Socially responsible investing (SRI) has undergone a remarkable journey from its faith-based origins in the early part of the 20th century, to a sudden acceleration in the last two decades. It now has over 100 products covering not only asset class, but also geography and global themes such as climate change, water and renewable energy
Despite the growth in SRI funds, a large dose of scepticism persists. The exclusion of companies via negative screening is seen by many critics as an Achilles heel.
There is a perception of increased risk by excluding companies involved in “negative” activities such as alcohol and tobacco production, armaments, pornography and gambling.
The natural mid- and small-cap bias for SRI funds combined with the inability to invest in defensive sectors such as defence, tobacco and alcohol during financial downturns are oft cited risk factors.
This in turn has arguably led to the biggest charge against SRI – sacrificing performance. This school of thought is centred on the exclusionist nature of SRI which leads to a limited investment universe where low levels of liquidity and high volatility dominate.
We are now seeing greater recognition sustainable business practices can lead to stronger financial performance. The United Nations Environment Programme Finance
Initiative published a review of 20 academic studies that analysed the performance of
funds that incorporated environmental, social and governance (ESG) factors into their investment process.
Their findings concluded there was a positive relationship in half the studies, while a further seven studies came out neutral and only three of the studies concluded a negative relationship.
The credit crisis
The economic downturn has led to a decline in ethical consumerism in the UK, with a recent market report showing ethical consumption amongst shoppers has fallen back to 1997 levels. It also reveals only a quarter of the UK public thought it was important a company should show a high degree of social responsibility – this is compared to half in the previous year.
Ethical investments have not been spared during the current financial crisis. According to the IMA data, 2007 was a strong year for ethical funds, despite accounting for only 1% of the total funds under management.
The story in 2008 is markedly different, with net retail sales down close to 70% year-on-year. However, in contrast to the overall industry, ethical equity funds registered positive net retail inflows in 2008.
The longer term picture is one of a sector very much in the ascendancy. Since 1992, ethical funds have grown by more than 19% per annum to 2008, and although the pace of that growth has levelled off, it is still higher than industry rate. More importantly, the amount of money invested in UK ethical funds has increased dramatically from £2m in 1999 to £5.5bn in Q3 2009.
SRI funds in Europe have bucked the trend and achieved considerable growth during the financial crisis. The number of retail funds increased by 27% to 683 over the year to June 2009, leading to an increase of 9% in assets under management. The current economic woe has not been the death knell for SRI industry and in many ways has opened up new possibilities.
Challenges and opportunities
Climate change and the rise of emerging economies such as Brazil, Russia, India and China (Bric) will be key SRI themes for 2010 and beyond. Both issues are intractably linked, giving investment managers and public policy makers alike a series of challenges and opportunities.
Beyond Copenhagen
The Copenhagen Summit brought together all the divergent agendas of the developing and developed world and tried to produce an agreement to be ratified by all the main protagonists, in particular the US and China. The challenge of producing a global framework that is not only robust, but also equitable, enforceable and one which can be easily verified proved to be elusive.
The transition towards a low carbon global economy has been given a massive boost with the recent global stimulus package, which included a $446bn pledge for “green” investments. Regulations on carbon emissions will help to drive out high-carbon technology over the next few decades. For example, the British government has stated it wants 15% of the UK’s energy to come via renewable energy sources – this currently stands at a mere 2%.
The Government will have to spend an estimated £100bn to meet its 2020 energy and emissions targets and the same amount again to meet the 2050 targets. The pressing challenge for policy makers will be how to develop the nascent low-carbon environmental goods and services sector, which is currently valued at £106bn and employs 880,000 people in the UK.
The global low-carbon market is forecast to grow from £3trn in 2008 to £4.3trn by 2015. With such large state-backed revenues flowing into the sector, climate change, despite presenting immense challenges, does offer compelling long-term investment opportunities.
Emerging markets
Investing in emerging markets brings a plethora of challenges for SRI analysts. Lack of data, both in terms of quality and quantity makes it difficult to test the integrity of the supply chain, this coupled with transparency issues and a different cultural attitude towards governance only serves to complicate matters. SRI analysis has had to incorporate new issues such as human rights and supply chain management.
In addition, more emphasis is now placed on how companies manage their environmental and social impact in the countries in which they operate. The development of SRI in non-Bric countries, with the recent launch of an African SRI fund outside South Africa and a Vietnam SRI fund, all point to a healthy and growing global SRI industry.
Niche to mainstream?
Despite its phenomenal growth, there is no doubt the SRI market is still a niche market. The key question remains as to whether it has achieved sufficient critical mass to become mainstream, or for the very bullish, replace the mainstream investment market. The terminology surrounding the market is often confusing – ethical, green, responsible, socially responsible, and sustainable, but in many ways this reflects the fluid nature of SRI. We are no where near the so called “tipping point”. The long term challenge is to convince the doubters that fully incorporating environmental, social and governance issues within investment leads to superior risk adjusted returns. This may require a very dramatic recasting of the global capital markets.
Ketan Patel, investment analyst at Ecclesiastical
