SRI – A Noble Idea, But ...
Socially responsible investing (SRI) has been around since the 1700s, but started to become mainstream in the 1990s. Global investment increased from $639 billion in 1995 to over $3 trillion in 2010 while the number of SRI investment vehicles increased from 55 to about 500.
SRI is an investment approach which takes into account returns and seeks out activities which do no ‘social harm,’ avoiding investments in companies involved in alcohol, tobacco, gambling, weapons, and the nuclear and mining industries as well as companies with poor environmental practices. Other similar SRI approaches include environmental, social, and corporate governance (ESG); corporate social responsibility (CSR) investing; or principles for responsible investing (PRI).
Easy To Identify
Deciding what constitutes ‘social harm’ is a challenge in itself. In adopting an SRI approach, a sponsor may have a specific ‘social harm’ in mind. For example, SRI investments that specifically avoid alcohol, tobacco, or armaments companies may appear to be easy to identify. Avoiding offending companies, given the multitude of other investment opportunities, isn't likely to have a major impact on overall portfolio performance. Sponsors or fund managers could, however, take a more general view of social harm resulting in many good investments being excluded. The more general the definition of social harm, the greater the investment excluded.
There is no standard or coherent definition of what constitutes SRI. It can include an unlimited number of activities and causes. Are companies supplying machinery, vehicles, software, computers, and supplies which enable the operation of offending companies not equally guilty of perpetrating the problem? Taken to an extreme, a substantial number of excellent investment opportunities could be excluded under SRI. Obviously, it's a question of degree, of where you draw the line and why.
A specific definition of social harm is needed to select and monitor the companies for compliance. If the investment is in a single company and there is a specific defined social harm, the selection and monitoring tasks may be easier. However, many companies are involved in a variety of activities in many locations. In the case of a pooled or mutual funds with broad social harm mandates and investments in many companies in many locations, it may not feasible or practical to select and then monitor the fund to ensure compliance with the SRI mandate.
From a legal perspective if you are screening out certain types of industries, companies, or activities, a specific authority should be included in the trust agreement. From a fiduciary perspective, return, style, or risk expectations included in the SIPP for other types of investments and the specific SRI conditions and expectations should be outlined and monitored for compliance.
The concept of SRI is not without critics. Some argue against SRI on the grounds that:
- it encroaches on what should be the role of government
- companies do more social good than bad in the form of jobs and innovation than explicit SRI firms do
- SRI involves playing with shareholder or pensioner money in pursuit of goodness versus profits
Robert Reich, a former U.S. labour secretary in the Clinton administration, argued that the social responsibility of business is to create profits.
SRI is a relatively new special case pension investment. From a governance and fiduciary perspective it is, therefore, important to clearly define the purpose, nature, and expectations in the SIPP to ensure the objective of the SRI investment is clear and achieving its mandate and return expectations. As a newer type of investment, documentation supporting the reason for, and selection of, a SRI investment and on-going monitoring are important because of the closer scrutiny SRI investments may receive.
One of the traditional arguments against SRI has been that it underperforms other types of investing because of the limitations on certain companies or industries. The research that has been done, however, does not support this perception.
An academic review of 35 years of studies found there was a positive, but weak, link between SRI companies and financial performance. A joint Harvard and London Business School study found that in the 18 years prior to 2011, a valued weighted portfolio of high sustainability organizations that adopted a number of environmental and social policies outperformed a similar portfolio that didn't. This could include companies not otherwise considered as SRI candidates such as a tobacco or alcohol company. In other words, this criteria isn't much of an indicator of SRI performance, but it does highlight the difficulty in identifying and monitoring SRI companies.
Research by Goldman Sachs analysts concluded that SRI investing, in itself added no value, but an SRI perspective in viewing the market over the long term can be advantageous as SRI analysis is a good proxy for evaluating management. A 2007 study by Phillips Hagar & North found that SRI does not result in lower investment returns. They also cited a 2005 study by Schroder that confirmed SRI indices had higher risk (volatility). Phillips Hagar & North concluded that the question of whether SRI negatively impacts returns would not be answered soon due to the ‘fuzziness’ over what is considered an SRI investment and research-related concerns about the methodologies used and quality of the data.
SRI should, however, be viewed differently for large defined benefit plans versus capital accumulation plans.
CPPIB, AIMco, bcIMC, OMERS, Teachers, and government heritage funds are a few of the government pension or investment organizations that could effectively undertake SRI. These types of organizations have professional staff and resources and have a better chance of clearly defining SRI objectives, selecting appropriate direct or fund investments, establishing unique benchmarks, and monitoring them on an on-going basis. Few DB plans or investment organizations, however, are 100 per cent SRI. In most cases, a small portion of a portfolio is allocated to SRI investments, but is this only a small bit of good?
Most small DB plans don't have the time, resources, or desire to try to effect socially responsible changes in another company. In addition, return and risk performance are unlikely to present a strong case for adding one or two SRI investments to a DB plan. Do smaller DB plan administrators or committees who are considering adding one or two SRIs understand or want the additional administrative and fiduciary responsibilities? Probably not!
Some argue that rather than SRI, large DB plans or investment organizations should make a significant investment in an offending company, then take on a shareholder activist role to try to influence behaviour. This is likely to be more effective than simply not investing in the company.
With a CP, adding SRI funds requires careful consideration given that CAP administrator must act in the best interest of the members. A critical question is whether a CAP sponsor's desire to be socially responsible and imposing their values through SRI means they are acting in the best interest of the CAP members. If the sponsor is aware that some CAP members are keen on SRI, is it prudent to offer only one or two SRI options? In the future, could the members argue that there were insufficient diversification opportunities or they were effectively forced to into using one or two investments? Would it be prudent to be 100 per cent SRI in a CAP? Sponsors need to address these issues in their governance documents.
Generally, CAP members are unsophisticated reluctant investors. CAP sponsors, therefore, need to try and keep the investment structure and member learning curve as straightforward as possible. Having numerous investment options – with different objectives, asset classes, styles, risk profiles, time horizons, and benchmarks – tends to intimidate and confuse the average CAP member. For example, adding a SRI equity fund is unlikely to improve risk or return performance versus similar non-SRI funds. In addition, communicating with and educating CAP members becomes more challenging and costly the greater the number of investment options.
There may be a ‘feel good’ factor resulting from investing a bit in a SRI option, but is it will not likely result in any meaningful reduction in social harm. CAP members' investments will mostly be in non-SRI investments. In addition, neither the sponsor or the members will likely know what social harm is being targeted or if the fund is in compliance with its mandate. From a fiduciary and member perspective – and given the extra administration, communication, education, monitoring, risk, and cost involved – is there really a good argument for having SRI funds in CAPs?
Where demand exists along with significant profits, as in the tobacco, alcohol, or armaments industries, it is unlikely that the companies accused of social harm will disappear or change their business because of SRI.
SRI or other similar approaches require additional governance and more fiduciary responsibilities.
Large investment organizations and DB plans are more likely to have the capacity to effectively undertake SRI, but they need to be open and vocal about their SRI policies. Alternatively, they may be more effective by investing in all types of companies and becoming activist shareholders encouraging practices that improve behaviours even in companies that are generally considered to inflict social harm.
In the case of CAPs, the ‘feel good’ factor is likely the strongest and only argument for having SRI investment options, but it is not likely to result in any effective or meaningful reduction in social harm.
Gerry Wahl is managing director at ComprehensivePensionGovernance (firstname.lastname@example.org).