Investing with a conscience

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SRI - FREEDOM OF CHOICE

One theory has socially responsible investing (SRI) dating back to

eighteenth century Pennsylvania which was settled as a safe place for Quakers to live and practice their faith, based on freedom of conscience. Quakers were a signiﬁcant force in the movement to abolish slavery, promote equal rights for women, and end warfare. Another cites John Wesley from the same century and his famous sermon “The Use of Money” which encapsulated three tenets: Gain all you can; Save all you can; Give all you can.

This is 2010 and environmentalism and ethical consumerism are

mainstream. People have the choice to buy organic food, goods that are manufactured using fair work practices and materials that do not have an adverse impact on the earth’s resources, to recycle, to conserve energy sources, to avoid food wastage, to vote for political parties that promote sustainability, and encourage their families and friends to also do so.

The rise in popularity of ethical consumerism over the last twenty years ties in with an increased appreciation of Corporate Social Responsibility (CSR). CSR is at the heart of socially responsible investment.

Sometimes it takes a crisis to precipitate attention. Arguably, people’s awareness of CSR has increased through the experience of some very sobering events.

Let’s look at a few examples:

Crisis 1.

The Exxon Valdez oil spill in 1989 – until very recently the largest ever in US waters – raised people’s awareness not only to the massive after effects on the environment, but to the corporate cover-up that ensued. The company was slow to get started on containing the oil spill. Equally as incriminating in the public eye, Exxon decided to confuse the issue and not

communicate openly. Both the spill and its environmental consequences, and Exxon’s terrible communications cost

Socially responsible investment, otherwise known as ethical

or socially conscious investing, is the choice of many investors

worldwide. Why has it become so popular? Where did it

spring from? Do investors in New Zealand have the same

opportunities to invest in socially responsible funds?

Investing with

a conscience

It’s your choice

"This is 2010 and environmentalism and ethical

consumerism are mainstream."

the company hugely. The spill was around $7 billion, including the clean up costs and large punitive ﬁnes for corporate irresponsibility. The cost to their reputation was worse; Exxon lost market share and slipped from being the largest oil company in the world to

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provide shareholders with information about company performance and ﬁnancial health, and to give

shareholders control over the incentive structures used for aligning the interests of management and shareholders. In New Zealand, although we have no Sarbanes-Oxley legislation, we are making our own progress. Currently there are proposals to upgrade the protection of investors through merging the regulatory bodies into a single agency – the Financial Markets Authority – and to update disclosure requirements to provide information that is relevant and

intelligible to the public. Minimum competency standards for financial advisers should also increase public confidence in the integrity of financial advice.

Crisis 3.

A very recent reminder of poor corporate behaviour is the Gulf of Mexico oil spill (or the BP oil spill as it is now known). Given the clamour of public indignation surrounding the Exxon spill (although 20 years prior), and the undeniable fact that the BP spill will result in an environmental disaster, BP’s public reaction is surprising and has attracted heavy criticism. There is growing concern that BP may not survive the oil spill and some investors have panicked, resulting in the share price plunging. In June, BP bonds and credit-default swaps began trading as if the energy company had lost its investment-grade credit rating. Unfortunately, several major Pension Funds that invest heavily in BP around the world have also been hit hard and that means many thousands of individual investors in these funds will be worse off.

No surprise that socially

responsible investors are staying away from certain institutions in droves. And no surprise that SRI funds are becoming very popular.

Funds tagged as socially responsible typically include investments into businesses whose corporate practices are transparent and promote environmental preservation, consumer protection, human rights, and diversity, and (generally) avoid those involved in alcohol, tobacco, gambling and weaponry. Others include animal testing (medical and cosmetic) and pornography in the list of criteria to avoid.

Most SRI fund managers invest in companies which are leaders in considering social and environmental issues in their business.

THE AGE OF RESPONSIBILITY FOR CAPITAL MARKETS

Several large global government or sovereign pension funds such as Norway’s have established ethical guardian bodies – in Norway’s case, The Advisory Council on Ethics in 2004. These ethical guardians have set up guidelines for the management of pension fund investments. This year, Norway’s Government Pension Fund (Global) excluded 17 tobacco companies from the fund; a total divestment of US$2 billion. A raft of other companies are also excluded from the investment mandate of the fund – including companies that deal in components for cluster munitions, production of nuclear missiles and simulation of nuclear explosions, those that cause environmental degradation and those that are guilty of human rights abuses. For instance, Wal-mart stores Inc. is excluded as an investment on the grounds of a “Breach of human rights and labour rights”.

become synonymous with corporate arrogance and dishonesty, not to mention environmental damage.

