Sunil K Sinha: Socially responsible investment

As emerging markets rise rapidly in significance for global investment flows, the share of SRI funds in their stocks will grow significantly.

After the announcement of the Principles of Responsible Investment (PRI) on April 27, 2006 by the then Secretary General of the UN, Kofi Annan, international funds worth $4 trillion have now endorsed the same. The backing of such a large fund to the PRI confirms that the integration of environmental, social and corporate governance considerations is now becoming an essential part of global investment business.

Responsible investing, socially responsible investing, socially aware investing, ethical investing, values-based investing, mission-based investing...all describe the same concept. These terms tend to be used interchangeably within the investment industry to describe an approach to investing which combines the intentions to maximise both financial return and social good. In general, Socially Responsible Investing (SRI) favours corporate practices which are environmentally responsible, community friendly, support workplace diversity and increase product safety and quality.

A brief history
The origin of the SRI movement cannot be traced to any single specific defining moment, as it has shaped over a period of time and drew momentum from a variety of historic developments. The first instance of social investing perhaps can be traced back to the 1920s when churches divested the so called 'sin stocks' "" alcohol, tobacco and gambling from their portfolio. However, the catalytic factor for SRI in the more recent past has been the environmental movements of the 1970s and 1980s. As the ability to conduct substantive social and environmental research on companies improved, 'negative' or 'avoidance' screening was supplemented by 'positive' or 'inclusionary' screening "" the practice of looking for companies with leading policies and practices. In this way, more recent products differ considerably from the main ethical indices that by their very nature need to exclude certain types of investment areas. The real evolution in methodology has come about by both the creation of research bodies focusing on the companies that meet SRI and sustainable criteria, together with the realisation by corporates that an open debate on policies can be beneficial. The increased transparency by companies and the willingness to have a dialogue with research groups meant that it became easier to compose research-based rankings together with quantifiable assessments of corporate behaviour and suitability. This has been a key factor in the development of more inclusive company rankings and SRI indices. Presently, several SRI indices are operational in the global space. The table provides a glimpse of these. 

SRI INDEX
Indices	Market  covered	Launch  date	Review	Available  Currency
European Indices
Dow Jones STOXX/Euro	Pan
STOXX Sustainabilty Index	Eurozone	Oct-01		Euro and US $
Ethibel Sustainabilty Index Europe	Europe	Jun-02	Querterly	Euro and US $
FTSE4Good Europe	Europe	Jul-01	Bi-annual	Euro
FTSE4Good UK	UK	Jul-01		GBP
Humanix	Europe	Jan-01	Querterly	Euro
World/ US Indices
Dow Jones Sustainability World Index	World	Sept-99	Annual & quarterly	US $ & Euro
FTSE4Good Global Index	World	Jul-01	Bi-annual	US $
FTSE4Good USA Index	USA	Jul-01	Bi-annual	US $
Calvert Social Index	USA	Apr-00	Annual	US $
Domini 400 Social Index	USA	1990	Not fixed	US $
Ethibel Sustainability
Index Global	World	Jun-02	Querterly	Euro & US $
Jantzi Social Index	Canada	Jan-00	Annual	Canadian $
Emerging Market Indices
JSE SRI Index	South Africa	May-04	Annual	Rand (R)
Bovespa Sustainability Index	Brazil	Dec-05	Annual	Real (R$)

Current status and growth
While the SRI as a concept and tool is now fairly well established in developed markets, it has yet not acquired any definite shape in emerging markets. However, given the increasing attractiveness of emerging economies as an investment destination, social investors would, sooner or later, want to enhance their investment in the firms of emerging economies provided they make reasonable assessments of how socially responsible the local firms are. Also, the trends that are likely to favour SRI in future are:

Globalisation of industry where social and environmental performance becomes a source of differentiation and competitive advantage.

Tightening global, regional and domestic regulatory pressure such as the Kyoto protocol.

Changing consumer/ investor demographics with many younger "greener" consumers and investors.

Growing institutional shareholder activism.

Global population pressure/resource consumption pressure.

Pressure from NGOs armed with better information and growing credibility.

Nevertheless, one criticism that has often been levelled at SRIs is that they entail systematic deterioration of the return/risk trade off for the investor. The origin of this criticism can be traced back to Milton Friedman's view during the early seventies where he stated that there is a fundamental and irreducible contradiction between the concepts of corporate social responsibility and free market driven shareholder value approach as the internalisation of social costs inevitably leads to a reduction of enterprise value.

However, thirty years later not only has the thinking undergone a fundamental change, a number of studies have demonstrated that social screens and shareholder engagement do not harm financial return, and in some cases, have improved corporate performance. For example, Orlitzky, Schmidt, and Rynes* (2003) found a statistically significant positive association between corporate social performance and corporate financial performance. Bauer, Kees, and Otten** (2002) found that there are no significant differences between SRI returns and those of unscreened funds. Similarly, Russo and Fouts*** (1997) found that companies with better environmental records appear to have better-than-average returns on assets. Besides these studies, it may also be worthwhile to point out that the Domini Social Index, a capitalisation weighted market index of 400 common US stocks screened according to broad social and environmental criteria, has outperformed the S&P 500 stock index on a total return basis since it went live on May 1, 1990. All this evidence suggests that for individual and institutional investors, addressing financial goals while also encouraging corporations to improve their social and environmental actions is a fiscally prudent and strategically advantageous objective.

SRI assets in the US were estimated to be $2.3 trillion in 2005. In 1995 this figure was $ 639 billion, suggesting a growth of 258 per cent in eight years. Similarly, in Europe the SRI assets grew from euro 336 billion in 2003 to euro1.033 trillion in 2005.

SRI and emerging markets
As compared to developed economies, the penetration of SRI funds in emerging markets is minuscule. According to an IFC report, merely 0.1 per cent of the total SRI fund assets worldwide were held in emerging market stocks in 2002. However, as emerging markets rise rapidly in significance for global investment flows, the share of SRI funds in emerging market stocks is likely to grow significantly. Since values-based retail and institutional investors who command a substantial size of global investment flows often want to align their personal values with their investment needs, even mainstream asset managers would find it difficult not to incorporate non-financial considerations into stock analysis and assess stocks from a long-term perspective taking sustainability considerations into account. It is quite likely, therefore, that SRI screening will increasingly get integrated into mainstream analysis and may be considered a proxy for sound strategy and good management practices.

*"http://staff.business.auckland.ac.nz/morlitzky" Orlitzky M, Schmidt F, Rynes S (2003) "http://business.auckland.ac.nz/newstaffnet/profile/publications_upload/000000556_orlitzkyschmidtrynes2003os.pdf" t "_blank" 'Corporate social and financial performance: A meta-analysis' Organisation Studies, 24, 403-441

**Bauer, Rob, Kees Koedijk, and Roger Otten, (2002) "International Evidence on Ethical Mutual Fund Performance and Investment Style", Maastricht University, Limburg Institute of Financial Economics, November

***Michael V Russo and Paul A Fouts, (1997) "A Resource-Based Perspective on Corporate Environmental Performance and Profitability" Academy of Management Journal, 40(3), 534-559

The writer is head and senior economist, CRISIL