In light of last year’s financial meltdown—a meltdown forewarned by many SRI funds—an increased emphasis on the consideration of environmental, social, and governance (ESG) criteria in investment strategies has gained wider clout.

Given the long-term investment horizon espoused by many who employ ESG considerations in their investment decision-making process, it is still far too early to discern if such factors will lead to outperformance over five or ten years. But as an early indicator of such a strategy, the year-to-date performance through November 30 of the Domini Social Equity Fund provides signs of positive growth.

Managed by Domini Social Investments, with Wellington Management performing as submanager—the Fund has been actively traded since November, 2006—, the Domini Social Equity Fund posted returns of 31.43% through November 30, outperforming the S&P 500 by more than 7%.

The Domini Social Equity Fund invests primarily in stocks of large-cap US companies, which are screened against Domini’s social and environmental standards to assess the quality of a corporation’s relations with communities, customers, ecosystems, employees, investors, and suppliers. As of November 30, the Fund’s largest holdings were Johnson & Johnson, IBM, and Microsoft.

The one-year returns posted by the Fund have been even more impressive. Its gain of 34.73% over one year outpaced the S&P 500 by more than 9%.

The Domini Fund’s weighting are biased toward Information Technology, Financials, and Health Care.

A significant aspect of Domini’s mission for the last 15 years has been shareowner activism, and 2009 saw the filing of its 200th shareowner resolution. Resolutions filed in 2009 addressed freedom of expression and privacy on the Internet, and predatory credit card practices. Domini also worked with the Securities and Exchange Commission (SEC) to require companies to report on their impact on society and the environment, and increase proxy access by share owners.

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By the end of September, investors in the JSE will be a step closer to accessing a fast developing global investment theme – responsible investment – as the exchange starts to disseminate live values of its Socially Responsible Investment (SRI) Index to the trading screens of thousands of investors worldwide.

The SRI index is a South African benchmark for corporate citizenship, and has as its constituents JSE-listed companies with high standards of environmental, economic and social performance as well as good governance.

Until now, only close of day values of the SRI index have been available, and the JSE hopes the new development will prompt the creation of instruments based on the index, to be traded on the exchange.

Responsible investing

According to the JSE, responsible investing, a significant investment theme in many developed countries, is also growing in South Africa.

Institutional interest in responsible investing came of age in 2008 when South Africa’s largest pension fund, the Government Employees Pension Fund (GEPF), placed its weight behind the index and required institutions managing GEPF funds to support responsible investing.

“Investors are no longer content to use the SRI Index as a benchmark, but would like to track the performance of the index on a minute-by-minute basis,” the JSE’s Corli le Roux said in a statement earlier this month.

“This development is significant as it opens the door to investment avenues on the index, which is in-line with our vision to make responsible investment accessible and be seen as mainstream investment activity rather than a peripheral one.”

Like the FTSE/JSE Top40 index or any other JSE index, it will now be possible to track the performance of the index at any time during the trading day. This makes it more attractive for a market maker to create products such as exchange traded funds (ETFs), unit trusts or tracker funds based on the index.

“Responsible investment is coming of age and is increasingly important to investors, most notably for institutional investors such as pension funds,” said Le Roux.

“This is being pushed by drivers such as the UN Principles of Responsible Investment, which is burgeoning in support globally as well as locally, where the Index has been an aspirational benchmark for some years, and the recent launch of King III which is likely to provide added impetus.”

‘Good corporate citizens’

The SRI Index is calculated by the JSE, and constituents are drawn from the companies that meet the SRI criteria as well as set liquidity ratios. It acts as a tool for investors to select certified good corporate citizens and a benchmark for companies looking to improve corporate responsibility.

Since 2008, South Africa’s largest pension fund, the Government Employee Pension Fund, has collaborated with the JSE on the SRI index, and plans to use the index to inform its investment decisions.

David van der Roest

 The groundbreaking “Carbon Counts USA” report examines the carbon performance of major U.S. mutual funds with a combined value of $1,551,067 million. The research covers 75 of the nation’s largest equity funds and 16 major sustainability/socially responsible investment (SRI) funds, using fund holdings and style analysis data provided by Lipper, a Thomson Reuters company.

Analysis of the greenhouse gas emissions associated with eight investment styles shows that overall, sustainability/SRI funds have a smaller carbon footprint than core, growth, value, index, country/regional, equity income and sector funds. However, some of the largest SRI funds are among the most carbon-intensive analyzed, reflecting the diverse environmental, social and governance criteria used by managers.

