How Long Does a Company Need to Stay in SRI Jail?
By Laura Isanuk
The modern world of Sustainable, Responsible, Impact (SRI) investing was initially based on avoiding undesirable companies.
Twenty-five years ago, responsible investment strategies were primarily based on "negative screening" which initially focused on avoiding "sin stocks" such as tobacco and alcohol. Over time, other avoidance criteria were included in the portfolio construction process to side-step companies and industries viewed as creating more negative than positive impacts. Companies causing serious environmental degradation, for example, were added to the avoidance lists beginning in the early 1990s.
More recently, portfolio managers have expanded their horizons to include evaluation of a broader set of corporate behaviors through the analysis of ESG (environmental, social, governance) factors. Some investment managers call this "positive screening;" others simply consider it part of their overall portfolio design and construction process.
Even managers who do not directly identify themselves as being in the responsible investing space are beginning to integrate ESG into portfolio construction. As the volume of available data grows, the evidence mounts that understanding such "non-financial" issues as a company's impact on its employees, customers, and communities, its impact on the natural environment which sustains us all, and its governance practices are critically important. In-depth analysis of ESG factors can shed a bright light on the financial risks and opportunities for public companies.
Some years ago, First Affirmative moved away from exclusively basing investment decisions on negative screens to focus more on the positive attributes of the companies we want to own. Our efforts are now aimed at seeking to own companies of the future.
We also redefined "SRI" as Sustainable, Responsible, Impact investing. We felt that the original acronym, which stood for “socially responsible investing,” was more negative and too restrictive. Our approach now reflects both the broadening scope of what responsible investors care about, as well as the positive impacts we can have on public companies through shareowner advocacy.
With discussions around terminology and process intensifying as the industry grows and evolves, we decided that the topic would make a great educational session at our recent regional Investing for Impact event in San Francisco. Specifically, we teed up a discussion focused on how long a company that has been shunned in the past should be considered untouchable and what might influence a manager's decision to let such a company out of "SRI Jail" and add it to a portfolio designed for responsible investors?
So Many Ways to Do SRI, So Little Consensus
What drives the future risk and impact of your portfolio? Many factors like human, social, and environmental capital.
Yelena Danzinger from HIP Investor highlighted the challenges of analyzing company investment potential when 84% of market value is considered "intangible" (value not captured in the financial statements). "Generally Accepted Accounting Principles (GAAP) do not properly account for intangible assets. In economics, land, labor, and capital are factors of production. While land is an asset on the balance sheet, labor is an expense. This can vastly miscalculate and understate the drivers of value creation for all organizations especially when many CEOs claim that people are the most important asset, but people are not classified that way financially."
The breadth and depth of ESG data now available to managers running investment strategies for responsible investors is significantly better than ever before. At the same time, the challenges managers face in deciding how to be truly responsible and positively impactful, while delivering the returns clients expect, are growing and becoming more complex.
Lincoln Pain put it this way: "If [portfolio managers] are looking at these new technologies that are avoiding the past, will they provide the upside for our clients with shorter time horizons, [or] will our clients face more risk?"
It is imperative to monitor macro data as well as actual on-the-ground behaviors and impacts. But there is no easy way to determine what tips the balance from "bad" to "good"- not yet, anyway. However, for those managers who participate in shareowner advocacy, there is always the upside of shareowner engagement creating positive change within targeted companies.
Ways to Get In and Out of SRI Jail
Companies can indeed change their behavior, and new information may present new opportunities. John Streur, CEO of Calvert Investments, stressed that Calvert works hard to gather metrics on how companies are managing risks to measure how well they are doing in meeting their responsibilities to control negative impacts and create positive ones. Streur shared a few success stories from Calvert's files.
- Ball Corporation, a worldwide leader in packaging, recently implemented a sustainability program throughout their manufacturing operations in the U.S. and eight other countries. After monitoring their progress, last year Calvert included the company in a fund portfolio.
- Similarly, Ford Motor Company had for many years been viewed as week on product safety and environmental sustainability. But, under new management, Ford has turned this around with new manufacturing techniques that have led to greater safety and sustainability. Streur says, "I think today one can look at the auto industry and see real leadership from Ford."
- Information on a company's supply chain is hard to come by, and the audit system is prone to misleading investors. Streur noted how Calvert works with small NGOs on the ground. He spotlighted Hanes for being an industry leader in supply chain best practices.
- Another Calvert holding once had a bad reputation for how it treated its workforce. However, over time, this company moved to hire and train a different type of employee and realized that a better connection with employees would result in better profits. It took about eight years to transition, but this company is now on Calvert's okay-to-buy-list.
The plethora of new information and the competitive advantages enjoyed by companies that generally receive high ESG scores has created more challenges as well as more opportunities for investment managers. The good news is that realizing positive impact in public market investments is becoming more and more of a reality every day!
Posted: April 25, 2016