Lisa Hayles and Stephanie Maier, Ethical Investment Research Services (EIRIS) Ltd
What was considered by some as a niche approach to investment is developing into a set of sophisticated, integrated and influential strategies adopted by a wide range of investors. The public's broader awareness of sustainable development issues, and the growing number of initiatives encouraging greater corporate transparency and accountability on CSR issues, have supported demand for the creation of new SRI investment products.
Increasingly, investors across the EU are running funds with sophisticated environmental, social and governance (ESG) criteria and are incorporating these issues into their financial analysis of companies. Moreover, both sell-side and buy-side analysts are beginning to see ESG issues as potential risks or opportunities or both.
The UK pension disclosure Act of 2000 has heralded the arrival of a wave of disclosure regulation in other European countries including Germany, Italy and Austria in the early nineties, alongside the recent EU Accounts Modernisation Directive1 which requires large quoted and unquoted companies to produce a 'business review' in addition to their current mandatory reporting.
This wave of legislation and regulation helped raise the profile of ESG considerations among the European investment community and has increased the profile of socially responsible investing.
In response to this, many European companies are developing responsible business practices across a broad range of issues. There is also a growing body of evidence to suggest that incorporating ESG issues into investment analyses helps fund managers better understand the future performance of companies – especially in the longer term. Customer demand, competitive pressures, increased transparency and a growing number of initiatives encouraging responsible business practices will continue to raise expectations of the CSR performance of companies.
Both retail and institutional SRI investments have grown steadily in the last decade. This growth is also contributing to the pressure on companies to improve their policies, management systems and reporting on a range of ESG issues. According to a pan-European survey by Eurosif, the European body of SRI representatives from EU member states that broad SRI totalled more than EUR$1 trillion in 2006.2
So how does SRI in Europe differ from its North American counterpart? European SRI employs the various strategies familiar to US investors including positive and negative screening and best in class rankings. Issues and approaches differ quite considerably across the EU. For example, exclusionary screening is a popular approach in the UK, which is most similar to the US in outlook and approaches to SRI. This strategy not only remains popular with retail investors, but also investors such as charities and other non-profits.
In continental Europe, best-in-class and thematic approaches are popular though engagement and integration remain the strategies of choice in terms of the mainstreaming of SRI. Engagement continues to grow in popularity with UK fund managers being the leading proponents of this strategy. Some large, specialist in-house teams are offering engagement services as a standalone product, separate from asset management to those institutional investors who seek to influence
companies' practices and behaviour and encourage more responsible business practice. Institutional investors via initiatives such as the Enhanced Analytics Initiative (http://www.enhancedanalytics.com) are also encouraging their brokers to produce integrate analysis of extra-financial issues and intangibles into their mainstream (sell-side) research.
Overall, there is a high degree of diversity in approaches and strategies adopted by investors across the EU. Screening issues have expanded to include references to international voluntary initiatives such as the UN Global Compact. A recent example is the highly-publicised divestment decision made by the Norwegian Pension Fund Global – a fund with more than US$250 billion under management, making it the largest pension fund in Europe.
The fund announced in 2006 it would divest from Wal-Mart for "complicity in serious or systematic human rights violations" and from Freeport McMoran because of "serious environmental damage" incurred by the company. Finance minister Kristin Halvorsen was quoted in a government statement as saying that the exclusions "reflect our refusal to contribute to serious, systematic or gross violations of ethical norms in these areas through our investments.”
Screening on a number of high-profile issues will continue to be important for a subset of institutional investors, as demonstrated by the recent resurgence of interest and public pressure on Danish pension schemes to boycott investments in companies linked to the manufacture of cluster munitions, after scathing criticism in the media from Danish Church Aid and NGO's including Danish Red Cross and Amnesty International.
