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Investing long-term

Bob Reynolds is editor of Offshore Red.

Family businesses have always had their principles and integrity as part of the drive behind their business. Now that corporate responsibility has spread throughout the business world, Bob Reynolds examines the effect of SRI

Family offices across the world are at the forefront of the move to socially responsible investing (SRI). Family offices are led by core principles, and investment strategies will reflect the charitable, social or political focus of each group.

Investment managers seek to combine attractive returns and asset security with a principled-approach to investment selection. Peter Leach, chairman of BDO's Centre for Family Business, says that family offices have been effectively in the vanguard of the SRI movement. He says that while they may not identify their strategies as socially responsible investing this, in practice, is what many of them are.

"Family offices have been guided traditionally by ethical principles," says Leach. "This could be a desire to invest positively in companies which seek to improve the welfare of poor people or develop new technologies which assist the greater good. They may also choose to screen against producers and distributors of alcohol, tobacco or weapons. They may also dislike particular political regimes."
At the end of April, the United Nations (UN) was the latest international body to introduce SRI guidelines. Its Principles for Responsible Investment provide a framework for avoiding investments in companies with poor records on pollution, labour relations or corporate governance.
These voluntary guidelines encourage investors to seek disclosures from companies about whether their policies encourage socially responsible behaviour among employees and management. Corporations also are asked to report on their progress in complying with the principles, which were developed in the past year by a group of international financiers organised by the UN.

"With rare exceptions, the financial community has not sufficiently recognised or rewarded corporate efforts to respond to environmental, labour or human rights challenges, even though they can be directly material to corporate performance," UN Secretary-General Kofi Annan said when he announced the guidelines.
Greg Carlson, a fund analyst for Morningstar, a Chicago financial research service, suggests that socially responsible funds rarely make the most money for investors.
"In the US, the funds typically use social screens to rule out investments in alcohol or tobacco companies, military contractors or chemical companies with a history of environmental abuses," he says. In Europe, where SRI has been around for longer, there are several ways to make SRI investments. There is often a negative cut but sometimes investors will seek to positive select companies or sectors with great SRI credentials.

In a survey conducted by Deloitte in 2003, 79% of fund managers and analysts across Europe said that interest in SRI was growing rapidly and that such interest had a long-term beneficial effect on companies. Though, they were quick to point out, there were almost no short-term benefits.

Although the European institutional market was worth h336 billion at the time of the survey, SRI products accounted for only h12.2 billion. However, since then the SRI market has developed and the latest figures are expected to show a much larger percentage of the total market devoted to SRI. The number of socially responsible funds in America has more than doubled in the past 10 years, from 51 in 1996 to 109 by this spring, according to Morningstar.

Deloitte's Dominique Gangneux says the countries leading the way are the UK, the Scandinavian nations, the Netherlands and Germany. "Sweden is very interested in SRI products but its market is, of course, much smaller than that of the UK."

The first significant body to lay down guidelines for socially responsible investing was the UK's Association of British Insurers (ABI). Many organisations still use the ABI's guidelines as the foundation of their own approaches.

In October 2001, the ABI published guidelines outlining what a company should state in its annual report with regard to socially responsible investing. The guidelines ask companies to disclose that their boards have assessed the business and reputational risks arising from the way they manage social, environmental and ethical issues, and that these risks are being properly managed.

The ABI also issued a brief on best practice. It said: "The cost of managing risks should be proportionate to their significance. Ideally, procedures should be integrated into existing management structures and systems. Statements relating to the guidelines should be made in the annual report, and not separately as part of the summary accounts or on a website dedicated to social responsibility."

An Institutional Voting Information Services (IVIS) report in 2004 said: "In the two years since the ABI guidelines were published the momentum behind corporate responsibility has continued to build, driven by renewed concerns about corporate behaviour and a growing acceptance that businesses need to be open about their operations and demonstrate their beneficial impacts on society."

In addition, IVIS reported that levels of trust in business have collapsed, stimulated by the corporate governance scandals at companies such as Enron and Ahold. Almost two-thirds of British adults do not trust business leaders in general and 80% say they cannot trust directors of large companies simply to tell the truth.
Over 60% of the public say big business doesn't care about social and environmental impacts. This is a global phenomenon, but especially marked in Europe, where NGOs are now much more widely trusted than business or government.

The growth in SRI has been stimulated by the FTSE4Good indices launched in 2001. They include only companies that meet minimum standards for environmental performance, human rights and stakeholder relationships.
City brokers expect the trend to continue growing – a survey of fund managers and analysts across Europe found just over half agreeing that social and environmental considerations would become part of mainstream investment analysis within three years. Interest has been driven by and has stimulated a stream of developments and initiatives in the fields of corporate responsibility and sustainability.
Corporate responsibility has spread throughout the business world. It is now seen as affecting every significant business and not just those exposed to particularly controversial issues (oil companies such as BP and Shell, brands such as Nike and Gap with developing country supply chains). Rather than being widely seen as a peripheral activity concerned primarily with community support, companies are now recognising that the most significant responsibility issues concern their core business activities – products, marketing and business strategies.

Companies have to identify the issues specific to themselves and their sectors. This follows from the previous trend, as issues stemming from core business activities are bound to be determined primarily by those specific activities. For example, while all companies operating in oppressive regimes need to be concerned about human rights, an issue such as social exclusion is bound to be more pertinent in sectors such as financials and utilities than in the motor industry or electronics. Similarly, retailers' most significant environmental impacts are indirect (stemming from product purchasing and customer behaviour), contrasting with the direct impacts of chemical companies and major manufacturers.

The result of these trends is that while all companies face a set of generic risks, sector-specific factors may be more important than any of these. Generic issues, which are significant in many sectors, are typically covered in codes and guidelines such as the UN Global Compact and the OECD Guidelines for Multinationals.

The main issues covered by such codes are:

- treatment of employees, embracing issues such as diversity, health and safety, as well as pay and conditions (especially in developing countries) and child labour;
- human rights issues such as torture, political imprisonment in countries where a company has a significant presence;
- environmental impacts, including sourcing of materials and products, product use and disposal;
- community impacts, including support for community organisations and the economic impacts of location decisions; and
- transparency – openness to and engagement in dialogue, as well as public reporting of performance in these areas.

Hermés is one of several leading fund management houses to encourage the move to ethical investing. In one of its many publications on corporate governance, the business says: "Companies should manage effectively relationships with their employees, suppliers and customers and with others who have a legitimate interest in their activities. Companies should behave ethically and have regard for the environment and society as a whole."

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