UMass Amherst has just released its first Toxic 100 report since 2005. This is a pretty sophisticated analysis of air emissions, taking into account not just the volume of emissions, but also toxicity and how many people are impacted - even the direction of prevailing winds.
Steve Miller, former CEO of Waste Management, once commented that "a reputation is an incredible asset, one you can't appreciate it until you lose it."
There are still plenty of people in the financial profession who are somewhat dismissive of the impact of reputational effects, despite many cautionary examples. The negative impact is greatest for firms in competitive businesses where the consumer is willing to pay up for quality or safety. Perrier, once the #1 vendor of bottled water, never fully recovered after having to recall the product due to benzene contamination.
I have not seen a good study of these things recently, but it's not hard to see recent examples in the market. (Let me pause here to say that I do not own or cover either of the two stocks that I am about to discuss, nor do I have any views on their investment prospects.)
One timely example is Mattel, which is down today after recalling millions of toys that might be contaminated with lead paint.
This comes on the heels of a similar recall of toys sold by RC2. The RC2 situation has been going on longer, so we have a little more information on which to make inferences about reputational impact. The first thing I'd note is that the stock didn't crack down much right away (the original press release is dated June 15), despite the fact that millions of toys would have to be recalled. The stock's high for the year was $46...it dropped to $40 in the weeks following the announcement. It fell from $40 to $36 yesterday, and after a weak quarter and guidance cut yesterday, it's $29.
I know there are many factors in play here, but the slowdown in sales and the safety recall may not be entirely unconnected. Another data point - some outlets are discounting the premium priced 'Thomas' toys, something I haven't seen before.
And, of course, there are lawsuits.
For those interested in studying this situation (I think it would make a great case study), The New York Times has covered the RC2 story aggressively. A Times reporter was actually detained at the factory where some of the toys were made for nine hours, as described here. It appears that RC2 has since cut all ties with the vendor - a Times update story is here.
One final comment, a quote from the Book of Buffett. Warren Buffett has been known to pay close attention to financial matters. But when he took over Salomon following their bond trading scandal, he didn't emphasize the numbers. He told employees: "If you lose dollars for the firm by bad decisions, I will be understanding. If you lose reputation for the firm, I will be ruthless."
I'm a bit behind in my reading, but enojyed this piece from The Economist's special report on business and climate change, particularly the graph (sourced from the Swedish utility Vattenfall).
The Economist correspondent drily observes that "people buy houses not because they have good insulation but because they have pretty views." One might say the same thing about why (most) people buy stocks and mutual funds - which might, in turn, explain their results (the mutual fund version is here).
Social investors and oil company CEOs agree: high oil prices are good.
Jack Robinson, who manages the Winslow Green Growth Fund, tempts fate in the latest CFA Institute Conference Proceedings Quarterly (link to abstract is here), quoting the most dangerous words in investing: "it's different this time."
Robinson focuses particularly on alternative energy, noting that "at times in the past [it] has seen an explosion of [investment] interest only to have it evaporate as oil prices declined. This time, however, unique circumstances may make green investing in general, and the search for alternative sources of energy in particular, a permanent recipient of investment capital."
Calvert seems to agree, and this month launched its own alternative energy fund.
I can't resist also linking to a slightly different view - this Fortune article explains why Exxon Mobil CEO Rex Tillerson has no interest in alternative energy investments.
Maybe everyone is right. High oil prices would be a boon to both alternative energy companies (by making alternative more attractive when compared to oil), and to Exxon Mobil (by allowing the company to continue to earn stellar returns on equity).
The futures markets have been predicting sustained higher oil prices for some time. This interview with Fatih Birol, chief economist of the International Energy Agency, certainly seems to support that view as well.
Two things bother me about all this. First, high oil prices are good for oil companies and alternative energy companies, but bad for consumers - especially poor ones. Birol argues that Africa is being hurt the most by the current high price environment. Second, former Exxon Mobil CEO Lee Raymond, who knows something about oil supply, last year predicted a decline in oil prices over the coming decade as the global industry catches up on the underinvestment of the prior decade.
Whomever is right, oil seems to be running everything right now. Last week Starbucks announced it would be very difficult for the company to hit the high end of earnings guidance. One key culprit: the price of milk. So why are milk prices so high? This article from Monday's Wall Street Journal offers several explanations - a cut in EU subsidies for export, a drought in Australia - and higher corn prices (feed for the cows).
So why are corn prices so high? Well, corn is an important ingredient in ethanol, although some experts had predicted that this would not have a major effect. (This is reminiscent of a headline from The Onion's history book, Our Dumb Century. After the 1929 market crash the headline reads: "Experts Blameless, Say Experts" ...)
As for the Australian drought? It's bad. Really bad. And unlikely to end any time soon.
My favorite part of all this is that today, the Fed Open Market Committee commented that "readings on core inflation have improved modestly in recent months," as they left the Fed Funds rate unchanged. And the core inflation numbers certainly are reassuring.
But the core numbers don't include oil, corn, and milk, three commodities that in recent years have stubbornly refused to regress to the mean.