 Simon Thomas, Trucost Chief Executive, said: “The research findings provide valuable information to fund managers and institutional investors looking to identify exposure to future liabilities from carbon emitted by companies in their funds. Using Trucost data, asset managers can reduce the carbon footprints of funds that employ any investment style to control carbon risks, without sacrificing financial returns.”

 Dr. James Salo, report author and vice president, strategy and research, Trucost, said: “Carbon emissions are a financial issue that will soon have a real price in the US, and companies and shareholders will likely bear a percentage of this cost in the future. Fund managers and asset owners can use carbon analysis to protect their assets from these costs.”

 Funds with large carbon footprints have holdings which could face greater financial risk from carbon being priced under cap-and-trade schemes. Companies with heavy carbon footprints for their sectors could be hardest hit by carbon costs under carbon trading, promised in the latest U.S. federal budget. The carbon intensity of companies will influence which are most exposed, with knock-on effects on investment returns. Carbon-efficient investment funds are set to be well positioned under carbon constraints.
 
Other findings in Carbon Counts USA: The Carbon Footprints of Mutual Funds in the U.S. include:

• The combined global emissions associated with fund holdings analyzed amount to over 615 million metric tons of greenhouse gases.
•  The carbon footprints of aggregated fund holdings is measured as 335 metric tons of greenhouse gas emissions for every million dollars of revenue allocated to holdings.
• Fund managers can reduce fund exposure to carbon liabilities while maintaining financial returns. Standard & Poor’s, NYSE Euronext and UBS are among financial institutions that are using carbon footprint data to manage carbon risks in indices and funds.

The most carbon-efficient mutual funds have the following characteristics:

• Each of the five most carbon-efficient funds has a different manager.
• Four of the funds do not invest in the Basic Resources sector.
• The top three do not invest in the carbon-intensive Utilities and Oil & Gas sectors, and have 80%+ invested in low-carbon sectors such as Financial Services, Banks, and Healthcare.
• Three of the funds are underweight in Food & Beverage companies relative to the S&P 500; the other two do not invest in the sector.
• The top two funds have a Sector investment style; two of the top five are Growth funds, and one is a Sustainability/SRI fund.

The least carbon-efficient funds share the following characteristics:

• Each of the five least carbon-efficient funds has a different manager.
• Four are underweight the Utilities sector against the S&P 500, but three pick Utilities stocks that are more carbon intensive than sector peers in the Index.
• For four of the five funds, stock selection rather than sector allocation is the main cause of their high carbon intensity against the benchmark S&P 500.
• Two are Growth funds, two are specific to either a sector or country, and the fifth is a Sustainability/SRI fund.

 Trucost method to calculate fund carbon footprints

Trucost has the world’s largest database of corporate greenhouse gas emissions. Carbon footprints of both active and index funds were measured where Trucost holds greenhouse gas emissions data on more than 90% of the value of holdings, using free-float adjusted holdings data as of 31 December 2008. Emissions are converted to their carbon dioxide-equivalents (CO 2-e). Total C02-e emissions are attributed to each fund in proportion to ownership of each company. To compare funds of different sizes, carbon footprints are calculated as quantities of CO 2-e emissions per million U.S. dollars of revenue.

Most outsiders, like me, assumed that a post-SOX world would ensure safe and transparent investments for the masses.  As we now know, things have only gotten worse.  Corporate behavior, especially in the finance sector, has been exemplified by the events surrounding Madoff and the obscene compensation packages on Wall Street.

As an optimist, I view all these events as a huge market correction which will alter how business is done in the future.  At the core of this correction, everyone from CEOs to hedge fund managers will have to re-discover new ways to attract capital.  I believe that this unending search for capital, in a free market, will require that firms embrace a socially responsible paradigm for interacting with investors, regulators, and the environments. 

Today, SRI is an alternative strategy for the highly enlighten.  Tomorrow, it will be the battle cry of every firm wanting to survive in a 21^st century economy.           

Job losses at these beleaguered financial services giants are hardly surprising, but the decision to completely slash these teams rather than just reducing their size could be taken as a sign of Wall Street’s attitude towards ethical investing – wealthy clients might like the idea of portraying themselves as investors with a conscious when markets are booming, but in tough times, making money is all that counts.

There is little doubt that wealthy investors have flocked to ethical and socially responsible investing in recent years. Europe provides a good example of this trend. Research by the European Social Investment Forum (EuroSIF) found that high net worth individuals in Europe have around 8% of their portfolios in ethical assets, or around €540 billion.

This looks set to grow sharply. EuroSIF’s survey of wealthy investors and wealth managers taken by EuroSIF in the middle of last year found huge interest in ethical investing. In spite of the tumultuous conditions on financial markets, 87% of respondents said interest for sustainable investments would grow in the next three years and 75% of surveyed family offices said sustainable investment will increase in the generational transfer of their family’s wealth.

