Ecology of SRI

‘Buy-side asset managers’ are investment institutions that buy, hold and sell the shares of companies in portfolios on behalf of beneficiaries.

The willingness and capability of these managers to incorporate environmental, social and economic factors into their analysis varies hugely between institutions and also between individuals within an institution.  Some pioneers have SRI in their blood having driven its development from the very earliest days; others have joined the market recently on the back of the industry’s strong growth and promise of future expansion.

Penetration of SRI interest is highest in Europe where about half of all major asset managers have developed form of SRI capacity.  Levels are much lower in other parts of the world.

Asset managers can deploy any of the 21 strategies that across an ever increasing number of asset classes.  At present newcomers appear to favour ‘constructive engagement’ and ‘thematic’ strategies while established players more likely to involved in ‘best-in-class’ and ‘integrated analysis’. Equities, followed by bonds are the dominant asset classes – with cash, property, forestry and commodities at a more experimental stage.  (More details in SRI Primer)

‘Asset owners’ have always been and will continue to be the driving force behind SRI.  Indeed, without their interest, support and money, there would be no such thing as SRI.

The approach that each ‘owner’ takes to SRI and the strategies that they adopt are clearly influenced by the type of investor that they are and, in particular, by whether they are investing on their own account – or acting on behalf of (in trust for) beneficiaries.

Asset owners can be divided into:

• Individuals
• ‘High-net-worth’ investors
• Retail investors
• Institutions
• Pension funds (for private, public and third sector employees)
• Insurance funds
• Sovereign wealth funds
• Churches, charities and foundations
• Family offices (& multi-family offices)
• Fund providers

Amongst institutional owners, there are widely differing levels of experience in SRI:

• A select group of ‘agenda setters’ are responding creatively to the challenge that climate change and sustainable development present by exploring and defining new options for the exercise of ‘responsible ownership’ prototypes for themselves and for others to follow
• A group of ‘active adopters’ have typically developed their own policy on sustainable investment, have signed the UN PRI and are now learning how to implement it
• An ‘aware’ cohort who are at the early stage of investigating what SRI means and what implications it has for them
• A group of antis / non-actors who are not engaging in SRI in any way

Finally, asset owners can be divided into those that:

• manage their own assets
• outsource the management of assets to specialist investment managers

Investment consultants cover a wide spectrum of professionals from which we distinguish between:

• Financial advisors - who advise on cash and mutual fund investments to individual (retail) investors
• Wealth managers - who advise on and manage the discretionary portfolios of ‘high-net worth’ investors
• Institutional pension fund consultants – who help institutional asset owners to develop and implement policies and management practices

Over the last twenty years, a number of these consultants have built successful businesses as specialists in SRI investment.  Equally importantly, ‘mainstream’ advisors have built SRI advisory capacity into their broad-based platforms.  Both groups have proven themselves to be important conduits for demand.  Indeed many have increased demand and crystallised latent demand through their advice to asset owners about SRI and its implications.  (In particular, they have played an important role in replacing myths and misconceptions about SRI with robust analysis of its performance.)

Investment consultants typically adjust their core services in the following ways to cater for clients’ (asset owners’) sustainability preferences as follows:

• Policy/strategy support – (for institutional investors) by helping trustees develop ‘Statements of Investment Principles’ that incorporate sustainability and responsibility objectives alongside their financial objectives.  Recently this has included developing policies and practices to ensure PRI-compliance
• Specialist evaluation of asset managers’ SRI capabilities
• For retail investors – leading to the selection of funds that best suit investors’ financial needs and environmental and social priorities
• For institutional investors – detailed evaluation and benchmarking of SRI asset managers’ capabilities, their deployment of various SRI strategies and (recently) their PRI compliance.  (This is, of course, set alongside (or integrated with) an evaluation of the managers’ investment capabilities)
• Monitor asset manager performance and reporting – including investment performance, SRI engagement activity and integrated analysis reporting
• Proactive research – to illustrate the investment relevance of sustainability factors some consultants have conducted research projects on specific issues with a view to making asset allocation or manager recommendations on the back of this research

