman, senior vice president of strategy for
VIRSA, a software solutions company, says he can implement a program in
20 minutes and spot financial crime. "We can not only see it, we can
prevent it," he says.
Firms like VIRSA, in Fremont, Calif. are popping up
to design and enforce corporate standards and policies on everything
from purchase orders to which countries they are allowed to operate in.
(CalPERS recently announced it would divest of any company with certain
ties to Sudan, for example.)
Bill Hancock, executive vice president of Secureinfo
in San Antonio, Texas, another risk management software and consulting
firm, says tools have become so sophisticated, they can dialogue with
executives and assess change. "If expenses are out of line or a
transaction is out of order, we can identify that violation," he says.
These are long-term solutions to cultivate and
enforce corporate culture. But they don't show up in short-term
returns. Yet.