Steven Lydenberg, Domini
How far do you have to go to apply the word ‘ethical’ to a stock? In a world of labyrinthine, inter-connected relationships, it’s a question New York City-based Steven Lydenberg, chief investment officer for Domini Social Investments, often ponders.
‘Is a company that makes flavors for a tobacco company a tobacco company?’ he asks. ‘What about one that supplies the paper the cigarettes are rolled in?
Or an electricity company that supplies the power for the tobacco company to run?’ Lydenberg draws the line at whether service providers are ‘key enablers’ – companies that provide something that actually goes into a product. But compliance analysis, he admits, can sometimes risk getting horribly snagged in its own nets.
Domini’s 400 Social Index – the fund draws its name from a heavy weighting to 400 large-cap screened stocks – is maintained by KLD Research & Analytics, the company that also created the exhaustive Socrates online social research database that handles Domini’s filtering process. Socrates measures issues like gender and ethnic diversity, employee relations and nuclear power. This means around half of the S&P 500 has been stripped out.
Since its 1990 start date, the Domini 400 has been a better investor punt than the S&P index, returning 438 percent compared with 368 percent from S&P in the same period. Once on the Domini index, companies tend to be stickers: only around three to four are asked to leave every year, often down to M&A activity rather than concerns over business ethics. ‘Every year we give a company the opportunity to provide input on its profile, and any other information it feels is relevant,’ Lydenberg says.
Campaigns to pressure Domini 400 companies to deal more equitably appear to work. Last year, Domini investors voiced their anger over third-world coffee growers, many of whom had been nearly obliterated by a global slump in demand. Procter & Gamble caved in and introduced a line of Fair Trade-certified coffee.
A run-in with Costco in Mexico also got tricky when the wholesaler demolished a 1931 historic hotel in the town of Cuernavaca that was packed to the roof with artistic murals, to make way for a mega-mall, tearing up ancient trees in the process. Mexican authorities backed the move but stories of bribery abounded. Domini applied shareholder pressure and Costco, it claims, has now begun to develop an anti-bribery policy.
Lydenberg says action like this shows US shareholders – some at least – are interested in investing in ethical investment products. ‘There’s this perception that the US has a long record in not participating in international treaties,’ he notes. ‘But developments in the investment world, such as the requirement that all mutual funds disclose votes on proxy issues, mean it’s not only easier to file shareholder resolutions in the US than anywhere else, but also that shareholders are more likely to oppose management on controversial issues.’
George Latham, Henderson Global Investors
A hulking 15,700-mile railway network that criss-crosses Canada, supporting the transport needs of heavy industry, is not an obvious cutting edge ‘green’ investment. But the Canadian National Railways (CNR) fleet is equipped with ‘smart-start’ devices that prompt trains to power down at every chance. Oil is carefully recycled. Dialogue with Native American communities living close to the rail lines is encouraged. What this means to socially responsible investment (SRI) fund manager George Latham is that CNR is a clear ‘buy’.
As are – perhaps surprisingly – pharmaceutical and bank stocks like GlaxoSmithKline and Barclays. ‘In banking,’ Latham explains, ‘we would look at responsible lending practices, remortgaging and credit card debt.’ For example, global bank Standard Chartered has an enlightened attitude toward HIV and its effect on the bank’s staff and their families in AIDS-torn southern and central Africa, says Latham.
The London-based Henderson SRI team, which manages the Global Care range of funds, comprises two fund managers, four SRI analysts and two corporate governance analysts. The retail funds adopt a darker green pigment than the institutional funds, which are screened through a lighter filter. High-minded CSR credentials are all well and good, but business sustainability backed by Latham’s investors’ cash – measured against peer and sector measuring sticks – remains the bottom line.
‘I’m looking for long-term growth, so I look strategically, but not exclusively, at certain themes, like environmental management and resource efficiency,’ he explains. Resource efficiency is a strong potential earner, he says, so insulation wholesaler SIG, for example, is a buy. Resource costs, on the other hand, are a headline issue, particularly with the European emissions trading platform that is part of the Kyoto obligations coming into force in January next year.
Good examples of companies that will benefit from increased investment in environmental infrastructure include RPS Group and Enterprise, says Latham. But what if these companies have clients who are less than ‘green’ themselves? ‘There are gray areas,’ Latham admits. ‘For example, if a company is providing housing to services people, is that classified as military money? We try to be pragmatic in interpreting the criteria, so we would say ‘no’ to a company selling military hardware, but a company selling light bulbs to the army is different.’
CEO and CFO meets are regular for Latham. Inevitably, he sometimes has to pick up the phone to tell a CEO his firm’s ethical or ‘green’ credentials are actually looking less than vert. ‘If we remove the approval status we obviously tell the company,’ Latham says, ‘but we don’t want to get caught up in playing a consultant role, telling the company how it can pass the SRI screen.’
Latham himself squirms a bit when the word ‘ethical’ is applied – often wrongly, he notes – to the funds. ‘Ethical is a difficult word,’ he explains. ‘It’s too simplistic because there are three pillars to SRI. First, there is the ethical dimension. Second, there is the opportunity side – but knowledge and sustainability themes aren’t necessarily about ethics. Third, there’s corporate accountability. These funds do all three of these things – ‘ethical’ is too one-dimensional.’
