When extolling a company’s investment virtues, investor relations practitioners have traditionally relied solely on the language of financial analysis. It may behoove them, however, to learn a new lexicon – one that reflects social and environmental concerns.
Socially screened portfolios are experiencing explosive growth. According to the Social Investment Forum, ‘socially responsible’ investments in the US reached $2.2 tn in 1999, up 82 percent from 1997. That sum represents nearly 13 percent of all money under professional management in the US. With over $6 bn in assets and some 30 mutual fund portfolios, Bethesda, Maryland-based Calvert Group is the country’s largest provider of purely socially screened mutual funds.
At Calvert, the investment process begins with the manager selection process. While fixed income research is done in-house, sub-advisors run all nine actively-managed Calvert equity funds. ‘Our management team decides what kinds of products we lack and how we should go about filling those empty buckets,’ explains Reno Martini, Calvert’s chief investment officer. ‘Once a product that can attract assets is defined, we look for managers with proven results who won’t be too aggressive or volatile. We aren’t value managers but neither are we conservative. Our equity products tend to be core holdings.’
Still, the manager chosen will not necessarily be the one producing the best numbers for a particular investment style. Calvert also studies the investment firm’s pedigree and examines how well a particular manager will fit with its brand of socially responsible investing. ‘We look at their portfolio’s core holdings to ensure they pass our screens,’ says John Nichols, vice president of sub-advisor management. ‘We don’t want to hire someone who buys 35 stocks and only 15 pass our social screens. In that case, the performance record may not be duplicable.’
Yes – performance. For many years, there was concern about the fiduciary appropriateness of socially responsible investment funds. Surely they produced sub-optimal returns, said the doubters. However, many studies indicate socially responsible investing (SRI) does just fine.
‘Good managers are not inhibited by the social screens,’ adds Martini. ‘We have learned that if a manager doesn’t produce returns, it is not because of the screens. It is because of their inability to produce returns outside the screens.’
Moreover, the US Department of Labor agrees. Two years ago, prompted by Calvert and others, the DOL issued a statement recognizing the fiduciary respectability of SRI under Erisa. As a result, firms like Calvert have enjoyed swift growth absorbing a growing torrent of 401K investment money.
In Calvert’s case, that money is attracted to both performance numbers and its philosophy on socially responsible investing which is spelled out in its literature: ‘Few things contribute more to a company’s success than a strong management team with a long-term view… Companies operating with integrity toward their employees, community and the environment will be better positioned to succeed in the long run.’
The gatekeeper
Identifying those companies works like this: As new names come into a manager’s universe they are given a preliminary examination and swiftly passed to Calvert’s social research department which decides if it is an appropriate investment. ‘If the social department says it is a fail, then the manager cannot buy it,’ says Martini. ‘In that case, the manager must find a suitable replacement.’
But don’t think these guys just buy wind farms and whale-watching outfitters. ‘We are an investment company first,’ says Jon Lickerman, director of the eleven-member social investment research department. ‘We only consider investing in a company if it meets our portfolio Managers’ overall criteria.’
Then what happens? ‘The fundamental question we want to answer is how a company affects society in a non-financial sense,’ explains Lickerman, who has been researching SRI issues for 14 years. More specifically, all Calvert’s social criteria collapse into four questions: What are the company’s products? What is its environmental impact? How does it treat its employees? And, what are a company’s practices within its community?
‘A company must meet our definition of the minimum standards for all categories to be eligible for investment,’ says Lickerman, whose team researches about 1,500 companies annually. ‘So if a company has a great environmental record but a poor labor relations record, we don’t ask ourselves if we care more about the environment than we do employees. That adds rigor to our work.’
In general, companies involved in the tobacco, alcohol, gambling, nuclear power and weapons contracting businesses are non grata, as are those with questionable track records on labor relations and human rights.
Those companies that are placed in a Calvert portfolio are closely monitored, though some are subsequently removed. ‘Usually, we dialogue with companies to ensure they are heading in the right direction,’ says Lickerman.
That dialogue mostly revolves around issues specific to the company’s industry. For example, if a company is in the waste management business, Calvert will want to know more about its pollution control practices than, say, its animal welfare practices. ‘We recognize that certain industries have certain predominant social impacts,’ adds Lickerman. ‘We are most successful when we focus on the sorts of issues management faces daily and which resonate with them.’
Calvert will bring its concerns to shareholder meetings if it feels it has reached an impasse with management. Still, Lickerman says shareholder resolutions are a last resort. ‘Of all SRI leaders, we file the fewest resolutions and do the least flag-waving at shareholder meetings,’ he says. ‘We are there to work with the companies we invest in. We will often file an independent resolution and then negotiate out to reach a compromise. Our desire is not to get into public arguments with management but we won’t hesitate to exercise that right if we deem it appropriate.’
Just like a traditional financial analyst, Lickerman craves greater transparency and more detailed disclosure, but he looks at how they impact social and environmental areas. While companies like Ford, Intel and Vivendi detail their initiatives in comprehensive reports, many others remain reluctant. Beyond the time and expense involved in producing a report, management fear simply talking about challenges on these fronts could increase their company’s risk profile and require ‘expectations management’ among stakeholders and shareholders.
Besides, who reads those reports anyway? ‘Well, we do,’ notes Lickerman. ‘We critique them and use them as a basis for dialoguing with management.’ However, Lickerman wants to see numbers. ‘Yes, we want to hear management articulate their commitment to social responsibility. But, as analysts, we want to see measurable indicators of how that commitment is being implemented.’
Lickerman’s job is an uncommon one today. But his kind of analytical requirements are likely to increasingly enter the mainstream. Notably, Calvert has partnered with the Vanguard Group, the US’s second largest mutual fund organization. Vanguard’s Social Index Fund, launched in May, uses Calvert’s analytics to screen its stock picks. This move promises to substantially broaden the horizons for social investing and sends a clear message that a new crop of investors has arrived. Successful public companies will learn to adapt.
Long-term horizon
Calvert rarely changes sub-managers, but its 1998 hire of Atlanta Capital Management to run its large-cap Social Investment Fund Equity Portfolio was an inspired move. In 1999, the $262 mn fund, now led by Daniel Boone, senior partner at Atlanta Capital, generated a total return of 23.17 percent versus 21.03 percent for the S&P 500 – enough to make many investors green with envy.
Boone’s investment process (and that of Atlanta Capital generally) is a three-stage affair. First, he and his team look for ‘favorably priced’ yet ‘high quality’ stocks that have at least a five-year history of steady earnings and dividend growth. Within that universe, he takes a top-down approach over an unusually long time horizon (three or four years) to spot themes to weight his portfolio. Finally, he mixes in a bottom-up analysis to find the most strategically placed companies within those themes.
‘We look for growth companies but we are not momentum players,’ says Boone. ‘We seek longer-term returns.’
Boone has no specific sell targets, yet remains cautious about today’s extremely high valuations. ‘Setting targets based on growth, PE or any other rigid valuation scheme is not productive,’ he says. ‘When we find good companies that are growing we tend to hold them for a while. As their valuation goes up, we will trim them back to control the size of those companies in the portfolio and therefore its risk.’
While he won’t buy a company simply because it is socially responsible, Boone believes there is a high correlation between successful companies and those that are socially responsible. ‘Companies that treat their people right and have intelligent policies towards minimizing environmental damage are those that end up with lower cost structures,’ he asserts. ‘For example, almost all companies probably under-measure the huge costs of employee turnover. Those with happier employees are more productive and that shows up on the bottom line.’
