Some companies may not realise that they're attractive to the socially responsible investment community
Any discussion about what turns on the socially responsible investment (SRI) community inevitably begins with what turns it off – and some companies just don’t have the right DNA to walk down the model company runway. Even a robust financial figure won’t help a ‘sin stock’, while companies involved in nuclear power or extractive industries – such as oil, gas and mining – usually find themselves summarily excluded from social investments.
Conversely, other companies may not even realize they’re attractive to the SRI community. They’re not green, they’re not goody-two-shoes, so they’ve ignored the hitherto marginal pool of ethical capital. That pool, however, is growing big – and fast. According to the Social Investment Forum, portfolios – screened to some degree according to SRI criteria – amount to almost $2.2 tn. What’s more, social investors have a reputation for being patient, long-term stockholders, even though some well-exercised vocal chords (especially during proxy season) might very well suggest otherwise.
That’s why IROs should learn more about them and what it takes to catch their eye. How can you tell if your company is an SRI candidate? Moreover, how do you best position your investment story to attract SRI attention?
Digging deep
The initial hurdle is a basic industry screen, including, of course, a sin screen. ‘Typical investors come to SRI first to avoid something,’ comments Peter Kinder, president and co-founder of KLD Research & Analytics, which provides benchmark indexes and research for socially responsible investors. ‘They don’t like tobacco; they don’t want major environmental polluters. They come with a feeling that certain companies are inconsistent with what they want.’
Passing that first test may get you into a mainstream pension portfolio with cursory screening, but serious SRI players dig deeper. Calvert, with $4.6 bn in social investments under management, further evaluates prospective investments using seven screens, explains Stu Dalheim, manager of advocacy and policy. These include governance and ethics, environment, workplace, product safety and impact, international operations and human rights, indigenous peoples’ rights, and community relations.
During the social screening process, analysts cull information from a wide variety of sources including government filings and actions from the SEC, Environmental Protection Agency (EPA), Occupational Safety and Health Administration (OSHA), and so on; Stanford University’s Securities Class Action Clearinghouse; Nexus; the Consumer Product Safety Commission; and news reports.
Different industry sectors shape expectations of social behavior. ‘A manufacturing company has to have stronger environmental performance and systems than a company that develops software because the environmental impact is very different,’ Dalheim says.
While one unfavorable report won’t knock a company out of the running, it must pass every social screen to make the final cut. ‘A company could be stellar in six areas, but if it didn’t meet the requirements of one screen we wouldn’t be able to invest in it,’ Dalheim adds. Although each screen examines different behavior, some commonalities must exist – good disclosure, transparency and strong systems to enforce appropriate policies.
‘We want to invest in companies that have good governance practices, board independence and diversity, and women and minorities represented on their boards,’ notes Dalheim, commenting on Calvert’s ethics and governance screen. ‘We want to avoid companies that violate the law, violate privacy rules or engage in corruption or bribery.’
Full screen ahead
Calvert’s environmental screen places a strong emphasis on how a company manages the full life cycle of its products – from pollution generated and waste produced during production to mitigating the environmental impact of its processes. A workplace screen seeks to identify companies that compensate workers fairly, hire and promote women and minorities, maintain good labor relations, provide a safe and healthy workplace, and offer good benefits for employees and their families.
Another screen looks for companies that respect the rights of indigenous people and seek to minimize the impact business will have on their land, heritage and environment, while a community relations screen identifies companies that are responsible corporate citizens and examines the extent of corporate philanthropy and employee volunteerism.
Doing business overseas brings a host of new challenges. ‘With globalization and expanding supply chains, companies are coming into contact with a range of environmental and social issues they haven’t faced before to such a degree,’ says Gavin Power, senior officer and head of financial markets initiatives for the United Nations Global Compact, a CSR initiative that includes nearly 2,500 companies from 80 countries.
Power lists developing world issues such as ‘endemic poverty, suppression of human rights, a range of health concerns and related pandemics such as HIV-Aids, labor standards in the supply chain and climate change. Environmental and social topics are no longer soft issues. They are serious matters that relate directly to risk management and, increasingly, to business opportunity. But the risk aspect is quite significant.’
