Report published about Social Responsible Investment

Sustainability, a well known UK consulting firm, published for the Institute of Chartered Accountants in England and Wales (ICAEW), British Airways, Dow Chemical, Ford and the NatWest Group a report about socially responsible investment.

A Responsible Investment?

Executive summary

Socially responsible investment (SRI) is beginning to impinge on corporate consciousness in ways thought unthinkable even four years ago. The sector is, according to some estimates, worth over $2 trillion in the US and over £25 billion in the UK. The impacts of this activity are, however, being felt beyond the direct influence of this money. Screening methodologies that have been developed by SRI analysts are increasingly being used by corporations in undertaking due diligence in mergers and acquisitions, as well as by the financial mainstream as an additional tool in uncovering hidden shareholder value.

The SRI Analysts

The first part of this report deals with the tools and techniques used in researching companies’ social performance. In the absence of mandatory environmental and social reporting, SRI analysts are still forced to rely on a wide range of resources for their information. Except in the US, where regulatory requirements are stronger, the most important source of information is still the company (and particularly direct interviews), though this is supplemented with information from other sources such as the media, NGOs and regulators.

The number of issues being researched is also growing rapidly. Originally just covering five or six issues, SRI has grown to embrace over 300 different criteria. This growth shows no signs of abating with new criteria being developed continuously, ranging from gun control issues to biotechnology.

The research community is also evolving and growing in response to this change and the sector now employs approximately 40-50 full-time researchers in the UK alone. New techniques are also being developed to add further value to clients. Techniques such as scenario building, weighting and indexes are being used to rate company performance and facilitate effective SRI decision-making. This trend towards ‘higher-value added’ activities is expected to continue with new software products and more sophisticated rating systems being developed.

Selecting Companies for Investment

Techniques used for selecting companies for investments have also evolved considerably in the last ten years. Originally companies were primarily screened out of SRI funds on the basis of their activities in certain controversial sectors. Increasingly however, the screening is done on the basis of what positive activities the company is involved in. New selection techniques based on the positive selection of companies involved in ‘sustainability’ industries are increasingly popular, as are so-called ‘best-in-class’ screens that select the best performing companies in what have traditionally been seen as ‘dirty’ industries.

Fund Management

The management of funds is also an important consideration in SRI. Some funds, for example, give priority to financial considerations while others consider social issues to be the most important criteria. Attitudes to ‘engagement’ with companies also differ considerably although it seems that active engagement with companies on SRI issues is likely to grow considerably both in Europe and in the US, where it is already a distinguishing feature. Indeed, there is evidence to suggest that active engagement of company management by SRI fund managers may become the central feature of SRI.

As with other parts of the investment community, passively managed funds are increasingly popular. This follows the development of a number of ‘social indexes’ that are intended to mirror developments in the socially responsible market as a whole.

The SRI Community

Although the SRI sector is growing rapidly, it is still very small relative to the financial mainstream. For this reason, there are comparatively few analysts and funds, and these can be classified into four groups; ‘monks’, ‘merchants’, ‘crusaders’ and ‘pioneers’. Each of these has a different agenda in involving themselves in SRI (ranging from a pure focus on financial returns to an exercise in changing corporate behaviour), and have different techniques for conducting SRI (ranging from passive screening to active engagement). In addition to the four main categories of investors, an increasingly diverse range of actors is populating the field. These include the media, regulators, the general public and the companies themselves. Each of these groups is likely to develop its role, and companies in particular may have a pivotal role in expanding the boundaries of SRI.

A Future in the Mainstream?

There are still some major hurdles in getting SRI to be taken seriously by the financial mainstream. There remain concerns over fiduciary responsibility, and while the evidence of a positive correlation between environmental and financial performance is growing, this has so far been inadequate to convince the majority of mainstream investors. Perhaps more important than this is the objective of "mainstreaming the message but not the methodology", as one respondent put it. The actual language and terminology used by the SRI community need to be changed in order that financial professionals can more easily understand the investment reasoning. Equally, the methodologies used in SRI may also need to be developed into techniques that more easily mesh with those used by mainstream investors, before significant further progress is made.

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