EuroSIF estimates that by 2012, wealthy investors will have 12% of their portfolios in ethical investments, or more that €1 trillion, with the bulk of the funds coming from newly wealthy entrepreneurs and existing investors.

It’s a bold prediction, particularly given the shocking performance of equity markets in Europe and around the world, which is likely to have lopped between 30% and 50% off the fortunes of most wealthy entrepreneurs.

Many in the ethical investment industry are worried about how their relatively immature market will cope with a downturn of this magnitude. Will spooked investors simply retreat to familiar investments and dump their commitment to socially responsible investing?

So far, it appears wealthy investors are sticking to their ideals.

In October, at the height of the credit crisis, outflows from European managed funds hit €154 billion, or 0.11% of total funds. By contrast, outflows from green funds were €834.7 million or 0.05% of total funds, and socially responsible investment (SRI) funds lost €496.3 million, or just 0.01% of their total.

Exactly how long wealthy investors remain committed to ethical investments probably depends on whether these funds can hold their own against non-constrained investment options.

While measuring the performance of SRI investments is a fairly contentious issue (mainly because of the huge variety of SRI funds out there) research from fund research firm Lipper shows that between 2003 and the peak of the US equity market in 2007, the median SRI fund underperformed the median regular fund by around 2%.

Further to this, there is some research to suggest that ethical investments funds may be at a disadvantage during a downturn because they exclude so-called sin industries such as alcohol, tobacco and casinos, which tend to do rather well during recessions. Indeed, analysis released last year by Merrill Lynch shows that, during the six recessions since 1970, alcohol, tobacco and casino stocks have, on average, returned 11%, compared with a 1.5% loss for the S&P500.

However, this recession appears to be a little different, and cigarettes, whisky and punting just aren’t holding up like they used to – in Australia, gaming and alcohol stocks have been particularly savaged in recent months.

Ethical investments, on the other hand, appear to be holding their own. The editor of British SRI site Responsible Investor, Hugh Wheelan, says SRI funds have actually outperformed their mainstream counterparts, returning -40.7% compared with -41.8%. They are not exactly pretty results, but wealthy ethical investors can take heart that they won’t lose out too badly if they follow their convictions with their portfolio.

The debate about whether investing ethically can deliver better returns over the long term is unlikely to be solved any time soon – a quick internet research reveals any number of academic papers and pieces of broker research supporting both arguments.

Anyway, the rise in ethical investing among the wealthy appears to be driven by more than raw figures. A generational change appears to be taking place in the high net worth individual community, and this younger breed want to be seen to do the right thing.

As one wealthy respondent told the EuroSIF survey: “Successful entrepreneurs of today are not the industrialists of yesterday.”

Basic Details

• Signatories should be clear about who they are and provide background information on the fund, and the fund manager.
• Provide the name of the fund(s) and fund manager to which these guidelines apply.
• Provide contact details for further information regarding the funds.
• What is the size of the fund? In currency at a specified date.
• Where can financial performance history data about the fund be found?
• Provide details of the content, frequency and means of communicating information to investors.
• Additional: Briefly describe the corporate responsibility policies of the organization that manages or promotes the fund(s), or give direction to where this information can be located.

 SRI Investment Criteria

• Signatories should be clear about their purpose and investment criteria.
• How does the fund define SRI?
• What are the SRI investment criteria of the fund?
• How is the SRI criteria defined, how frequently and by whom are the criteria reviewed?
• How are criteria changes communicated to investors?

Research Process

• Signatories should provide information on their research process.
• Describe your SRI research methodology and process.
• Does the fund manager use an in-house research team and/or an external research team? Please explain.
• Is there an external control or external verification process in place for the research process? Where an Advisory Committee is used, please state its responsibilities.
• Does the research process include stakeholder consultation? If yes, please provide details.
• Do companies have the opportunity to see their profile or analysis? If yes, how often?
• How frequently is the research process reviewed?
• What research findings are disclosed to the public? How?

Evaluation and Implementation

• Signatories should provide information on how the research is used to build and maintain their portfolio.
• How are the results of research integrated into the investment process, including selection and approval of companies for investment?
• What internal or external measures are in place to ensure portfolio holdings* comply with SRI investment criteria?
• What is the policy and procedure for divestments* on SRI grounds?
• Are investors informed about divestments on SRI grounds? If yes, how frequently and by what means?
• Does the fund manager inform companies of portfolio exclusions or divestments due to non-compliance with its SRI policy and criteria?

