The emergence of socially responsible investment (SRI) funds in the Australian market over the past several years has highlighted a number of issues.
Firstly, it has shown that a significant number of investors want to include long-term sustainability in their investment rationale. For such investors, short-term profitability is not acceptable if it means a company is using negative social or environmental practices. It has also shown that some critics of SRI are very difficult to please.
The material to date on SRI funds shows a wide variety of findings and therefore tends to support any view on the topic. For instance, some studies confirm that SRI funds underperform in the wider market while plenty of others conclude the opposite.
However, some Australian studies have produced consistent findings which are overwhelmingly negative. Surprisingly, these studies are usually produced by groups that seemingly would stand to benefit much from the growth of the SRI market.
For all their differences, environment groups share the common agenda of protecting nature. It is, of course, a worthwhile cause. Who wants to live in a polluted world surrounded with rapidly disappearing wildlife?
So presumably funds managed with the specific goal of directing capital towards companies with reduced environmental and social impacts would be favourably received by these groups. Right? Wrong!
Over the past several years, a number of mainstream fund managers have launched products onto the SRI market. These include AMP, ING, Perpetual, Rothschild and Westpac. Others have integrated assessment of social and environmental aspects of company operations with traditional financial analysis to obtain a more rounded picture of the investment merits of a company.
However, it is these very funds which have been exposed to the criticisms and derision of numerous environmental groups. Why are SRI funds criticised when funds that do not even attempt to place a value on the environmental impacts of business are not?
The moral high ground
The origins of social responsible investing provide a clue to this apparent anomaly in the expected support of SRI funds. The term "socially responsible" (or increasingly, "sustainable") investing has arisen from "ethical" investment.
In its earliest incarnation, the investment style that aimed not to invest in companies involved in activities perceived as harmful was primarily concerned with aligning investment practices with personal codes of morality.
Church groups were instrumental in establishing this style of investing. Thus, any producer of a product not meeting church approval would be ineligible as an investment target for a church-based ethical fund.
In recent years, the emphasis on this style of investing has shifted somewhat, to remove the notion of ethics and replace this instead with the notion of long-term sustainability. This encompasses both financial and social aspects, with social aspects intrinsically linked to environmental aspects.
This shift in definition has removed the contentious argument of morality and ethics. SRI funds are increasingly looking at how companies operate to assess how sustainable investing in that company would be, rather than looking at whether company activities meet the personal standards of an individual, (and morally superior) investor.
SRI fund philosophy has changed, what else should?
What implications does this change have on companies and SRI? For companies, this shift in investment parameters by SRI fund managers theoretically should have little impact on their activities. After all, management should always focus on maintaining the long-term sustainability of earnings.
Strategic decisions based on factors beyond purely financial ones should be part of this. In other words, businesses are always best advised to account for environmental impacts, and to value strong links in the wider community.
Companies that do these things will be at an advantage compared with those that do not. Those companies that do consider broader environmental and social impacts should not be blind-sided by impending changes in environmental aspects (such as those resulting from the current drought) or by changes in social attitudes (which should be discerned in advance if stakeholder views are considered important).
For an optimally managed company, SRI should be seen as a validation of what is important in strategic operations. On the other hand, companies that do not operate in a manner that is sustainable in the long term, will one day find themselves having to address concerns that are more fundamental than whether an SRI manager will hold their stock.
So companies should only really be affected by SRI funds if those funds highlight inadequacies in the way those companies address issues affecting future earning capacity.
But what about investors?
How should changes in SRI philosophy affect those that seek to support companies that affect positive environmental or social change, while obtaining positive financial returns at the same time?
In short, it shouldn't. Investing is fundamentally about generating returns. SRI investing adds another factor to this, but it is still a method to deliver a financial benefit to the investor. This fundamental truth needs to be restated to some groups who lose sight of this, and confuse SRI funds with venture capital or charitable funds.
SRI funds are investment vehicles, not moral arbiters. Given that the fundamental truths of investing apply equally to SRI, it should be clear that some overlaps should exist between mainstream funds and SRI funds.
Depending on particular fund styles, some overlap in investment targets will be inevitable, particularly where funds are limited to domestic equities in a relatively small market.
Where a stock held by an SRI fund does not match the ethical ideals of a certain group of investors, an automatic response seems to be to criticise the SRI fund, alleging misleading or deceptive practices.
But why should fund holdings match with the ideals of all groups with a loudly stated concern for environmental and social issues? A managed fund with a conservative growth strategy is not criticised by groups who feel certain stocks in the portfolio would be better labelled as high growth.
Yet SRI funds face such definitional criticisms very day. The investors channelling money into these funds could be reasonably expected to be those who share a concern for environmental and social issues. But beyond that, there will be differences in opinion as to how each investor feels that environmental and social best practice be followed.
For example, should an SRI fund hold stock in a resources company? Some SRI investors would argue that they should, since extracted resources are vital to maintaining current levels of (economic and social) development, and are therefore sustainable in the current social climate.
Provided that the company in question meets appropriate standards--such as maintaining an environmental management system and undertaking site remediation--investors see that material benefits can be gained whilst supporting a responsible company in a vital industry. Others argue that under no circumstances should an investor pour money into a company active in a contentious industry.
But the list of industries that are "contentious" will always be subject to individual views.
Sustainable activities in banking and finance
Rightly or wrongly, SRI funds find themselves the targets of criticism. The banking and finance industry in general attracts criticism from many of the very same critics, and for many of the same reasons.
This industry does have a long way to go until it is beyond reproach in terms of its environmental and social sensitivity, but this is true of all industries, all markets and all societies. This is due to one simple fact: every action has an environmental and social impact.
Financial institutions are undertaking efforts to address these impacts. Westpac, for instance, has measured its social and environmental impact by becoming the first Australian bank to adopt so-called triple bottom line reporting.
In the case of the Commonwealth Bank of Australia, much of the bank's 2002 annual meeting was devoted to discussing a Wilderness Society-introduced motion calling for the bank to cease investing in the timber company Gunns Ltd. While the motion was defeated by proxy votes, it drew surprisingly strong support from the floor.
Many financial institutions also display initiatives that demonstrate such efforts to take wider aspects of corporate activity into account.
These include implementing environmental management systems, increased dialogue with communities the companies operate in, accounting for environmental exposures, and the development of specialised financial products.
SRI funds are an example of such specialised products. These funds should be seen for what they are: profit-seeking funds that consider environmental and social aspects when making investment decisions.
Not all decisions will be met with unanimous support, but this is true of investment decisions that are made without consideration of environmental or social impacts.
Rather than deriding such funds, critics should instead welcome the integration of financial and non-financial investment parameters.
There is room for debate and for constructive criticism. What there is not room for is automatic negativity, or worse, indignant offence towards SRI funds. Such responses to SRI demonstrate a lack of awareness of the realities of investing.
By jeopardising the success of SRI, such criticism is counter-productive to the long-term aim of making commercial and social development truly sustainable.
MICHAEL HARDIMAN AAIBF (SNR) IS AN ANALYST AND RESEARCH MANAGER AT THE SUSTAINABLE INVESTMENT RESEARCH INSTITUTE (SIRIS). FAYE HARRISON WAS ALSO AN ANALYST AT SIRIS, AFTER HAVING WORKED IN FUNDS MANAGEMENT IN LONDON. SHE IS AGAIN NOW BASED IN THE UK.…