Better Business
October 2006
Banner photo: Partially Harvested Corn Field/corbis
Responsible Investment
As a society, we have developed a streamlined but opaque system for allocating our private resources. Through mutual funds, pension funds, trusts and independently-advised accounts, modern investors pass their life savings on to professional managers charged solely with generating financial returns. The managers typically use the savings to purchase ownership of and provide loans to corporations on the investors' behalf. The managers of the corporations, also charged solely with generating financial returns, then use these funds to buy the equipment and resources they need to conduct their operations.
Without knowledge or thought, investors deploy their resources to bring heat to homes and foodstuffs to grocers, develop antiretroviral drugs and hybrid engines. But sometimes these resources are used to make a product that slowly kills its consumers, or empowers them to kill. Sometimes the resources are used in a project that leaks oil across the North Pacific, dumps cyanide into local fishing grounds, or streams billows of poisonous gas into crowded settlements.
People may read about such things, and bemoan the enormous profits corporations reap at the expense of the common good, without necessarily connecting these profits to their pension plan, their mutual fund, their private account, or the endowment of the organization for which they volunteer their time.
Socially-responsible investing, a small movement that has been growing since the 1970s, proposes that investors take ethical responsibility as owners for the things firms do on their behalf. It also proposes that sustainable investments can provide competitive if not superior returns in the long run. Social investors demand that the firms they own conduct themselves according to the values they follow in their personal lives, and they pursue investments that have a place in the kind of future they would like to realize. If a firm egregiously violates basic norms, social investors want no part in it. If a firm has shortcomings, social investors want to improve it. If a firm is helping shape a more positive future, social investors want to nurture it.
Fringe and Vanguard
In part, socially-responsible investing is a fringe movement. About 10 percent of managed assets use at least some type of social restriction, usually narrow screens on weapons, tobacco or alcohol. However, only a tiny fraction of global investors look comprehensively at issues like labor relations, environmental impact and human rights.
On specific issues, this tiny fraction has formed a vanguard, bringing critical ideas from the nonprofit and activist communities to the attention of mainstream investors. In the 1970s and 1980s, a broader coalition formed around efforts to boycott infant formula manufacturers that were marketing their product irresponsibly in the developing world, and public pensions and university endowments joined the campaign to divest from apartheid South Africa. These initiatives signaled the great potential for like-minded investors to change the way resources are allocated and influence corporate decision-making. Over the years, socially-responsible investors have pushed corporations to adopt everything from more comprehensive nondiscrimination policies to Fair Trade products, and helped spur a proliferation of formal sustainability reporting, particularly in Europe.
The issue that shows the most potential right now for attracting broad-based support is climate change. Organizations such as Ceres, an environmentally-concerned network of investment funds and environmental organizations, are joining forces to encourage corporations to begin reporting and planning on how they would adapt to a carbon-controlled future. The result has been a wave of resolutions, reporting and advocacy on this issue. In 2004, Boston Common Asset Management's resolution proposing that an oil and gas producer engage in climate change reporting received a record 37 percent of shareholders' votes, despite recommendations from the firm's executives that shareholders reject it. This level of shareholder feedback suggests that the movement is gaining broad recognition in the investing public. Hopefully, the growing consciousness associated with these exchanges will lead to action, as investors shift resources into more sustainable investments and corporations adapt accordingly.
Principles and Profits
Traditionally, the socially-responsible investing movement has suffered from the pervasive notion that there is a trade-off between principles and profits. Corporate managers and investment professionals could see the immediate financial rewards to be reaped by sourcing production from low-cost sweatshops, extracting commodities from untouched wilderness, and bringing new goods to market as quickly and aggressively as possible. Harder to predict or discern were the fallout of labor disputes, community uprisings and product liability lawsuits many years later.
As their track record grows, socially-responsible investors are calling into question the conventional wisdom on this trade-off. Wall Street analysts feverishly model a firm's earnings for the next few quarters, and conjecture on its outlook for the next few years. However, they generally consider the further future too remote and uncertain to value. But according to a standard valuation model, 70 percent of a typical large, publicly-traded firm's value is locked up in expectations of the profits it will earn more than 10 years from now. If an investor could uncover any untapped insight into a firm's ability to sustain and grow its profits in the longer run, the investor would have a distinct advantage.
The idea that sustainability analysis is this untapped insight is leading some in the mainstream to embrace socially-responsible investing. This school of thought has gained currency among Northern European foundations and pension plans, and has recently received an endorsement from CalPERS, America's largest pension fund. These organizations maintain that "environmental and sustainability factors" confer underappreciated advantages on long-term business performance. They suggest that generous employment practices fuel worker motivation and ensure a firm's long-term access to its labor supply. That product safety and responsible marketing build a firm's reputation with consumers. That responsible governance protects a firm against legal liabilities and adverse regulatory action. And that money managers who understand these factors are more likely to choose superior investment opportunities in the long run.
Innovations and External Returns
The socially-responsible investment movement also has nurtured a growing pool of capital that seeks both returns to investors and an "external return" that enriches society through innovation. Small enterprises that pioneered Fair Trade and organic produce have posted growth and profitability, commanding price premiums in the marketplace for their superior quality. The run-up in oil prices over the last few years has ushered a boom in venture capital and public equity offerings devoted to solar power, wind energy and ethanol. Early investors in these enterprises often believe that a combination of entrepreneurial discipline and philanthropic ethos will create more vibrant institutions than either of those two forces would separately.
Socially-responsible investing is a diverse movement that is growing in viability and sophistication. It embraces a set of often complementary, occasionally competing ideas: that ownership is a means of promoting social compliance and transparency; that sustainability can become a conventional tool in investment analysis; and that investing can be a pathway to a better future. Regardless of whether the movement touches the mainstream or becomes the mainstream, it remains primarily a personal choice investors make to implement their principles and realize their aspirations in this as in other walks of life.
Nathan Foley-Mendelssohn is a research analyst at Boston Common Asset Management, an employee-owned investment firm dedicated to the pursuit of financial return and social change.