Crisis 2.

"The Smartest Guys in the Room" Corruption is not a new problem, it has existed in some form in almost every society. Over the years, events have precipitated legislation to protect consumers/investors.

With the advent of Enron, possibly the biggest audit farce in history, the

Sarbanes-Oxley Act passed into US law in 2002. Subsequent political, judicial and market focus on corporate governance became intense. Sarbanes-Oxley was intended to ensure the reliability of publicly reported ﬁnancial information and bolster conﬁdence in capital markets. Broadly speaking, it sought to restructure the way that executives, directors and auditors combine to

are staying away from cer tain institutions

in droves. And no surprise that SR I funds are

becoming very popular."

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Norway’s pension fund also has companies that are “under

observation”, one such being German business Siemens, for “gross and systematic corruption”.

PUTTING YOUR MONEY WHERE YOUR MOUTH IS

The most signiﬁcant consequence of the establishment of ethical or socially responsible funds is the impact of blacklisting those companies whose practices are deemed to breach ethical criteria.

An example, again from the massive Norway Pension Fund, is its documented list of reinstated companies. Companies are put on a watchlist and those that can show they are no longer involved in the activities that led to their exclusion are reinstated.

Angus Dennis, Senior Investment Specialist in the socially responsible investment ﬁeld for AMP Capital Investors, is adamant that SRI investors can make a difference. “We have found that a combination of capital allocation and corporate engagement can be inﬂuential on company performance. Our experience is that as a share holder it is possible to engage with some of the larger companies in the world to share our concerns about labour practices and operations within the supply chain and achieve changes. We’ve had some good successes in working with management,

particularly in the global IT sector and the auto industry, and we’ve found that a number of those companies have introduced new practices which we think achieve better outcomes for the company and for stakeholders.”

Based in New Zealand, Australasia’s biggest philanthropic

trust, the ASB Community Trust has become a signatory to the UN Global Compact which is an initiative established to encourage businesses worldwide to adopt the UN Principles for Responsible Investment (PRI). The Trust has also partnered with the Centre for Australian Ethical Research (CAER) who will monitor the behaviour of companies in the Trust’s portfolios. As CEO Jennifer Gill says, it’s not about immediate divestment of major investments overnight. “Where there has been a breach of the UN guidelines we will be encouraging dialogue and discussion. As long as a company is talking about the issue and is seen to be making progress in remedying it, we will continue to hold them.”

CAER is an independent not-for-proﬁt organisation that assists fund managers seeking to apply

environmental, social and governance criteria to their Australian, New Zealand and international investments. In association with UK-based EIRIS, CAER provides consistent

sustainability data on almost 3,000 of the world’s leading companies.

AMP Capital Investors in Australia and New Zealand have commissioned CAER to monitor companies for their range of SRI funds. In New Zealand, companies listed on the NZX 50 are not only rated as to their

environmental, social and ethical considerations, but Occupational Health and Safety and ILO standards, corporate governance and board composition, are all under scrutiny.

IT’S YOUR CHOICE

Back in 2000 there were no SRI funds being actively marketed in New Zealand. Now there are a range of

wholesale and retail funds for the ethical consumer. It’s even possible for people to choose to invest their Kiwisaver funds into SRI portfolios through a number of providers. Although it appears that is a well kept secret.

Head of Distribution for AMP Capital Investors in New Zealand, David Chote, says the emphasis is on the word ‘choice’.

“As they realise they have the option, I think we are going to see people a lot more discerning with their investment choices going forward. I do believe that New Zealanders will choose to invest their money where they know it will make a positive difference. Socially responsible investment is designed to help alleviate suffering and contribute to a cleaner world, and has a framework within which companies become part of the solution – all while providing competitive returns.”

SO HOW DO RETURNS COMPARE WITH OTHER MAINSTREAM FUND RETURNS?

Does investing responsibly mean weaker returns?

Angus Dennis says no. “Our studies indicate that three quarters of a company is made up of intangibles such as brand, reputation, staff and customer relations, and increasingly these are interlinked with the company’s attitude and consideration of environmental and social issues. In essence, the approach is about looking at these additional factors in a company’s operations that often other managers who are making stock selections are overlooking. We think these sorts of considerations provide better insights into the growth proﬁle of a company.

The reality, he says, is the returns are competitive. “From AMP Capital’s experience our SRI funds have performed very well and have often been in the top quartile performers.”

