The ability to balance acceptable risk against a healthy return is an essential component in any investment expert’s box of skills. Twenty years ago the key measures used to scrutinize stock and carry out such a balancing act were based only on hard financial data. Then a new factor began to gain significance: social responsibility. At first ethical, environmental and social considerations received a muted response from most mainstream investors. And those funds that adopted principles of socially responsible investment (SRI) attracted comparatively few subscribers because performance was poor by market standards.
But now, from being a low level consideration on the IRO’s list of priorities, there are signs of change that could make IR departments all over the world rethink their attitude to the SRI factor. Instead of simply excluding baddies, SRI funds are now embracing goodies.
Craig Mackenzie, head of ethical investment at Friends Ivory & Sime, the fund management arm of UK financial services firm Friends Provident, sees the glimmer of a new dawn for the ethical and environmentalist lobby. He explains that the traditional screening model used to assess stock eligibility has until now been a negative one. Companies in certain sectors were excluded because of the nature of their business, not the way they conducted their affairs.
Starting in July 2000, all UK occupational pension funds will have to state the extent to which they take social, ethical and environmental issues into account in their investment policy. This applies to 10,000-odd pension funds with total assets of about £800 bn. Some of these have substantial overseas interests so it won’t only affect UK companies.
‘From a legal point of view, companies have no right to be pushing their pension funds around on this or any other issue; the trustees have to take a view purely in the financial interests of their beneficiaries,’ Mackenzie says. ‘But in the real world, if companies get targeted, it will be embarrassing and the public won’t make the fine legal distinction.’
He says a number of major pension funds are going to want to do something positive in the light of these changes. And companies that usually expect to be screened out of any ethical or environmental investment fund – just because of their core business activity – may see such funds taking more interest in their affairs if they do good in other ways.
New dawn
Add into the equation official UK thinking on corporate governance, which suggests companies set up systems of risk management to cover all risks – including ethical and environmental – and there are some persuasive indications that Mackenzie’s forecast new dawn is more than an optical illusion.
This turn of events may provide an opening for companies that, for so long, have been kept out in the cold by many ethical and environmental funds. The funds themselves might then contain a better performing stock portfolio and thus attract more investors.
BP Amoco may be one such multinational, despite the fact that it has for some time taken these issues very seriously. IR manager Peter Hall explains: ‘Where we tended to part in the past with these ethical funds was that they had a blanket policy which stated, You cannot invest in companies involved in the chemicals business.’
BP’s response to objections has been to stress the action it takes to clean up processes, monitor emissions and so on. A good example of what Craig Mackenzie calls a new evolutionary approach is arguably BP Amoco’s stated aim to reduce CO2 emissions over ten years. It’s possible that ethical and environmental funds will in future rate this incremental approach more highly than at present.
Some investors might see too much enviro-friendly spending as harmful to the bottom line. Hall reckons that as long as BP doesn’t spend too much money cleaning up its act or investing in renewable fuels, analysts will be content. But if it started to impinge on financial performance, they might ‘get agitated’.
Proactive approach
BP is not unusual in adopting an ethical and environmental stance, regardless of actual investor or analyst interest. Dick Windham, director of public relations at US textile group Burlington Industries, hasn’t experienced any great shareholder interest on the ethical or environmentalist front, but he still takes a proactive approach. Windham says there is a lot of interest from customers simply because of ‘the way the market is orientated’, but there is virtually no cross-over from consumer concerns to investor pressure. This may be because the company has very few retail shareholders.
‘Basically, we know consumers are interested in environmental issues, so if you’re making a product to sell to consumers your manufacturing processes have to be environmentally sound,’ he says. ‘But we haven’t seen the investing community – or our shareholders specifically – picking up on those issues.’
The company addresses these issues by getting involved in industry-wide environmental initiatives, including a commitment to annual improvement goals. ‘We call attention to this stance in our annual report and we always publish our guiding principles covering ethical behavior and related issues. Our annual report is also required to have the details of any significant environmental problems,’ he says. ‘We feel we actually take a proactive stance on this. It’s not a reaction to any investor pressure.’
Across the Atlantic, Swiss chemicals company Clariant reports an increase in interest from fund managers with ethical questions, while the experience at a much smaller Swiss company, Saurer, is quite different.
Clariant spokesman Walter Vaterlaus says, ‘We have seen a slight increase in questionnaires regarding ethical behavior and environmental issues, but because we have just published our position on these matters most of their questions are now answered without the need for further explanation.’ Setting out the company position meant extra work initially but the position paper has helped reduce the workload in the long run. Whether it will lure SRI fund managers to consider a company involved in the chemicals business remains to be seen.
By contrast, at textile machinery company Saurer, IR manager Carole Ackermann reports that it’s not ethics or the environment bothering fund managers, but another e-term. ‘Interest from ethical funds has not changed a lot. In fact last year I would say it even reduced a bit. We actually received many more questionnaires on e-commerce than on ethical or environmental issues.’
Ackermann says there’s nothing in the annual report which states the company’s ethical or environmental position. ‘In fact I don’t think investors are really interested. Almost everything we use complies with environmental standards, so our business doesn’t have any impact on the environment,’ she explains.
Despite this clean bill of health, Ackermann knows of no ethical funds which invest in the company. But she thinks she knows the reason why: small and medium-cap companies like Saurer tend to be chosen for their overall performance potential, not for other reasons.
Green screen
Such a lacklustre attitude to ethics and the environment by fund managers may be set to change. The UK’s Prudential Group plans to introduce a new green screening for all its UK equities. It currently has around £55 bn of equities in this category and a Prudential spokesperson says the institution has always incorporated environmental factors into the investment process.
However, this will be ‘a more systematic approach’ using the database provided by the Ethical Investment Research Service (Eiris). ‘It’s based on the belief that well-managed companies – in all areas including environmental policy – produce superior returns over the longer term for our clients,’ she explains. ‘So obviously we are taking an ethical and environmental stance [on principle], but it’s also because we believe those sorts of companies produce better returns.’
‘Eiris asks the companies questions then feed responses back to us,’ Prudential’s spokesperson goes on to explain. ‘We then apply our own criteria. This could mean we need to discuss with the management of a particular company whenever we think something is missing from their approach.’
The head of client services at Eiris, Karen Eldridge, says Prudential is not the only institution that is now showing more interest in this kind of approach. Many investment managers are considering various ethical and environmental moves, including offering optional ethical or environmental funds to pension scheme members in a defined contribution arrangement.
A recent Eiris survey entitled Does ethical investment pay? underscores the view that, in the future, it may not just be a question of principle which raises SRI factors up the investor relations agenda. The survey contains a summary of the findings by Klassen & McLaughlin in the US market, suggesting a firm link between environmental management and a company’s financial performance.
For one thing, the researchers discovered that the market rewarded companies that received awards of an environmental nature. An environmental award in the US typically boosted share price by 0.82 percent and raised market value by an average of $80.5 mn. By contrast, oil spills and other environmental disasters lost firms 1.5 percent of share price and an average of $390 mn in market value.
So investor relations practitioners may soon be counting the real cost of a failure to apply cast iron ethical and environmentalist policies on an equal footing with other performance measures. Indeed, this summer green-tinted shades could be all the rage for IR professionals – and it might not just be a seasonal fad.