Looking ahead, European power generation looks promising, Latham says, particularly for companies such as Scottish Power and Scottish and Southern Energy, which should benefit from expected power price hikes across Northern Europe. ‘The biggest losers would be significant users of wholesale electricity, such as aluminum and electro-steel producers,’ he notes. ‘The cost of electricity can be up to 50 percent of costs in some of those industries.’
Karina Litvack, Isis
Two years ago, Isis governance social research head Karina Litvack was asked to help pull together a corporate governance code for the Russian equivalent of the SEC, the Russian Federal Commission for the Securities Market. The draft document she received back from the Russians, Litvack recalls, noted ‘that it was preferable [her emphasis] that nominees for board positions not have a record of criminal convictions. We fired straight back saying under no circumstances should there be directors with a criminal past. Their response went something like, Well, if you’re going to be like that, everyone might as well go home.
Isis’ eight Stewardship ethical funds don’t invest in Russia and the firm’s unscreened funds are run on ‘activist’ lines that ensure voting and shareholder engagement pressure is kept up against companies like ExxonMobil and Total. Some oil companies, though, do appear more attractive from an overall SRI/CSR point of view. ‘We have different striped [ethical] funds,’ Litvack explains. ‘Some are very dark green, which wouldn’t include, for example, BP. Then there are more middle of the road ethical funds that would include BP or Rio Tinto.’ The deepest green Stewardship fund – $2.7 bn – excludes bank stocks. Stewardship won’t touch arms or alcohol producers and any bank that lends money to such operators is off-list. Mortgage banks like Abbey and Northern Rock slip under the wire by virtue of their core consumer long-term lending business.
Litvack stresses the importance of IROs acting as a vital link between all company departments. ‘Let’s say you’re talking to environmental management about the company’s impact assessment of a pipeline,’ she explains, ‘and then you ask it to translate the implications on the cost of capital or return on investment – where are you adding value? Often, that department can’t answer the question. So you wind up having all these parallel dialogues. What you want is the coherent whole.’
CEO pay is an oil tanker-sized issue for Litvack, though she thinks most Americans don’t have a problem with it. ‘By and large, most Americans accept the idea that CEOs make a lot of money because they should be adding a heck of a lot of shareholder value to the company,’ Litvack says. ‘We don’t get involved with discussions on whether a CEO should earn a multiple of average earnings or lowest earnings. It’s not necessarily about equitable pay. It’s about properly aligning pay with the long-term value that person creates in that company. Stock options were thought to be the perfect instrument until they had adverse side effects, such as concentrating the holder’s mind only on the short term.’
Dr Julie Fox Gorte, Calvert
Strappy thongs, herbal tea, ethical funds – underperformance. They all seem to go together somehow. But it’s just this perception that Julie Fox Gorte, social research director at Calvert, says is so, so wrong. ‘There are still perceptions that if you get into an SRI fund you give up one or two percentage points, but we think we’ve thoroughly demolished that,’ she states.
Gorte, based in Bethesda, Maryland, is talking about Calvert Social Investors Equity (CSI) fund, advised by Dan Boone of Atlanta Capital Management. Boone has just been named a Business Week mutual fund manager of the year. The fund is five-star rated by Morningstar and has beaten the S&P for the last five consecutive years. ‘The point is that it is really no harder to run a good ethical fund than it is to run a normal one,’ Gorte notes.
In total, Calvert has seven SRI funds totaling $3.2 bn, and invests in 1,200-1,500 firms every year, mostly large caps. Independent verification of a company’s environmental and SRI performance can be winnowed from web sites like Scorecard.org, says Gorte. ‘We also get a lot of information from government data providers such as the Environmental Protection Agency (EPA) and the Department of Labor,’ she adds. ‘Sometimes, information on corporate social performance comes from non-profit or watchdog groups such as Caniccor, which is an SRI database provider for financial institutions.’
Still, Calvert’s SRI funds invest in the boom-time emerging markets of Russia and China where corporate transparency isn’t so hot and human rights records are often grim. ‘It’s true many emerging or developing nations have poor records on social issues,’ Gorte admits. ‘But there are companies headquartered in emerging markets that do a much better job than their national governments when it comes to treating workers and communities well, and managing environmental impacts. The important thing for Calvert is to examine the firm – not just to decide all companies in countries with problematic records are poor corporate citizens.’
Back on home turf, Gorte says CEO pay continues to be a sensitive, high-voltage issue for investors. ‘It’s one of those issues that unites Americans unlike any other,’ she explains. ‘Superstar CEOs are definitely a trouble spot, especially where large transactions like personal loans between the company and its senior executives or board members take place.’
Gorte is skeptical about board independence, too. ‘Disney’s new chairman is George Mitchell, a former senator and very statesmanlike,’ she says. ‘But those who purport to be close to Eisner say Mitchell is very close to him. So is Mitchell truly independent?’
Adrian Holliday is a London-based freelance business journalist, specializing in investment and finance issues.