Head of Investment Strategy, Jason Wong says the SRI balanced fund in the AMP Capital stable of funds he is responsible for, has proved to be just as

"Companies are put on a watchlist and those

that can show they are no longer involved in the

ac tivities that led to their exclusion

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“While the dollar amount in our SRI funds is well short of that invested in our regular funds, the performance has been very good. Possibly people do not realise there is an option to invest in diversified funds which are also SRI. Until recently, in New Zealand only single sector funds were available – like global equities for example – whereas now people can invest in a more diversified socially responsible product. AMP Capital’s Responsible Investment Leaders (RIL) Balanced Fund fits that bill perfectly, an SRI fund with a 60/40 benchmark weighting towards growth/ income assets.”

Overseas, where SRI funds have been available for at least a decade, there is more data available to compare returns to those of regular funds. According to Australia’s Financial Standard (April 2009): “Causing the stir among US investors is how SRI fixed-income funds have outperformed traditional funds by four percentage points in the last 12 months.” According to Cerulli Associates’ (a global asset management and distribution research firm) Pamela DeBolt, while traditional funds earned -6.3%, their SRI equivalents earned -2%. “In fact, socially conscious mutual funds have held their ground over the last 10 years. SRI fixed income funds have outperformed other fixed income mutual funds in five of the past 10 years.”

New Zealand Asset magazine’s May issue published analysis by Corporate Monitor of the performance to December 2009 of publicly offered responsible investment managed portfolios which showed that the average responsible investor in Australia is getting better returns for almost all periods from one to seven years in the three major investment categories in which the sector operates.

RESPONSIBLE INVESTMENT VS MAINSTREAM SHARE FUNDS

Returns to December 2009 (net of management fees) % pa

Number of funds in each responsible investment category is shown in brackets.

Australian Share Funds 1 Year 3 Years 5 Years 7 Years

Average Responsible Investment Fund (17)

40.49 -0.04 8.42 12.64

Average Mainstream Fund 36.37 -0.27 8.25 11.52 S&P/ASX 300 Accumulated 32.52 -0.79 8.18 11.02

Overseas Share Funds

21.09 -4.98 4.73 8.06

Average Mainstream Fund 9.37 -9.72 -0.49 1.43 MSCI World ex Australia Index

(Net Divs)

0.77 -9.69 -0.75 0.78

Balanced Growth Funds

18.35 -0.49 5.54 5.09

Average Mainstream Fund 13.29 -0.63 3.76 5.16

Source: Morningstar, Fund Manager data

Above: Angus Dennis, Senior Investment Specialist, Sustainable Alpha and RIL AMP Capital Investors

Angus Dennis sums up. “Considering social and environmental issues in the context of investment is not a fad. SRI is fast becoming a mainstream choice. Over half the institutional investors in Australia and New Zealand are signed up to the UN Principles of Responsible Investment under which investors commit to address environmental, social and governance factors as part of their decision making process. On top of that individual investors are electing to put their (member choice) superannuation contributions, like Kiwisaver, into specialist responsible investment options. The decision to do this is often linked with a personal interest in social and environment issues, but also increasingly on the competitive track record of those options. And the growth rate of SRI funds is typically outpacing their traditional counterparts.”

"I do believe that New Zealanders will choose

to invest their money where they know it will

make a positive difference."

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In early 2005 the United Nations Secretary-General invited a group of the world’s largest institutional investors to join a process to develop the Principles for Responsible Investment (PRI). The Group was supported by a 70-person multi-stakeholder group of experts from the investment industry,

intergovernmental and governmental organisations, civil society and academia. The process, conducted between April 2005 and January 2006 involved a total of ﬁve days of face-to-face deliberations by the investors and four days by the experts, with hundreds of hours of follow-up activity. The Principles for Responsible Investment emerged as a result of these meetings. The process was coordinated by the United Nations Environment Programme Finance Initiative (UNEP FI) and the UN Global Compact also known as Compact or UNGC. UNGC is a United Nations initiative to encourage businesses worldwide to adopt sustainable and socially responsible policies, and to report on their implementation.

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Yes you have a choice to invest in the

bad guys too.

The US-based Vice Fund invests in companies, both domestic and foreign, engaged in the aerospace and defence industries, owners and operators of gaming facilities as well as manufacturers of gaming equipment, manufacturers of tobacco products and producers of alcoholic beverages.

The Vice Fund seeks to select well-performing stocks of tobacco, gaming and weapons/defence companies because its managers believe that these industries tend to thrive regardless of the economy as a whole. In fact, they may have the potential to perform better when times are uncertain, leading many to view investment in "Vice" industries as a solid strategy during recessionary periods.