Turning morals into money
Paula Garrido assesses the trend for socially responsible investment by funds
If pensions funds in Europe do not get involved in examining socially responsible investment (SRI) issues, they may find that SRI issues are brought to them, as is already happening in the UK.
By July 2000, UK’s pension fund trustees will have to include their approach to SRI in their Statement of Investment Principles (SIP). The new legislation does not require pension funds to pursue SRI policies , but they must specify in their SIP to what extent these policies are being followed. The government says the aim is to ensure SRI issues are debated.
An earlier survey this year by the National Association of Pension Funds (NAPF) underlined that pension fund trustees continue to regard financial considerations as their prime concern.
Earlier this year Ann Robinson, NAPF director general, said: “Most trustees see their fiduciary duties to scheme members and employers who bear the cost of running schemes to be their primary responsibility, and the lack of firm evidence that ethical funds perform at least as well as other investment continues to be a deterrent. However, that some schemes have considered ethical investment shows that debate on the issue has highlighted awareness.”
The debate is becoming increasingly political. At a recent ERPF/NAPF international conference in Monaco, Peter Murray, head of the Railway Pension Trust, commented that the new regulations could limit funds’ freedom to invest in tobacco companies and other industries considered unethical or environmentally unfriendly. He said the government was turning the spotlight on pension fund trustees, instead of introducing an election manifesto commitment to ban cigarette sales, thus making trustees responsible for the tobacco industry’s future. Murray said that if tobacco shares, for example, were excluded, it was possible that pension fund performance could be reduced. The thinking goes that those trustees who do not take an anti-tobacco stance could be targeted by campaigners, thus forcing them to contravene UK trust law by neglecting to invest in high-performing companies that deliver high returns to scheme members.
But SRI and acting in the best interest of plan members should be compatible, a report by consultants Frank Russell Company underlines. Report co-author Bob Collie says: “Most private sector funds will go down the minimum-compliance route. This means asserting in the_SIP a well-crafted sentence or paragraph that does not signal a change in the current investment practices.” Trustees adopting a socially responsible approach should ensure that these policies do not reduce the expected returns, and that they maintain effective diversification, can be implemented effectively, have general member support and are well documented.
Russell expects local authority pension funds to pursue SRI policies more aggressively than private sector funds. Local authorities have been the natural starting point for SRI policies because they can see, at ground level, how public opinion is being formed. Roger Latham, Nottinghamshire County Council treasurer, who wrote a keynote report on the issues for pension funds. He gives several reasons why local authorities are showing more interest in SRI than the average pension funds. “One is that we are essentially public sector bodies with responsibilities in social and environmental issues. There is a natural interest among the trustees of the pension funds about environmental issues,” he says.
Another reason is legislation. “Following the Rio and Kyoto summits, the government has given specific responsibilities to local authorities to have a policy on responding to environmental and climate change issues,” he says.
“At present, we are dealing fundamentally with environmental issues. We look at ethical investment but we have yet to come to a firm view about a policy on that,” Latham says. “We have done quite a lot of very detailed research and the results convinced us that there was a good reason to believe that by taking environmental issues into account, we could improve the return of pension funds and, therefore, we think that it is important to pursue that return and see whether or not, in practice, we could achieve what our research suggested we can.”
Latham believes the new regulation will have a positive impact. Those companies who believe that SRI is not part of their fundamental investing policies will just say “we do not do that, full stop”, he comments. “But for those who are wavering, the tendency will be to say something more positive than negative. This may encourage people who are thinking about these issues to make positive statements and start to take action.”
Nottinghamshire county council’s pension fund has £1.3bn ($2bn) in assets and dedicates £150m to SRI. It recently appointed London-based Henderson Investors to manage part of this. The company is a typical example of a fund manager that believes now is the right moment to invest in a socially responsible way.
“Ethical and socially responsible investment encompasses a range of different approaches,” says Henderson’s Mike Shaw. “Typically in the past, ethical investing has been about excluding certain companies or industries on the basis that their business activities in some way were regarded as being unethical. That has evolved over the years into SRI.
“We undertake ethical investment but we also do investment which is based more on an environmental approach. The two key elements in being able to deliver professional SRI are a good investment process and a very powerful research that enable us to analyse companies from an environmental, ethical or social perspective. In general, there is very little information available about companies activities and we believe that by integrating our own research into the investment process, we can simply move quicker.”
