- About Us
- Products & Solutions
- Industry Solutions
- Thought Leadership
- News Room
- Contact Us
|
by Dorian Andritoiu
Socially Responsible Investing (“SRI”) receives significant attention among institutional investors. Specifically, many public pension plans face regulatory or other requirements that may include SRI provisions. In our view, the universe of SRI involves a wide variety of approaches, opportunities and challenges. Socially Responsible Investing is an approach to investing that seeks to channel funds towards companies which are deemed to have a positive impact on the community, employees and/or the environment. According to the Social Investment Forum, SRI encompasses approximately $2.7 trillion, or 8%, of the total U.S. investment marketplace as of December 2009. The investor base reflects a wide range of investors from individuals to corporations, universities, religious institutions, and public and private pension funds. The fastest growing segment of the SRI world is represented by institutional investors, in part due to social pressures and political motivation. The J.P. Morgan Investment Analytics and Consulting team analyzed close to 3,500 equity funds and over 1,500 fixed income funds in order to isolate those funds which offer SRI screening. On the equity side, approximately 57% of the funds offered some type of SRI screening. On the fixed income side, 38% of the 1,500 funds offered SRI screening. In Exhibits 1 and 2, we illustrate the percentage of equity and fixed income funds that offer SRI screening. Exhibit 1 – SRI Equity Funds as of December 2009
SRI screening is available for a significant component of the segregated account universe of traditional assets. The most prevalent screening methods exclude companies that produce alcohol, tobacco, firearms/weaponry, pornography and gambling. The screens may also filter out companies with a negative environmental impact and/or poor labor and community relations. Many of these managers also offer custom screening which can be implemented according to the investors’ needs. Creating a Socially Responsible Portfolio A Socially Responsible Investing strategy can be implemented in several ways. Three of the primary SRI strategies are screening, shareholder advocacy, and community investing. Screening: Screening is the most prevalent SRI strategy. Through screening, the investor is attempting to overweight the stock of companies that have demonstrated themselves to be socially responsible, and reject the stock of companies that have not demonstrated themselves to be socially responsible. The screening process generate SRI buy lists that may include those companies that have environmentally friendly products or practices, operations that exhibit respect for employees and communities, and/or products that are not harmful. Similarly, the screening process rejects the stock of companies that do not meet certain SRI guidelines. These companies are typically associated with tobacco, alcohol, weapons, gambling, nuclear operations, and other products that may be deemed to be environmentally or socially harmful. Screening also exclude those companies that do not provide safe work environments for their employees or do not respect human rights worldwide. Shareholder Advocacy or Activist Investing: In this SRI strategy, the investor acquires shares in companies that would otherwise be rejected by the screening process. The investor’s goal is to take an active role in influencing the company’s policies. Through dialogue and filing shareholder resolutions, the investor seeks to create pressure on the company’s management to amend any social, environmental or labor issues affecting the corporation. The advantage of this strategy is that it allows the investor to benefit from the company’s stock price appreciation and dividends, if there are any, while at the same time working to change the company’s policies. The disadvantage of the strategy is that it generally requires a large commitment of time and capital. Community Investing: Another SRI strategy available to the investor is community-focused investing. With this strategy, the investor directs capital to communities around the world that have limited access to traditional financial services institutions. Performance of Socially Responsible Indices Two of the most commonly used SRI Indices are the KLD 400 and the Calvert Social Index. Both indices use screening as the prevalent method for selecting their constituents. According to KLD, the KLD 400 is a float-adjusted, market capitalization-weighted, common stock index of U.S. equities. Its holdings are composed of approximately 90% large-cap companies, 9% mid-cap companies chosen for sector diversification, and 1% small-cap companies with exemplary social and environmental records. The index disqualifies companies with significant involvement in tobacco, gambling, alcohol, firearms, military weapons, and nuclear power. From 2000 to 2009, on a total return basis, the KLD 400 has underperformed when compared to the S&P 500. This underperformance could partially be attributed to the exclusion of so-called “sin stocks”. In a 2008 study titled “The Wages of Social Responsibility”, authors Meir Statman and Denys Glushkov pointed out that “sin stocks” such as tobacco, gambling, firearms, alcohol, military, and nuclear have historically outperformed the market. Another popular index used for benchmarking SRI fund performance is the Calvert Social Index. According to the Calvert web site, the index is compiled from a list of the largest U.S. companies that are listed on the NYSE and NASDAQ-AMEX: “These companies are ranked in descending order based on their three-month average market capitalization. The 1,000 largest companies are then selected for further review. The Calvert Social Research Department analyzes each company’s corporate performance to identify those with good business practices in seven broad areas including, Governance and ethics; Environment; Workplace; Product safety and impact; International operations and human rights; Indigenous peoples’ rights and Community relations.” When benchmarked against the Russell 1000, this SRI index also underperforms, on a total return basis, from 2000 to 2009. Despite lower returns of these SRI indices, there seems to be no shortage of commitment from investors. According to the Social Investment Forum, “SRI assets rose more than 324 percent from $639 billion in 1995 (the year of the first Report on Socially Responsible Investing Trends in the United States) to $2.71 trillion in 2007. During the same period, the broader universe of assets under professional management increased less than 260 percent from $7 trillion to $25.1 trillion.” A recent study, published by the CFA Digest in May 2009, suggests that the popularity of Socially Responsible Investing has lead to increased demand for the small universe of SRI stocks. As a result, investors are paying a premium for these stocks and are not generally reaping a reward. Conversely, a shortage in demand for the large universe of non-SRI stocks has left some bargains for investors. SRI investors will likely that a large part of SRI returns cannot be quantified. The societal and environmental benefits created by socially responsible corporations and investors may not always be reflected in higher per share returns. In addition, just because SRI indices fell short when compared to existing benchmarks, this does not mean that SRI funds/managers were not able to outperform their benchmarks. Four of the largest SRI mutual funds: Ariel Fund, Ariel Appreciation, Parnassus Equity Income, and PaxWorld Balanced Fund, all outperformed their benchmarks (on a total return basis) over the past 10 years. Conclusion Currently, Socially Responsible Investing is still considered a niche product. For the most part, SRI is sought by investors who uphold certain religious, social, cultural or personal values. However, as Socially Responsible Investing continues to evolve and the pool of available assets expands to include global stocks and alternative investments, SRI may continue to attract more interest from traditional investors. To view the next article, Modeling Univariate Volatility, click here.
|
print