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
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.