Socially responsible investing (SRI) has for some time been in fashion among institutional investors. Yet it is an approach that is easier to talk about than put into practice. This year’s SRI winner – the Environment Agency Active Fund – has, however, managed to translate the rhetoric into action.
The Environment Agency is the leading public body for protecting and improving the environment in England and Wales. Its corporate vision includes the need to help achieve a greener business world. This envisages an environment where industry and businesses value the assets of rich and diverse natural surroundings. In the process, they should reap the benefits of sustainable business practices, improve competitiveness and value, and win the trust of the wider community.
At €1.77bn, the Environment Agency Active Fund (EAAF) is one of the largest members of the UK’s Local Government Pension Scheme. The fund’s pensions committee – equivalent to a board of trustees – is responsible for setting its investment strategy. A key issue for the committee is how to incorporate the relevant portions of the agency’s corporate vision into an investment strategy, while maintaining its fiduciary responsibility to obtain the best risk-adjusted returns.
The EAAF has evolved a process called sustainable environmentally responsible investment (SERI), which it says is the answer to this problem.
SERI came out of research commissioned by the EAAF, demonstrating that there are positive financial benefits from investing in companies that commit to good corporate environmental governance. Furthermore, there are also positive benefits to be gained from investing in companies that avoid environmental risks, and in companies positioning to take advantage of the possibilities from ‘clean’ technologies and environmentally friendly ways of doing business.

In 2004, EAAF’s pensions committee agreed a new investment strategy based on a move from traditional balanced managers to specialist managers. At the same time, it approved an environmental overlay strategy, which set out the ways in which the fund aims to help create a greener business world. This would be done through EAAF’s strategies and policies for investment and management of its assets.
The last of the fund’s eight new managers were appointed in July 2005. The fund says that the tendering process needed to identify these new specialist managers allowed it to develop the SERI process, thereby making it a pioneer in responsible investing.
However, the fund emphasises that corporate governance is not about ticking the right boxes, because best practice corporate governance includes non-financial as well as financial matters.
The fund says that a well-governed company will exceed recognised governance standards by implementing robust non-financial governance standards, such as appointment of a nominated director to take responsibility for the company’s environmental impact. The director would be responsible for documenting an environmental policy complying with the relevant legislation, making efficient use of resources, minimising waste, preventing pollution as far as possible, and striving for continuous improvement in performance.
To promote a greener business world, EAAF’s equity managers are obliged to engage regularly with companies. They are expected to discuss key environmental risks and opportunities with company management, and to encourage greater disclosure of these issues, since no company can be properly valued without disclosure of all the relevant financial and non-financial information.
The fund’s external managers are obliged to discuss with the fund any environmental resolutions at forthcoming company meetings before the meeting takes place. Furthermore, the managers must vote at all meetings.
All the active managers are encouraged to undertake and share non-financial research with the pension fund, and to join programmes such as the Enhanced Analytics Initiative.
EAAF’s multi-manager property manager, Morley, encourages individual fund managers to achieve, as a minimum, high BREEAM ratings on developments. (BREEAM, the Building Research Establishment’s Environmental Assessment Method, is used to measure the environmental performance of both new and existing buildings, and is regarded by the UK property sector as the measure of best practice in environmental design and management.)

Morley’s individual managers are also required to take full account of potential flood risks on all holdings. EAAF prefers to avoid developments on flood plains, but where this is not possible, it requires flood risk alleviation projects to be in place. Each of its managers has to complete a due diligence questionnaire which has a clear focus on environmental issues before the EAAF invests in their fund.
EAAF’s private equity manager, Robeco, has developed its own sustainable investment guidelines, to which the fund subscribes. Potential investee funds must agree to meet these guidelines before the fund commits to them. In addition, a substantial proportion of the fund’s mandate will be invested in ‘clean technology’ funds.
Although the new strategy was only recently implemented, the fund says that the early signs are encouraging. The fund is confident that sustainable environmentally responsible investment will deliver returns at least in line with its expectations.

Highlights and achievements
The EAAF has developed the SERI model as a practical way of investing in an environmentally friendly way, while meeting its obligation to get the best possible risk-adjusted returns.
It has switched from balanced to specialist managers. These are expected to invest in companies with corporate governance standards that exceed the norm, including non-financial as well as financial standards. The managers must regularly discuss environmental issues with companies, as well as the disclosure of these issues. They must always inform the fund of any environmental vote taking place, as well as voting at all meetings. And fund managers are encouraged to undertake and share non-financial research with the EAAF.
Although it is too early to assess the financial results, the fund says that SERI will deliver results at least in line with expectations. Furthermore, the process has placed mandates with environmentally aware managers such as Robeco, which has its own sustainable investment guidelines, and Morley, on the property side, which insists on the use of the BREEAM benchmark, as well as consideration of flood risks, by its individual managers.