Rather like the road to hell, the road to outperformance appears to be paved with good intentions. If the experience of socially responsible investment (SRI) in the UK is anything to go by, though, then those intentions appear somewhat half-hearted.
SRI in its purest form was the exclusion of offensive stocks, the stocks of companies whose practices were deemed offensive by pension funds and investment managers. Such an ideology has proved a little too restrictive though. “There has been a realisation that excluding certain types of security has a long-term impact on performance,” says Charles Farquharson, managing director of institutional clients at Merrill Lynch Investment Management in London.
Then there’s the problem of coverage – the Dow Jones Sustainable Global Index includes just 250 stocks for its world coverage. Another issue is subjectivity and defining ‘offensive’. Generally for anyone in the US considering SRI, tobacco, alcohol and arms are unacceptable, whereas in the UK, labour relations and the environment are of greater import.
Such are the problems that investment in socially responsible funds in the UK has been almost negligible. Miles O’Connor, head of business development at Barclays Global Investors, says there has been very little interest. “In the UK it was politically imposed and the feedback we are getting from our clients is that this is an issue they have to pay regard to but they are not prepared to put assets into a socially responsible fund.”
This is not to dismiss SRI as woolly; rather it has evolved and adapted. Corporate governance and positive engagement – working from within as an investor as opposed to overall exclusion – appear more mainstream and representative. Schroders, for example, has a number of local authority pension funds on its books that for political reasons tend to be interested in SRI and corporate governance.
There exists a belief that superior corporate governance in turn leads to superior long-term performance. But there is a great difference between corporate governance and making socially responsible investments. At present most SRI funds are performing well, yet the impression from talking to UK managers is that any fall in performance will be met with little tolerance. “Even the most left-wing authorities know that they have a fiduciary responsibility to return a certain amount,” says Bill Baker, a director at Schroder Investment Management.
So while the exclusion of certain stocks has been dismissed as too ideological, there is still progress. In the UK it is the likes of Hermes, Henderson and Friends, Ivory & Sime that are leading the way. In January the Netherlands’ PGGM awarded Friends, Ivory & Sime a E5.5bn SRI overlay mandate that will be run according to the manager’s ‘engagement approach’, which encourages the companies invested in to improve their approach to social, environmental and ethical issues. In Switzerland, State Street Global Advisors won a E325m passive SRI mandate from the Swiss federal social security fund.
Last July it became mandatory for UK pension funds to say in their statement of investment principles whether or not they follow an SRI approach and the European social investment forum, or Eurosif, is promoting SRI in Europe. Back in the UK, FTSE recently launched a series of socially responsible indices in conjunction with EIRIS, the ethical investment research service. Close Fund Management, the subsidiary of UK merchant bank Close Brothers Group, announced it was launching a fund tracking the FTSE4Good UK index.
Never has the approach received more attention but, even so, many trustees remain more preoccupied with other matters. Baring Asset Management’s CIO Michael Hughes says they put out a paper on SRI about nine months ago yet he is able to count on one hand the number of trustee meetings that have raised it. “I think there are bigger issues around. That’s not to say that it’s insignificant or won’t be of relevance but in the context of what’s happening to pensions generally, it’s quite low down the batting list.”