Engagement Approach

• Signatories should explain their approach to engagement if the fund has such a policy.
• What are the aims of the engagement policy?
• How does the fund priorities which companies it will engage with?
• Who undertakes engagement on behalf of the fund?
• What methods of engagement are employed?
• How is the effectiveness of engagement activity monitored/addressed?
• What further steps, if any, are taken if engagement is considered unsuccessful?
• How, and how frequently, are engagement activities communicated to investors and other stakeholders?

Voting Policy

• Signatories should make clear their policies on voting.
• Does the fund have a voting policy? If so, what is it?
• Does the fund disclose its voting practices and reasoning for decisions?
• Does the fund sponsor/co-sponsor shareholder resolutions?

Periodical Activities

• Signatories should periodically disclose information about their activities.
• List the fund holdings at a specified date within the last 6 months.
• What engagement activity has been carried out on behalf of the fund during the past year?
• What voting actions occurred that were related to the SRI fund criteria?
• Additional What divestments occurred in the past year related to the SRI fund criteria?
• Additional What were the amount of donations and the percentage of management fees that the fund gave to charities this past year?

Definitions of key terms used in the guidelines:

Divestments – Companies that are sold from the fund portfolio.

Engagement – A long-term process of dialogue with companies which seeks to influence company behavior in relation to their social, ethical and environmental practices.

Exclusion – The exclusion of sectors or companies from a fund if involved in certain activities based on specific SRI fund criteria (e.g. no tobacco or no animal testing).

Fund(s) – A legal entity, the purpose of which is solely the acquisition of portfolio investments.  This also includes compartments and sub-funds. 

Fund Manager – The entity responsible for overall management of the fund. 

Fund Purpose – The spirit and overall focus of the fund, but not the investment criteria employed.  Holdings – Equities and/or bonds of companies that collectively comprise the fund portfolio. 

Portfolio – A collection of investments managed by the fund manager.

Signatories – Fund(s) and/or fund manager that commits to disclose SRI information in

line with the Guidelines. 

SRI Investment Criteria – The principle or standard of judgment used to determine what the fund can Criteria and cannot invest in from a social, ethical or environmental (SEE) perspective.

Voting Policy – Policy of a fund to exercise it’s voting rights as investors to influence company behavior.

I’ve picked the following funds based on a number of fundamental criteria such as management track record, MPT statistics, and industry outlook.  However, the “niche” nature of each SRI sub-categories must be taken with a grain of salt due to the lack of competition.  The youthful nature of many funds in this sector also hiders forecasting. 

An important litmus test for any “alternative fund” requires determining if management has jumped on the “green bandwagon” for short-run gain.  Unfortunately, this last quarter has seen a number of self proclaimed SRI funds mislead investors.  To ensure these imitation funds don’t show up on my list, I’ve dug into each fund’s holdings to confirm consistency with the fund strategy.  Ultimately, I’m looking for funds that demonstrate a long-run commitment to well articulated objectives that are consistent with socially responsible investing.        

These “top picks” are not a static snapshot of the current SRI industry.  Rather, it is an evolving list that I hope to refine over time.  I welcome suggestions and recommendations.

Alternative Energy/ Resource

• PowerShares Wilderhill Clean Energy Portfolio Fund (PBW)
• Van Eck Global Alternative Energy (GEX)
• PowerShares WilderHill Progressive Energy Portfolio (PUW)

Global/International

• Calvert International Opportunities Fund (CIOAX)

Fixed income (Bonds)

• Calvert Social Investment Bond A (CSIBX)
• AHA Full Maturity Fixed Income Fund – Institutional Class (AHFMX)
• AHA Limited Maturity Fixed Income Fund – Institutional Class (AHLFX)

Equity Large Cap.

• Calvert Large Cap Growth I (CLCIX)
• Pax World Growth (PXWGX)
• MMA Praxis Growth Index Fund A (MGNDX)

Balanced Funds

• Walden Social Balanced Fund (WSBFX)
• Calvert Social Investment Equity Fund (CSIEX )
• Pax World Balanced (PAXWX)

Environmental

• Winslow Green Growth (WGGFX)
• Portfolio 21 (PORTX)

Technology

• Clean Edge U.S. Liquid Series Index Fund (QCLN)
• PowerShares Cleantech Portfolio (PZD)

Religious Funds

• Guide Stone Int’l Equity GS4 (GIEZX)
• Amana Trust Growth (AMAGX)
• Amana Trust Income (AMANX)
• New Covenant Funds (NCGFX)
• Ave Maria Mutual Funds (AVEGX)
• LKCM Aquinas Fixed Income (AQFIX)
• LKCM Aquinas Value (AQEIX)

Copyright © 2008 David van der Roest