Two reports have recently been published that review the SRI capabilities of investment consultants:

• Europe: 2009 Investment Consultants and Responsible Investment
• USA: Investment consultants and responsible investing – current practice and outlook in the United States

The vast majority of companies affected by SRI have issued equities or bonds onto developed country stock markets.  Such companies want their stock price to reflect accurately the company and its future prospects.  To achieve this, senior management and investor relations teams aim to communicate comprehensive information in a clear, timely and efficient manner to capital markets in order to:

• Retain existing shareholders
• Attract new shareholders
• Confirm a mandate for their ongoing strategy from existing shareholders
• Take the temperature of the wider market and understand the issues that interest it

Until recently, few companies saw SRI investors as material contributors to this objective.  They were seen as a niche group with quirky information demands that were not worth the added effort.

This has changed as the longevity and growth of SRI, the increasing importance of sustainability to the management and strategy of companies and emerging interest from ‘mainstream’ investors has encouraged more companies to develop pro-active strategies for communicating to SRI investors.

An SRI Index is a weighted listing of stocks that is typically constructed by filtering a broader stock index according to a set of social or environmental criteria.  Indices are typically developed via a partnership between:

• An index provider (such as Dow Jones, FTSE. MSCI etc)
• An SRI research provider (sometimes an SRI agency sometimes a fund manager)

Unlike ‘funds’, indices are rules-based and methodology-driven.

To help companies and investors understand SRI indices, we have summarised the following aspects below:

• SRI indices: types & usage
• SRI indices: the value chain
• SRI indices: who cares?
• SRI indices: 8 tips for companies

For the past 20 years, SRI agencies have been the sole specialist providers to asset managers of sustainability data, ratings and research.  Their analysis is used by fund managers to determine SRI fund universes and index constituents.  Their services can be grouped into four with most agencies provide a range of different services:

• Data – the provision of raw environmental and social data to fund managers and index providers
• Screening – the provision of stock (equity or bond) lists based on the compliance of the underlying issuer with one or multiple ‘ethical’ or ‘sustainability’ factors
• Ratings – the interpretation of that data to create rankings and ratings of companies and to develop ‘approved lists’ and ‘at risk’ recommendations that are then used by asset managers
• Research – broader analysis of environmental and social factors and their interaction with company performance

Agencies tend to charge fund managers an annual fee at either a flat rate or as a percentage of assets under management.  In addition, they often undertake specific research projects for asset owners, fund managers, NGOs etc.

After many false starts the SRI research business finally appears to be going through a sustained period of disruptive change.  Financial pressures, new entrants and changing client demands are forcing substantive re-examination of the various business models that operate in this segment of the market.

It is too early to tell whether this process will be one of creative destruction that sees the SRI research business emerge as a more economically-rational, client-focussed business that can contribute to the next phase of SRI development – and specifically to the ‘mainstreaming’ of sustainability factors within broader investment processes.

In a worst case scenario, the industry will sleepwalk through a consolidation process that strips it of creative research in favour of lowest common denominator ‘pile ’em high, sell ‘em cheap’ data products.

In 2001, the first specialist sustainability research services were set up within 'sell-side' investment research departments.  Since then, a number of banks joined the pioneers in this area with each developing their own focus and style – but all centred on the idea that scrutiny of the environmental, social and economic aspects of corporate performance can add value to investment decision-making.

The arrival of the sell-side in SRI brought a number of new aspects and services to the SRI industry, most notably:

• Integrated research – which sets stock and sector research within a sustainability context and corporate sustainability performance within a financial context.
• Corporate access – through which companies and investors are introduced to discuss directly with each other strategic sustainability themes (and progress on ‘corporate responsibility’).
• Stock selection and market commentary – whereby financial analysis is combined with sustainability analysis to select the best investable ideas.

Then, at the end of 2008, Citi, JP Morgan and Merrill Lynch closed their sustainability research teams (...and there were other quieter cuts).  This effectively shut down half of the sell-side sustainability research capacity.

