Finding common ground

Reading about socially responsible investing (SRI) can feel like wading through alphabet soup - SRI, ESG, CG, EFI, GSEE, UNPRI*. Picking your way through the initials is a tricky business, and feelings can run high when it comes to their interpretation. Bringing morality into investing can be profitable some SRI proponents say; it certainly seems to encourage people to claim a moral high ground.

The common thread that dominates the popular perception of SRI today is that of ‘exclusion’. Led by church investors who wanted to avoid contamination by sin, ethical investors simply avoided in investing in what they disapproved of, such as arms, alcohol, pornography and so on.

The exclusions vary according to trend - tobacco is now almost invariably on the banned list - but the principle still exists in many ethical funds.

The exclusion principle is limiting. By cutting off whole sectors, you severely limit your investment universe, thereby making it harder to produce comparable returns. There is no financial argument in favour of it. The number of retail investors who are prepared to pay that price for their moral principles is strictly limited, while most institutional investors find that it is not consonant with their fiduciary duties so to do.

While it was referred to as ethical investing, there was no possibility of moving this investment style towards the mainstream of investment. SRI opens up more possibilities, especially as it starts to make the argument for itself being a positive investment tool, rather than one just of exclusion.

By including analysis of topics that appear to fall into the ethical or moral realm rather than the traditional financial realm, it is possible to feel good while also avoiding certain unrewarded risks. Avoiding tobacco investments does not just mean you are not implicated in hundreds of thousands of deaths; you also avoid punitive damages if smokers decide to sue the cigarette makers for giving them cancer.

Enhanced analysis can cover a huge range of topics, from corporate governance through regulation and human rights to environmental issues.

For most of the last 15 years, it has chugged quietly away in the SRI corner, the preserve of specialist teams who are usually ignored by their mainstream colleagues as they market their niche product to a small target audience.

Enhanced analysis has become rather fashionable, boosted by the activities of the Enhanced Analytics Initiative (EAI).

Supplementing the innovative research the sell-side is starting to produce under the influence of the EAI is a set of data providers such as Innovest, Asset4 and Governance Metrics. These companies offer quantitative analysis of companies’ practices in different areas, such as corporate governance, which can then be integrated into investment processes, whether mainstream or specialist SRI.

Many active SRI managers also offer a degree of engagement, which could mean that they pay for an engagement overlay such F&C’s responsible engagement overlay, which makes sure that your proxy voting is in line with your principles, or it could mean that they engage directly with management.

One commentator has pointed out that the word ‘engagement’ can mean going to war or being betrothed; this opacity is also there in investment, where engagement can refer to a positive relationship of shareholder advice and support for management improvement, or a confrontational relationship.

Centuries ago, people asked ‘what’s in a name?’ But in today’s marketing driven world, only a heretic or a recluse would ask whether it mattered what you call something. Most of the variations of the abbreviations are arbitrary orderings of the elements of SRI that a particular company has chosen to prioritise, whether environmental issues, social responsibility or corporate governance.

here is a real divide between the camps that espouse SRI and EFI. The supporters of EFI will tell you that their chosen terminology is intended to emphasise that these are hard-headed investment issues that do not rely on woolly liberal ideas of right and wrong to make decisions. Their tagline: ‘Promoting better research for better investment decisions’, makes it clear that improving investment performance is the aim.

SRI, these people would have you understand, carries with it the associations of the exclusive ethical funds, whose fund managers have to fight of the image of muesli-eating, sandal-wearing do-gooders who might pray for guidance on investment decisions.

On the contrary, says the other camp, which holds tightly to the SRI label. In this world view, ‘extra-financial’ implies that these issues are not financially relevant, pushing the whole movement back into the same niche that they have spent years trying to escape. Those who insist on using SRI as opposed to talking about EFIs tend to be the asset managers with a track record in the field, often pioneers who have built up a brand against considerable resistance, believe in the usefulness of their investment style and are unhappy with these newcomers who have swept the field by renaming their ideas.

Another term that is currently creeping in is ‘long-term investing’. The Marathon Club, a collaboration of investment organisations, recently issued guidance for institutional investors on how to focus on their long-term investment interests (see page 6)

While it is mostly talking about how to implement a long-term approach, it is inevitable that encouraging such an approach must put an emphasis on extra financial issues (or socially responsibility, if that is what you prefer), which almost invariably have their impact over a period longer than the quarterly or even yearly returns that many investors look at.

In a similar vein, Dexia Asset Management, which regards itself as a leader in this field, refers to ‘sustainable’ investing, to underline its belief that investing with regard to sustainability issues should lead to sustainable investment performance.

Just when you feel that you may have a handle on the terms in the field, different countries have different interpretations of SRI. Eurosif, the European social investment forum, notes on its website that this is the case and declares: “The approach to SRI has specific national characteristics linked to the particularities of the structure of financial markets and the legislative and cultural environments of each country. Eurosif takes these factors into account and addresses SRI issues with the European scope in mind.”

Bear in mind that the French feel that SRI will make markets more efficient, the Italians value engagement with stakeholders, the Swiss focus on sustainability and UK investors are following in the tradition of Victorian philanthropists.

*Socially responsible investment; environmental, social and governance (issues); corporate governance; extra financial issues; governance, social, environmental and ethical (issues); UN’s ‘principles of responsible investing’