Henderson offers clients a ‘menu’. “Sometimes they come to you with a very clear idea of what they want. Nottinghamshire County, for instance, has very strong environmental concerns. For others, religious and ethical issues are more important. Because sometimes there are two different perspectives on one issue, we need to know our clients’ views and have the right information in order to build a portfolio with the restrictions they desire,” says Kate Murphy of Henderson.
When investing in difficult regions, Henderson takes a company-by-company approach. “You can think that investing in certain countries – such as Indonesia – does not feel right, but we know companies there who are doing fantastic things in terms of SRI. You have to go there to find out whether these companies have links with the government or the military, or whether there are involved in that oppressive regime. We have discovered that some Indonesian companies are actually bringing very good practice into the economy and should be encouraged with investments,” Murphy says. “This is a classical example of why doing your own research is so important.”
Interest in SRI is growing throughout Europe. In Switzerland, the Ethos foundation was created two years ago by two pension funds: the CIA (Geneva canton pension scheme for public employees) and the private pension fund of Geneva’s building companies. Both funds wanted to have their assets managed taking into account not only financial criteria, but also environmental and social issues.
With more than 27,000 members, the CIA pension scheme is one of the country’s largest and it has been increasing its exposure to equities in order to get more long-term returns. The funds believe companies chosen for environmental and social criteria will outperform others because they will prove to have higher quality management and vision.
Ethos director Dominique Biedermann believes pension funds in Switzerland are increasingly choosing a sustainable development approach, which means putting financial management and environmental considerations at the same level. “We began two years ago with two pension funds and now we have 65,” he says. The foundation, which works with banks Lombard Odier and Banque Sarasin, now manages Sfr550m (e344m).
Biedermann considers that in terms of SRI policies, public pension funds are doing more on the voting rights side. “Public pension funds are more free to vote at general assemblies, because they are more independent. But on the investment side, the SRI trend is affecting private pensions in the same way,” he says.
In Sweden, KPA (Local Government Pensions) has developed investment criteria to screen for companies from the areas of weapons production, tobacco, alcohol and gambling. On the environmental side they apply to two main criteria: the exclusion of fossil fuel production for energy, and uranium production.
Ronald Lubberts, from the ethical department of Amsterdam-based SNS Asset Management (SAM), stresses the importance of adequate research: “We have our own in-house team and we develop our own questionnaire and rating procedure,” he says. “They update information every time something changes in the policy of a company, and make the decision of whether we should take someone out of our ‘universe’ or not.”
SAM clients are allowed to incorporate ethics considerations into the investment process, adopting criteria related to companies’ policies on the environment, human rights, nuclear energy, genetic engineering, animal testing and social issues. Launched in 1997, the Return on Environment fund, one of the ethical funds it is offering, was, SAM says, the first Dutch investment fund for institutional investors to use a company’s environmental performance as a criterion when putting together an equity portfolio.
SAM, which has Dfl23bn (e10.4bn) assets for pension funds under manage, also finances and supports the Institute for Environmental Studies (IVM) at the Free University of Amsterdam, which runs a PhD project on the influence of financial stakeholders on the environmental policy of companies.
Lubberts thinks SRI issues are becoming very important among Dutch investors. “Now pension funds are discussing the need for investing in ethical funds, there is a debate going on,” he says.
This debate has also started in Spain, where interest in SRI has increased significantly. Gestora Renta 4, in collaboration with Fundación Ecología y Desarrollo, launched the first ethical fund approved by the Spanish government, Renta 4 Ecofondo FIM this year.
Ramón Pueyo, head of research for Fundación Ecología y Desarrollo, says: “We believe most people do not like weapons or nuclear energy but sometimes they somehow finance this activities because they don’t know where their money is being invested. We thought it was the right moment to offer this possibility to people so they can invest according to their convictions.”
Antonio García Rebollar, director general of gestora Renta 4, says: “We decided to launch this fund because we thought it was an interesting field with a lot of possibilities. Our clients are mainly institutional investors, from local authorities to one of the major Spanish companies’ pension fund.”
Since this fund was launched in April, the offer of ethical funds in Spain has increased. “At present , there are at least six or seven ethical funds in Spain. This is due to a high demand from clients who were not satisfied with the funds available in the market,” García says, adding: “People’s awareness is increasing and we are realising that ethics are profitable.”
Although it is difficult to predict the overall impact of SRI policies, more and more investors are asking about them. It is up to individual schemes to determine their own definition according to their own preferences, most companies and investors agree that SRI should combine their commitment to social and environmental issues with financial objectives. “At the end of the day, you still have to invest the money, so it is not just a question of picking up companies that look right from an ethical point of view. They also have to be good investments,” says Henderson’s Shaw.