A number of traditional providers of financial news and data have recently extended their product offer by creating specialist SRI-focussed wrappers to leverage their core capabilities and placing them at the disposal of SRI investors and companies.  Notably in the past year, Bloomberg, Thomson Reuters and MSCI have all entered the market via product launches or acquisitions.

Before this, financial news and data agencies’ exposure to SRI came principally through their contribution of stock weightings data to specialist SRI indices.

Most major index providers have the capacity – either themselves or (more usually) via partnerships with specialist SRI research agencies to construct and market SRI indices.  As a result, the number of specialist SRI indices has grown exponentially from one in 1999 to over fifty in 2010.  (See SRI indices, for details)

Independent research houses (as distinct from specialist SRI agencies & sell-side brokers) have not yet made any sustained in-roads into the SRI industry.

There is latent interest within the SRI industry to look beyond conventional financial research and to engage independent research on sustainability themes.  However, to date, this has not found practical application beyond a few ad hoc research projects commissioned by individual asset managers and conducted by consultants and policy NGOs.  There is no breadth or depth in the market for independent research and certainly not enough for a research organisation to establish itself with the SRI industry as a primary income source.

Three reasons can be identified for this:

• Asset managers tend to have relatively small external budgets for SRI
• More importantly, those SRI research budgets are typically paid out on an annual or bi-annual basis to a single specialist SRI research providers
• Brokerage commission still ends up largely with brokers as few commission-sharing arrangements have been set up for specialist SRI agencies

To encourage companies to improve specific aspects of their environmental or social performance investors sometimes form coalitions to share the burden of specialist research, corporate engagement, publicity etc.  Such coalitions take a variety of forms ranging from those that have a permanent independent executive (such as the Carbon Disclosure Project) through to short-term initiatives that are raised to address specific issues and then rapidly disbanded (such as those developed under the PRI Engagement Clearinghouse).

The national and regional ‘Social Investment Fora’ are the trade bodies for SRI investors around the world.  They have nurtured and promoted the concept of SRI from the very earliest stages and are critical to the next phase of growth, legitimisation and integration.  Their multi-faceted role typically includes:

• Promoting SRI and, more broadly, sustainability within all investment
• Monitoring the size and development of SRI
• Stimulating demand for SRI within different asset owner groups
• Representing the industry to government and other stakeholders
• Managing industry self-regulation and standard setting
• Incubating the development of new services before releasing them to private sector supply
• Managing networking activities and conferences
• ...and everything else that would be expected of industry bodies...

Any growing industry spawns conferences and network events of varying quality.  SRI is no exception.

• At their worst, SRI conferences involve the converted preaching to the converted about policy developments that will never happen
• At their best, conferences provide a platform for participants to discuss cutting-edge developments in research and product development and challenge consensus-thinking.

To host successful conferences, organisers need to:

• absorb the current themes and emerging ideas from the industry and to use this to raise in their conference the unspoken questions of industry participants
• develop a brand and network around their conferences that sustains support from conference to conference

Sustainable and Responsible Investment works to correct market failure and to encourage investors and companies to address voluntarily their environmental, social and economic impacts.  This voluntary action reduces the need for government intervention – and may be particularly helpful in areas where governments are reluctant (whether from complexity or prioritisation) to tread.

SRI should therefore be wholeheartedly welcomed and pro-actively supported by governments around the world.  However, with a few notable exceptions, governments have conspicuously failed to engage with SRI effectively.  To address this, we discuss below some broad options for government wishing to engage pro-actively with SRI and point them to further sources and points of contact.

Governments interact with SRI investment in three ways:

• As regulators and developers of policy for the financial services industry
• As asset owners / trustee of government funds (either government employee pension funds or sovereign wealth funds)
• As a developer / communicator of social, environmental and economic policy

As regulators and developers of policy for the financial services industry

One of the principal constraints on the growth of SRI is the lack of awareness by people and organisations who would be inherently supportive of it if they knew anything about it.  In most cases, therefore, highlighting the existence of an SRI option (rather than the mandating of it) can be sufficient to support its growth.  Government, as they set the context for financial sector regulation of all types, have numerous opportunities to ensure that an ‘SRI’ option is presented to potential suppliers and users of financial services.

