Not just a matter of fashion

Until recently, the socially responsible investing label was worn only by an exclusive few within the investment community. Today, high profile issues such as climate change and carbon emissions have made SRI fashionable with a wider audience. Mainstream investors are starting to infiltrate SRI circles although they are not only looking at the negatives but also pinpointing the companies who can actively add value.

It is no surprise that SRI investing has attracted a bigger following. Climate change, carbon emissions and human rights have all become front page news. Moreover, there has been a raft of regulation and initiatives that are pushing environmental, social and governance (ESG) topics to the fore.

Simon Thomas, chief executive of Trucost, a UK-based environmental research firm, believes that one of the biggest changes is that the different regulations, particularly the carbon emissions acts, such as Europe's Greenhouse Gas Emission Trading Scheme, are focusing investors' minds on the issues because they have become more easily quantifiable.

According to Thomas, the EU ETS, which came into effect at the beginning of 2005, will see companies issued with a fixed amount of 'trading allowances', which will cap the amount of C02 emissions they can make. Around 15,000 entities across the EU will have to comply with the new regulations. "Although we have several different environmental criteria and impacts, carbon has become one of the most important. If companies are not complying with these new regulations, we can quantify the cost of them not doing so."

The launch of the United Nation's Principles for Responsible Investing this past spring is another programme that is expected to change the way companies and investors conduct business. PRI encourages signatories to integrate the six main principles of ESG as well as act as watchdogs to ensure that companies are towing the line.

Moreover, investors are obliged to report on the developments in this area. They are seen as a turning point because they move the issues onto the mainstream stage and send a signal to the industry that ESG or extra financial risks can have an impact on the long term performance of a company.

Tim Currell, senior investment consultant at Watson Wyatt, notes, "There is much more public awareness and attention given to ESG issues in general and as a result, we are seeing an increase in the number of mainstream investors including them in their investment decision making process. They are looking at both the impact of ESG, in terms of financial and reputation risk, but also how well companies manage these risks which will enhance the company's overall long-term performance."

The main difference, perhaps, with today's investors whether it be traditional or SRI, is that they are both looking at the opportunities these issues can present. This is a far cry from the original SRI followers, who can be traced back to religious organisations such as the Methodists.

They employed a negative screening process that excluded companies engaged in activities such as gambling or alcohol. The SRI movement gained momentum in the 1970s which saw the establishment of the Pax World Fund which shunned companies involved in the Vietnam War and in the 1980s with companies based in South Africa during apartheid being given the cold shoulder.

However, it was only until relatively recently that investors started to focus on the positive aspects of SRI. Stewart Armer, head of SRI at Fortis Investments, notes "in the beginning investors were mainly applying a filter to exclude products that did not fit in with their religious beliefs.

This changed in the 1990s when investors started to use a positive screen and chose companies who were best in their class in terms of their environmental, social and governance practices. For example, they looked at whether a company had a corporate governance or human rights policy."

Now, Armer notes there is a greater emphasis on sustainability and looking at companies who can proactively tackle ESG issues with the appropriate technologies and solutions. In other words, climate change may be a burning issue but it is no longer about excluding companies from the portfolio that pollute the air. It is including those who have the technology to clean the air.

Emma Howard Boyle, head of Jupiter Asset Management's environmental research unit echoes these sentiments. "One of the major themes that we are seeing is investors looking for companies who are providing solutions and products to address environmental problems. This can range from companies such as Suzlon in India that produces wind turbines to Bio Treat Technology in Singapore, a manufacturer of waste water treatments."

Niall Paul, head of equities at Morley Fund Management,also believes the trend reaches farther than companies involved in environmental issues to those engaged in the social and corporate governance arena. "Overall, we are seeing SRI considerations being taken into account much more than in the past and investors want to identify those companies who are developing answers to specific problems.

This is not just in alternative energy or water purification but also in the area of healthcare. For example, there is a drug company in South Africa called Aspen Pharmacare, which produces generic HIV drugs that are affordable and accessible to southern Africa. The company has been able to thrive in that industry but it is also providing a solution to what is a massive problem in southern Africa."

Although mainstream investors seem committed, not everyone sees these conventional players as a permanent fixture. After all, SRI investing requires taking a longer term view and moving away from the short term, performance oriented approach that has become the hallmark of the asset management industry over the past 20 years.

Some analysts do not believe that fund managers are ready to forsake potentially higher returns in the short term for the exchange of environmental improvements and possibly better performance over the long term.

Valery Lucas-Leclin, SRI financial analyst at Société Générale is one who questions whether some mainstream funds will have the patience to wait it out and invest in companies with an SRI angle. "Traditionally, mainstream funds focus on short-term financial performance. They are not ready to spend time and resources to understand more complex, hard-to-quantify, long-term issues linked to governance, human capital, environmental mangement, etc. It could take them a long time to outperform the market and this may not fit in with their investment strategy."

Paul de Marcellus, global products specialist, SRI at HSBC, on the other hand, believes that the trend is here to stay and that investors will increasingly factor ESG criteria into their investment process. He believes that chief executives who effectively manage the risks in the ESG context and act as "good citizens" will produce strong stock market performance, which will win over investors.