Jeffrey MacDonald at The Christian Science Monitor has made corporate social responsibility his beat. His latest piece, on how companies are acting more quickly to address social and environmental concerns before they get out of hand, is excellent.
The Monitor's website has an 'Ethical Investing' section, with an archive of his past stories and a series of video interviews (by Laurent Belsie) with social investment practitioners.
I wrote last year about the energy problem - the underperformance of some social indexes as energy stocks took over the market in recent years. It is not just an energy problem, it's a utility problem, too. Here are the returns to the S&P 500 by sector for the three years ended 8/6/06 (source: Bloomberg):
| Energy | 131% |
| Utilities | 66% |
| Materials | 43% |
| Industrials | 39% |
| Financials | 33% |
| Telecom Serv | 32% |
| Cons Staples | 25% |
| Cons Disret | 20% |
| Health Care | 14% |
| Info Tech | 14% |
Many social investors avoid both energy companies and utilities - energy companies because of their environmental problems, and utilities because most are involved in nuclear power. Whether these restrictions make sense can be debated. A financial academic once asked me why we excluded stocks that will outperform with higher energy prices when they are the best thing that could happen to the alternative energy sector (they create a subsidy to development of cleaner energy). And some influential people are arguing that, given our climate issues, nuclear could be part of the solution (Socialfunds covered this very well last summer).
Anyway, it's hard to outperform when you're underweighted the two best-performing sectors in the market. The Domini Social Index is still ahead of the S&P 500 from inception and over the past ten years, but its three year record has been well behind the broader market as of 7/31/06 (annualized +8.5% vs. +10.8% - full performance details here). The Calvert Social Index is in the same boat, up 8.0% over the same period (performance details here).
There are a couple of points I'd like to make about this:
And finally, I get a chance to mention the Canadia social research firm Jantzi Research on this blog. Founder Michael Jantzi has been involved in social research since 1990, and knows what he's doing. They have just published a report reviewing the sustainability records of 23 large energy companies. BP comes out at the top of the heap, which is consistent with other research I've seen.
This speech by Wal-Mart President and CEO Lee Scott is drawing a lot attention from social researchers. Wal-Mart, of course, has been involved in many controversies, and is not currently represented in (for example) the Domini or Calvert social indexes. But the speech is notable for its ambition, its scope, and its detailed analysis. A brief excerpt:
"Our environmental goals at Wal-Mart are simple and straightforward:
Can't be much clearer, or more ambitious, than that. Scott makes the business case for these goals, pointing out that all waste has a cost.
Although my instinct is to look at deeds vs. words, I have to say that the speech strikes me as more than a PR piece. On first reading it looks like the beginning of a meaningful effort by the company to address some difficult issues.
Others are not so impressed: Op-Ed columnist Harold Meyerson of the Washington Post offers this harsh critique of the speech and its context.
[10/27 Update: There is additional news on this today.]
I had the pleasure last night of presenting the 2005 Moskowitz Prize to Nadja Guenster of Erasmus University in the Netherlands, who accepted on behalf of her three co-authors. (Official announcement is here.)
Nadja gave a great presentation on the study this morning at the SRI in the Rockies conference in Snowbird, Utah. Here is my abstract of the study, and the full text is available here.
If you are interested in the financial impact of environmental and sustainability practices, I think it is fair to say that this is a must-read. We have seen several studies showing environmental alpha in recent years, most recently Derwall(2005). But until now no one had really explained how or why this was happening. Nadja's piece is careful, thorough, and full of good judgments about methodology and data.
Congratulations also to Meir Statman, who received an Honorable Mention for his article on socially responsible indexes. Meir is having a good year, as he also is headlining the just-released Journal of Investing special issue with a different piece on SRI.
Of course the minute I write a note saying the sell side will never do much social responsibility research, Merrill Lynch comes out with a new report on clean cars, prepared in cooperation with the World Resources Institute.
posted by Jeff MacDonagh
I was pleasantly surprised to see FAJ publish this piece on the portfolio management implications (via backtesting) of using Innovest ratings. "The Eco-Efficiency Premium Puzzle" (Derwall, Guenster, Bauer, and Koedijk) is another decent article to contribute to our growing body of literature showing the legitimacy of using non-traditional data in stock picking. Moreover, I think the authors are correct is raising the possibility of "mispricing" based on the degree of outperformance and their use of a multifactor model to control for several traditional financial factors.
Here's the abstract:
Does socially responsible investing (SRI) lead to inferior or superior portfolio performance? This study focused on the concept of "eco-efficiency," which can be thought of as the economic value a company creates relative to the waste it generates, and found that SRI produced superior performance. Based on Innovest Strategic Value Advisors' corporate eco-efficiency scores, the study constructed and evaluated two equity portfolios that differed in eco-efficiency. The high-ranked portfolio provided substantially higher average returns than its low-ranked counterpart over the 1995–2003 period. This performance differential could not be explained by differences in market sensitivity, investment style, or industry-specific factors. Moreover, the results remained significant for all levels of transaction costs, suggesting that the incremental benefits of SRI can be substantial.