Notably positive examples include: the UK Government’s Pension Disclosure Regulation that requires pension fund trustees to disclose the extent to which social and environmental factors are taken into account in the investment process

As asset owners / trustee of government funds

Whether as trustees of government employee pension funds or of sovereign wealth funds, governments are, of course, in a position to ensure that their own funds are invested in a manner that is consistent with their overall social and environmental objectives.  In many cases, this does not require government to take new policy positions but simply to ensure that existing policy is applied through their investment practice as well as through their regulatory or legislative activity.  (For example, it would be logically consistent for a government with an international climate change mitigation commitment to instruct asset managers to invest in line with that objective being achieved.)

Positive examples include the action taken by The UK Environment Agency, the Norwegian Oil Fund, some of the French government pension funds and some US state pension funds.

Notably, a number of Scandinavian government funds avoid investment in companies whose activities run counter to the countries international obligations or reputation (particularly on issues relating to climate change, human rights and cluster munitions).

As a developer / communicator of social, environmental and economic policy

SRI could be an extremely useful soft instrument of policy for government – particularly in areas where it wants to encourage voluntary private sector practice and avoid regulation or legislation.  However, to crystallise the latent support of SRI for progressive environmental and social policy, government departments need become much more effective at communicating their research and policy intentions to the SRI community.

Few positive examples exist – although some work between the UK’s Department of Environment and the UK SRI community on climate change adaptation ventures into this area.

Government agencies and SRI communication

The SRI industry is not one of the primary stakeholders or communications targets for government (as their attention is more normally directed towards the political, commercial or civil spheres).  However, it can be incrementally useful to them to promote discussion of their ideas and objectives within the investment sphere and to receive reciprocal feedback on the interest of capital markets in their activity.

Government departments can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics discussion paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

As the SRI industry has developed, headhunters have emerged to enable organisations to resource the increasingly specialist SRI roles that they need to fill.

Three factors combine to make the job of SRI headhunting an increasingly sophisticated and specialist one:

• Growth in the SRI product area
• Current market turbulence – and the hiatus in hiring caused by the credit crunch
• Diversity of specialist skills needed –the SRI industry has traditionally recruited from relatively homogenous backgrounds.  However, finding individuals with the combined skills (investment analysis and sustainability awareness) required to execute increasingly sophisticated SRI strategies is a task that requires professionally targeted searches

It often falls to industry bodies and trade associations to monitor the emergence of new social and environmental trends at the early stages of their development and to keep their members informed – before such trends become a central part of the competitive dynamic of the sector.  In this respect, they share common interests with SRI investors who often monitor issues at the same stage of development with a view to identifying investable opportunities for SRI funds and keeping their mainstream colleagues informed of industry developments.

Responsible business groups

Sometimes, companies come together in coalitions as ‘Responsible Business Groups’ to explore and promote specific aspects of sustainable or responsible business practice.

There is a natural synergy of interest between these groups (which represent business at its most progressive and collaborative) and SRI (who are investors at their most progressive):

• SRI investors watch Responsible Business Groups with interest to learn from their research, to identify best practice and to preview emerging industry norms.
• Reciprocally, Responsible Business Groups often seek the support of SRI investors to promote the extension of their best practice initiatives and to encourage uptake by their peers.

The SRI industry is not one of the primary stakeholders or communications targets for industry bodies (as their attention is more normally directed towards the political, commercial or civil spheres).  However, it can be incrementally useful to them to promote discussion of their ideas and objectives within the investment sphere and to receive reciprocal feedback on the interest of capital markets in their activity.

