If smart investment requires vision that doesn’t stop at balance sheets and stock prices—if traditional financial analysis and accounting fail to capture the true value of a company—then where can we look for a more complete picture? SRI provides an important part of the answer. Today’s SRI goes beyond the “sin stocks” of the past and into three broad, forward-looking areas of analysis; to a company’s record on the environment, social responsibility, and corporate governance issues.
Companies with a history of environmental insensitivity can be toxic to investors. They carry the very real risk of future litigation, can have higher costs (such as in waste-disposal) and stand to lose competitive advantage to their “greener” counterparts. Some of these risks are indeed reflected in balance sheets and may be evident to traditional asset managers. But other environmental risks require a deeper level of SRI analysis to uncover.
A prime example is the use of water in industrial processes, such as agriculture and energy production, which has not only damaged many ecosystems—at times beyond repair—but is also significantly unrepresented in traditional accounting formulas.
As demand for water grows and the finite supply of this crucial resource dwindles, companies who have proactively addressed the specter of water scarcity will be best positioned for the future; and those are the companies that merit a second look by investors.
Water scarcity and the cost of water use are just one area of additional analysis that a traditional analyst may never consider but which is the core of SRI analysis.
Other environmental criteria an SRI analyst might evaluate before making an investment recommendation are carbon emissions (that might one day be the subject of taxes or fines); the long-term impact of climate change on a company’s business; and whether sustainable forestry methods are in use, both at the company level and throughout its supply chain.
SRI encompasses an array of social issues, from human rights and labor rights to the "sin stock” (alcohol, tobacco, gambling) screening that defined its early days. An analysis of a company’s record on social issues reveals a company’s true character and, we believe, one indicator of its long-term financial viability. Companies with strong social policies often have lower turnover, higher productivity, better brand reputation and customer loyalty. Traditional asset managers have tended to examine the bottom-line impact of social actions only after a scandal unfolds (a clothing line is found to employ child labor, for instance). Analysis of social criteria can also identify early warning signals of even larger company-wide problems.
When you invest in a company, you deserve to know how that company truly operates. Characteristics such as transparency — to shareholders and the public — diversity and ethical conduct are all key components of good corporate governance. Today’s SRI looks at all of these factors.
Calvert views diversity as both a social and business imperative. The ability to draw on a wide range of viewpoints, backgrounds, skills, and experience is critical to a company’s success, and Calvert believes this can only be achieved if company management includes women and minorities. A company’s board of directors—the members of which are key parts of that organization’s governance—should also be diverse in its composition. The members of the board should also be independent and free of conflicts of interest so that they can make decisions that are in the best interests of shareholders and, by extension, to society in general.
Executive pay is another key area of SRI scrutiny. When executives receive extravagant bonuses—often while their companies are foundering—that is usually a signal that corporate priorities are woefully misguided.
Analysis of SRI criteria, in addition to traditional financial analysis, can provide a more comprehensive picture of a company than financial analysis alone, letting investors make better judgments about the consequences—and potential opportunities—associated with investing in a particular company. Perhaps just as importantly for the pragmatic investor is that “Responsible investment does not have to come at a cost to performance.”*
That’s the conclusion reached by Mercer and the United Nations Environmental Program Finance Initiative’s (UNEP-FI) Asset Management Working Group. Mercer is a global strategic consulting firm serving clients globally in the areas of human resources and financial products and services. UNEP-FI is a global partnership between UNEP and the private financial sector. More than 170 institutions, including banks, insurers and fund managers, work with UNEP to understand the impacts of environmental and social considerations on financial performance.
These two highly respected groups conducted a review of 20 academic studies examining the link between investment performance and analysis of environmental, social and governance (or ESG) factors, and their findings couldn’t be clearer: in 17 of the 20 studies, it was found that ESG factors had a positive or neutral effect on investment returns.
*Source: Demystifying Responsible Investment, published by Mercer and the Asset Management Working Group of the United Nations Environmental Program Finance Initiative, Oct. 2007.