(Published in The Financial Times of 14 december 2003).
To ask whether socially responsible investment (SRI) pays is a bit like asking whether it is possible to have your cake and eat it too. Many mainstream investors are still not convinced that it is possible to invest according to sustainable criteria and earn the same or even more than investors who are not subject to any restrictions.
On the other side, the proponents of SRI claim that it is not only good for your conscience but also for your wallet. So who is right?
Simply to repeat the mantra that SRI automatically generates systematic outperformance is not very helpful. The fact is that SRI is a complex topic, and sustainability, which lies at the core of any SRI strategy, encompasses a multitude of environmental and social factors. And, as a study by Pictet & Cie of the stock price performance of 288 European listed companies over the past 4½ years demonstrated, each of these factors has a different impact on financial performance.
Were we, for instance, merely to aggregate all the relevant sustainability indicators on an equally-weighted basis into a global sustainability score and then bet on that score, we would, as investors, have produced a significant underperformance. But, by applying a sophisticated weighting system, we were able to beat the benchmark slightly over the 4½-year period.
We found that not everything a company does to improve its SRI rating – and therefore its appeal to investors – has a positive impact. For instance, the mere existence of pleasing environmental strategies did not add any value for the investor, while actual environmental accomplishments in the field were much better rewarded. –
On the other hand, companies whose relations with clients were rated as excellent have consistently outperformed the market. The same holds true for companies benefiting from a good public reputation. They were able to reap above-average profits over 4½ years.
Oddly enough, the effect of good labour relations was neutral. Companies which supposedly had good relations with their employees were not rewarded by financial markets as expected – but nor were they penalised.
Another interesting result was that companies who were considered to have an excellent relationship with their suppliers fared worse – in financial terms – than companies who ruled their suppliers with an iron fist.
Perhaps the most surprising finding was the negative contribution of good corporate governance practices. Companies which complied with all the formal corporate governance recommendations seem to have destroyed value over the past few years. But it is important to point out that the study does not make any pronouncements on the performance contribution of other ways of improving corporate governance, such as engagement procedures or the exercise of voting rights.
So, what do these mixed findings suggest? Should performance-oriented investors only bet on sustainable factors that have proved to deliver financially as well? Hardly. While it is true that the concept of sustainability encompasses the economic viability of a company, other ingredients are needed to bake the cake, some of which seem to come at a cost.
An investment style which bets exclusively on individual supposedly value-driving factors cannot therefore be considered to be "sustainable". The challenge is to mix all the relevant sustainability factors in a judicious manner to meet the demands of sustainable development without impairing the risk and the return characteristics of the investment.
Christoph Butz is SRI specialist within the Quantitative team of Geneva-based Pictet & Cie, the Geneva-based private bank.