Industry bodies and SRI communication

The SRI industry is not one of the primary stakeholders or communications targets for industry bodies (as their attention is more normally directed towards the political, commercial or civil spheres).  However, it can be incrementally useful to them to promote discussion of their ideas and objectives within the investment sphere and to receive reciprocal feedback on the interest of capital markets in their activity.

Industry bodies can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics discussion paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

Coverage of SRI within the investment media has been somewhat depressing over recent years.  Although the frequency of coverage continues to grow in line with investor interest, few journalists have actively engaged with developments in the SRI market.  So, with the exception of the occasional foray into renewable energy, the mainstream media has failed to track or scrutinize the most interesting developments in SRI – most notably ‘engagement’ and ‘integrated analysis’.

As a result, many investors and advisors believe erroneously that SRI is little changed from the ‘ethical investment’ of the 1990s and that the principal question to be investigated is whether screened funds have outperformed their unscreened peers.  Responsibility for this situation is, as ever, shared – and will, as ever, take time to redress.

An important role has been played by a small number of specialist SRI media sources that have tracked the emerging industry closely, have reported critically and constructively, have stimulated debate and thereby have supported the healthy development of the industry.

SRI-C welcomes the participation of these specialist news providers but reminds them of the SRI-CONNECT principle that “what goes on the site, stays on the site”.  In practice, this means that specialist SRI media can:

• Publish their news on the site
• View the news of practitioners

But they cannot:

• Source stories from the site
• Publish information that they find on the site in other places

(Repeating information published on SRI-CONNECT outside the site defeats the trust necessary for the operation of the site and will lead to an immediate ban of the user concerned and potentially to ‘naming and shaming’.)

In recent years, coverage of sustainability & CSR issues has grown in volume and sophistication through the:

• emergence of specialist news and information providers
• greater attention paid to sustainability issues by mainstream media

In addition to this, new web-based media communication media enable:

• practitioners to communicate directly to their news directly
• news recipients to filter what they receive to their specific needs

In the wider communications arena, a battle is being fought between professionally-filtered and edited (paid for) news provision and free-to-air, user-generated information.  SRI-CONNECT believes that both have a role to play in SRI and aims to incorporate both within the site.

The NGO spectrum ranges from direct-action headline-seeking campaigners at one end to cerebral policy wonks at the other.  While both are essential for the broader processes of change, the SRI community has (unsurprisingly!) found it easier to engage with the policy wonks.  This is because most SRI engagement with companies takes place within a trusted relationship and behind closed doors using the shared interest of owners and executives as the point of leverage.

Over a long(ish) period of trial and error, NGOs have found that SRI investors can sometimes be an effective channel for NGOs to promote corporate change, but often are not.

The SRI industry is not one of the primary stakeholders or communications targets for NGOs (as their attention is more normally directed towards the political, commercial or civil spheres).  However, it can be incrementally useful to them to promote discussion of their ideas and objectives within the investment sphere and to receive reciprocal feedback on the interest of capital markets in their activity.  NGOs can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

Policy and research organisations are non-governmental organisations that monitor environmental and social trends and develop suggestions for market interventions or policy changes.

The SRI industry has not traditionally been one of the primary stakeholders or communications targets for policy organisations (as their attention is more normally directed towards the political, commercial or civil spheres).

However, these organisations can be of great value to SRI investors that need to understand the scientific, regulatory and consumer background to sustainability trends.  (While ‘mainstream’ investors receive considerable amounts of background research on issues and industries from sell-side analysts and specialist news providers, SRI analysts typically have to find this information themselves from other sources.)

Equally, policy organisations can benefit from promoting discussion of their ideas and objectives within the investment sphere and receiving reciprocal feedback on how the sustainability factors that they analyse are received within capital markets.

At present, however, much of the onus lies on investors to identify the relevant policy organisations and to find any appropriate research and/or experts.  Policy organisations rarely consider SRI investors as an outlet for their research and do not tend to direct their research pro-actively at this community.

They can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

Professional associations are organisations that represent experts on particular aspects of sustainable corporate practice.  They include associations of human resources professionals, environmental management professionals, accounting professionals, corporate reporting professionals etc.