The Global Compact has set down corporate social responsibility (CSR) principles for companies. The next step will be a companion set of principles for investors. Pension funds, other institutional investors and banks have banded together under the auspices of the Global Compact and the UN Environment Program Finance Initiative to develop principles of responsible investment that will integrate environmental, social and governance considerations in their investment processes.
‘The working thesis is that these issues can be, and often are, material to long-term investment horizons,’ states Power. ‘When the principles are announced in March, I think they’re going to send a signal to financial markets that institutional investors are taking these issues seriously.’
Some companies, though conscious of room for improvement and subsequently making an effort, may be unaware they’re included in the Calvert Social Index or the Domini 400 Social Index, or that they have significant SRI ownership. So exactly how ‘perfect’ are companies tapped by the SRI community?
Complex entities
‘We really try to avoid this whole concept of companies as either devils or angels,’ says Adam Kanzer, general counsel and director of social advocacy at Domini Social Investments, which is devoted exclusively to SRI with about $1.8 bn under management. ‘Companies are very complex entities. They have lots of good and bad qualities – and they can change.’
Of the companies in Domini’s socially screened funds, Kanzer says, ‘They’re not perfect, but we think they are companies that are moving in the right direction and that have certain qualities we’d like to reward from a social perspective.’
Social investors are not shy about calling for change – shareholder activism goes with their turf. Any company targeting social investors should prepare for an active and ongoing dialogue with these stockholders. ‘We’re all investors,’ says Sister Patricia Wolf, executive director of the Interfaith Center on Corporate Responsibility (ICCR), a coalition of 275 faith-based institutional investors with a combined portfolio value estimated at $110 bn. ‘We expect, and want, the company to do well. Our engagement with the company has to do with how it can improve within the scope of the areas ICCR has identified as critical issues.’
Let’s assume you’re confident your corporate closets are clean of social and environmental skeletons, and you’re not afraid of engaging with activist shareholders. Is more groundwork needed before setting up some one-on-ones with social investors? ‘You can’t wait to become perfect because you’re never going to be perfect,’ says Kellie McElhaney, executive director of the Center for Responsible Business at the University of California’s Haas School of Business. On the other hand, McElhaney urges companies to develop CSR commitment and execution before talking it up. ‘Any company going out there to do a big campaign about CSR before the substance or content is in place is absolutely crazy and will get called on the carpet,’ she warns.
No avoiding the issue
Social and environmental reporting is, of course, a must. Remember the lesson of UK supermarket chain Tesco, which was left out of the first FTSE4Good index not because it was any worse than other companies in the index (like BP and Shell, for instance), but because it had yet to start social or environmental reporting. ‘All investors have put an increasing premium on transparency and disclosure,’ says Steve Lippman, vice president of social research at Trillium Asset Management, an SRI firm. ‘So we’ve looked for companies to report more on what they’re doing on social and environmental issues.’
According to a 2005 study conducted by the Social Investment Research Analyst Network (Siran), an increasing number of large publicly traded companies are reporting annually on their social and environmental performance, sometimes on company web sites. ‘Of the companies in the S&P 100, about 40 percent are issuing annual sustainability reports and about 25 percent are basing their report on Global Reporting Initiative guidelines,’ says Lippman, who is also co-chair of Siran.
Nevertheless, companies should not expect the SRI community to accept corporate reports simply without question. ‘When a company publishes an internally created corporate citizenship report, non-Gaap report or CSR report, that sets off a red flag right away,’ says Joe Sibilia, president and CEO of Meadowbrook Lane Capital, an SRI bank. ‘You need third-party verification – outside, independent verification.’
A lot of information is outside the IRO’s control because SRI funds increasingly look beyond both financial statements and non-financial reports, explains Sibilia, who is also president of CSRwire, a newswire service. He cites internet blogs as a good way to discover what employees, vendors and suppliers are saying about a company.
Another way to find out how these fund managers research potential investments is to simply ask them where they look to gather information on companies of interest. While not all will be willing to divulge their research techniques, some may be surprisingly candid.