DJSI Adds "Sin" Stocks to Indexes, Raising Questions on the Definition of Sustainability



On September 4, the Dow Jones Sustainability Indexes (DJSI) and the Sustainable Asset Management (SAM) announced the reconstitution of the DJSI based on their annual analyses of eligible companies. Many social investors were surprised at the addition of companies from the tobacco and arms manufacturing sectors. Tobacco producer British American Tobacco (BATS.L) and arms manufacturer United Technologies (ticker: UTX) are new DJSI constituents that have been shunned by many social investors for years

The Director of London-based Action on Smoking and Health (ASH) Clive Bates sent a letter to SAM Head of Research Alois Flatz calling into question the inclusion of British American Tobacco in an index of companies defined by their commitment to sustainability. Mr. Flatz clarified SAM’s definition of sustainability.

"We do not consider BAT a ‘sustainable company.’" Mr. Flatz wrote. "No company anywhere is sustainable in an absolute sense. We identify companies that lead in the transition to a sustainable future, and therefore identify the relative sustainability performance of a company to its peer group."

SAM and DJSI use a best-in-class approach that identifies the top sustainability performer in all sectors, regardless of any given sector’s social or environmental impact. It is possible that if no company in a given sector exceeds a defined threshold of sustainability, no company in that sector is included in the indexes. In other words, SAM and DJSI do not include a bad company just because its peers are even worse. However, they do not exclude a company simply because it operates in a so-called ‘sin’ sector such as arms or tobacco.

"If you exclude them, you do not give them an appropriate incentive to improve," said SAM Managing Director Alexander Barkawi. "Also, we cater to mainstream investors who want to be exposed to the entire economy in their portfolios. The exclusion of an industry is an ethical decision, with so many different views on what industry is considered ‘sin.’ We therefore follow a flexible approach of providing a composite index and at the same time subset indexes that exclude certain industries. And then the asset manager or the licensee can decide which path to follow."

The inclusion of United Technologies and BAT particularly concerned the Dutch asset management firm Robeco. The additions prompted Robeco, which manages approximately $106 million US, to discontinue using DJSI to benchmark its Duurzaam Aandelen fund. The Duurzaam Aandelen fund excludes armaments and tobacco as well as fur, pornography, and gambling.

"Once we decided we had to switch to another index, we took into consideration not only other SAM DJSI indices but also sustainable indices from other providers like FTSE," said Ronald Florisson of Robeco’s Corporate Communications department. "Based on a number of criteria such as sector and regional weight, market capitalization, and definition of sustainability, we decided to use the FTSE4Good Global index. The definitions of FTSE4Good as well as the combination with the expertise from EIRIS [Ethical Investment Research Service] used by FTSE resulted in better fit to our SRI philosophy."

FTSE4Good excludes companies involved in tobacco, arms, and nuclear power. Exclusions represent the other major strategy in socially responsible investing besides best-in-class. Both practices are employed by social investors, depending on which fits best with their philosophical approach to investing.

While Robeco’s defection represents an expression of preference for one method of advocating sustainability over another, both methods enjoy widespread support. Robeco’s action is counterbalanced by opinion that calls into question the exclusionary approach. In his presentation at the New Zealand Socially Responsible Investment (SRI) Conference in May, VicSuper CEO Bob Welsh explained how his foundation, which manages a multi-employer superannuation fund for the State of Victoria, considered applying SRI criteria to its investments.

"Our research started with a look at ethical investing," said Mr. Welsh. "We were disappointed as this approach seemed to involve a moralistic and often single issue focus: no nuke, no grog, no smokes."

Instead of implementing exclusions, VicSuper selected a fund manager who screened companies on a best-in-class basis.

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