The types of ESG issues which are of concern to investors are continuing to expand. The advent of the UN principles for responsible investment has provided institutional investors with a framework for incorporating these environmental, social and governance issues into their ownership practices in a way consistent with their fiduciary duty. Key asset owners such as the Environment Agency in the UK and the FRR in France have been instrumental in encouraging research into how environmental, social and governance issues affect financial performance. EIRIS' own research approach has been to develop a matrix of sectors and issues where ESG issues have the most significant financial impact, based in part on input from more than 40 institutional investors around the world.
In early 2007, EIRIS published the results of a survey asking asset managers to rank the environmental, social and governance (ESG) issues most important to investment performance entitled "Valuing ESG Issues: A Survey of Investors."
Respondents identified five general themes that emerged as serious areas of concern for investors:
Product safety and liability including genetically modified foods, food additives and food contamination
Chemicals of concern
Single sector issues including responsible banking practices and obesity
For the food producer sector, concerns about the growing obesity crisis in the western world have put their products and strategy under a spotlight. Drivers such as regulatory pressures for stricter guidelines on marketing to children and food-labelling, changing consumer perceptions and potential damage to brand have led to companies such as Cadbury Schweppes and Pepsi to develop healthier product ranges and decrease portion sizes. Another emerging issue is access to medicines and the pharmaceutical sector. This particular issue has been the focus for an investor initiative – Pharma Futures – an investor-led dialogue between the pharmaceutical industry and its investors about how to manage a rapidly changing operating environment to deliver long-term value.
Another huge issue is climate change. It is widely acknowledged that in order to make the significant changes that are required in the way we live, develop and do business, we all need to play our part and that includes investors. One of the key success factors for the Kyoto Protocol is the development of flexible mechanisms to tackle climate change – providing an incentive to the market to seek and develop efficient solutions to reducing greenhouse gas emissions.
Targeted investment to take advantage of opportunities presented by ESG factors is also on the rise. For example, Dutch pension fund giants ABP and PGGM have taken stakes in the world's largest private sector carbon fund, Climate Change Capital (CCC)'s Carbon II fund. The fund will invest in projects in developing countries aiming to reduce greenhouse gas emissions. ABP has invested EUR$275 million in the fund. CCC stated that the profile of the investors backing this new asset class reflected the progress in the development of the carbon market created by the market mechanisms of the Kyoto Protocol.
European socially responsible investment (or sustainability investment or simply responsible investment) is as much a means of incorporating values and priorities into investment decisions, as it was when it was first established. The values and priorities of investors (and society) may have changed and will continue to change. However, the incorporation of extra-financial factors will also continue to reflect wider societal trends and the desire among all stakeholders to create more sustainable and just society. Happily, this goal is increasingly understood to be compatible with sustainable, long-term investment strategies.
EIRIS' experience of researching ESG issues for nearly 25 years suggests that European investors' appetite for responsible investment along with their peers around the world will continue to be a significant factor in driving sustainability improvements in corporate performance.
The EIRIS Foundation is a charity set up in 1983. Ethical Investment Research Services (EIRIS) Ltd, a subsidiary company of the Foundation, provides the independent research into corporate social, environmental and ethical performance that is needed by investors to make informed and responsible investment decisions as well as by charities wishing to screen their donors or suppliers. For more information, see www.eiris.org.
This report appeared in GreenMoney Journal in its Spring 2008 issue. Article reprinted with permission from the GreenMoney Journal, a socially responsible investing newsletter publishing since 1992. For more information, visit GreenMoney Journal online at www.greenmoney.com.
1 The review must include a 'fair review of the business of the company' and should report relevant environment and employee matters using key performance indicators (KPIs) 'to the extent necessary for an understanding of the development, performance or position of the business of the company.'
2 Eurosif included the following strategies in their definition of 'broad SRI' – ethical exclusions, best in class, pioneer screening (thematic funds). Other positive screens include single issue screening, integration of Social, Environmental and Ethical (SEE) issues and engagement on SEE issues. Interestingly, Eurosif did not include tobacco, human rights or weapons screening as a 'core SRI' practice. See http://www.eurosif.org