The SRI industry has not traditionally been one of the primary stakeholders or communications targets for these associations (as their attention is more normally directed towards the political, commercial or civil spheres).

However, they can be of great value to SRI investors that need to understand the scientific, regulatory and consumer background to sustainability trends.  (While ‘mainstream’ investors receive considerable amounts of background research on issues and industries from sell-side analysts and specialist news providers, SRI analysts typically have to find this information themselves from other sources.)

Equally, professional associations can benefit from promoting discussion of their ideas and objectives within the investment sphere and receiving reciprocal feedback on how the sustainability factors that they analyse are received within capital markets.

At present, however, much of the onus lies on investors to identify the relevant associations and to find any appropriate research and/or experts.  Associations rarely consider SRI investors as an outlet for their research and do not tend to direct their research pro-actively at this community.

They can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

Exchanges are relative newcomers to the SRI market and the World Federation of Exchanges has only recently gathered together a collection of best-practice initiatives.  These include:

• Support for SRI indices
• Guidance on best practice in disclosure
• The inclusion of sustainability considerations within listing rules
• Creation of exchanges for new sustainable markets (e.g. for carbon markets)
• Active targeting of sustainable market opportunities (e.g. actively marketing the exchange to clean tech IPOs)

Exchanges appear to be at the earliest stages of identifying how they should interpret the growing demand for SRI.  In this respect, the following report may be of most use to them:

• SRI Primer – which considers SRI from first principles and aims to address all of the questions that newcomers may have about the industry.  For the more advanced, it also describes 21 distinct SRI strategies, outlines progress in 5 asset classes and addresses the question of ‘proof, prejudice & investment performance’

SRI investors are often heard to complain that ‘social issues are much harder to evaluate than environmental ones.  It is therefore surprising that there is so little contact between SRI investors and the policy teams of trade unions who should be well able to advise on best-practice in company-employee relationships and human capital management.  It is equally surprising that the contact that has taken place has often centred on the specific and controversial campaigns that SRI analysts are least able to deal with.  (The exception is perhaps to be found in France where unions have engaged more actively in the development of SRI (notably through their shareholding in Vigeo)).

The SRI industry has not traditionally been one of the primary stakeholders or communications targets for trade unions (as their attention is more normally directed towards the political, commercial or civil spheres).

However, unions can be of great value to SRI investors that need to understand the employee and labour relations practice and trends.  (While ‘mainstream’ investors receive considerable amounts of background research on issues and industries from sell-side analysts and specialist news providers, SRI analysts typically have to find this information themselves from other sources.)

Equally, unions can benefit from promoting discussion of their ideas and objectives within the investment sphere and receiving reciprocal feedback on how the sustainability factors that they analyse are received within capital markets.

At present, however, much of the onus lies on investors to identify the relevant unions and to find any appropriate research and/or experts.  The unions themselves rarely consider SRI investors as an outlet for their research and do not tend to direct their research pro-actively at this community.

They can rarely justify the cost of maintaining their own SRI communications programme and therefore need to ensure that the engagement that they do undertake is as efficient and targeted as possible.

Advice on this is contained within our SRI-Dynamics paper:

• Engaging SRI: top tips - (coming soon) which outlines to industry outsiders how to shape and communicate social and environmental news and research in a way that maximises its value to the SRI industry

For the last twenty years, SRI has been an industry in rapid development and constant evolution and there has been little time for self-analysis by the practitioners.  The industry, therefore, has derived great benefit from academic research that has reviewed emerging industry practice, evaluated its assumptions and tested the performance of its theories and outputs.

Considerable academic research has been undertaken on the relationship between the application of sustainability criteria and the financial performance of funds.  Subjects that are, perhaps, under-researched include:

• The business dynamics of the SRI industry – perhaps one for MBA students?
• Sector-by-sector analysis of how individual environmental or social interventions (by government, employees or customers) have influenced the profitability of individual companies – and how (and when) this is recognised by the company’s share price