SRI Notes

Who Are These Guys?

A bit of a shock from Financial Times this morning:  "Large ethical companies consistently outperform the market, according to a survey of corporate social responsibility by Goldman Sachs, the investment bank."

Well, not really.  The report actually asserts that SRI indexes have historically underperformed, and offers this comment:  "one explanation for the historical relative underperformance of various SRI and/or ethical investment indices is the lack of integration with financial analysis". 

I'm sympathetic with the thought - social factors do need to be better-integrated with mainstream securities analysis.  But there's actually not much evidence to support what they're saying about performance.  Social investments haven't historically underperformed (for a long discussion of this see my 2005 Journal of Investing paper), and despite a rough three years the Domini Index is still ahead of the S&P 500 from inception.  If you're keeping score, it's currently Domini +12.1% (annualized return) vs. S&P 500 +11.5% from inception (5/90).  Major variations in performance appear to be explained by the Fama & French factors.  When you adjust for those factors, the big problem is explaining why the Domini index seems to have positive alpha. 

[Non quantitative readers can skip this note.  But if you're quantitatively inclined you can do your own analysis of the Domini numbers using the Fama & French factors from Ken French's website.  William Bernstein gives excellent step-by-step instructions here.  If you're in business school, ask your finance professor why the intercept is positive.  You'll get some interesting answers.]

The report is saying that certain companies Goldman Sachs likes have outperformed, and it introduces the GS SUSTAIN methodology to identify these companies going forward.  The report says that "our methodology is not designed to be comprehensive, nor is it designed to be prescriptive in judging what is good or bad practice."  (If you don't have access to Goldman research, this Associated Press article is a good backgrounder on the report.)

Peter Kinder has usefully divided social investors into three groups:

• Values-based investors - investors whose values drive portfolio construction with relatively little attention to the financial impact of those decisions
• Value-seeking investors - investors seeking to improve investment performance through the use of social or environmental variables
• Value-enhancing investors - investors that use shareholder engagement to increase shareholder value, but do not otherwise view themselves as 'socially responsible'

The Goldman report falls under the second heading.  They are not trying to make distinctions about what is right or wrong, or to serve a particular type of social or environmental investor.  The SUSTAIN project instead represents a serious effort to integrate stakeholder analysis with securities analysis, with a view toward improving investment returns.  That's a smart thing to do, and mainstream portfolio managers should take a hard look at it.

KLD Blog

I'm happy to report that the SRI research firm, KLD, is starting a firm blog that will offer insights and commentary on SRI.  Peter Kinder, CEO and co-founder of the company has the first post. 

Update to sritudies.org

I've done my annual update on the sristudies.org bibiliography page.  Sorry, time doesn't permit a list of recent additions, but you can find them easily enough - just go to the web page, and using the search function in your browser (the "Find" command on the "Edit" menu in Firefox), look for "2006" or "2005".

One reason I've never put much directory functionality into sristudies.org is that Google is so powerful.  Try this - go to Google and type in:

site:www.sristudies.org 2004

That gives you a list of every instance of 2004 on sristudies.org.  When Google gets around to indexing the updated site (next week?  next month?) you can use this command to get a comprehensive list of more recent studies.

If you notice typos etc...I know, I know...anyone know a good proofreader?

Rating the Energy Companies

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:

• Social investors as individuals need to think hard about how they're going to handle these issues.  Energy matters a lot, not just in financial markets, but in the real world.  Economist James Hamilton has written intelligently about both the possibility we are near peak global oil production, and the impact of higher oil prices on the economy.  WSJ Online has a good online piece with contributions from both Hamilton and Robert Kaufman of Boston University.
• There are energy investments that are palatable to some social investors.  There are both ETFs and mutual funds focusing on clean energy.
• Nothing lasts forever.  Lee Raymond recently said "the seeds are being sown right now for another turn in the cycle of the oil industry.  For those people who think there will not be a day of reckoning on the other side, and I hope I live long enough to see it ... it just takes a long time in this industry for supply and demand to react. This isn't like going out and producing a few more semiconductors."  I have no idea if he's right, but it's something to think about.

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.

Some Reports on CSR and SRI

Here are a few recent reports on corporate social responsibility that I haven't had time to go through yet - just wanted to get all the links in one place...

The biggest recent news, of course, is the Social Investment Forum's Trends Report, which came out January 26th.  This report gives a sense of how much money is manged according to social constraints in the U.S.

In October 2005, the international law firm Freshfields Bruckhaus Deringer issued a report for the UN Environment Programme (UNEP) Finance Initiative entitled "A legal framework for the integration of environmental, social, and governance issues into institutional investment".  It reviews the legal basis for social investing in the U.S., Canada, Japan, and western Europe.  (Thanks to Glynn Washington at the Council for Responsible Public Investment for telling me about this one.)  You can find a copy of the report here.

McKinsey and Company's nonprofit practice has had a series of recent articles on social responsibility, including one on the UN Global compact.  You can review the whole list here (registration required).

Last June KPMG issued its International Survey of Corporate Responsibility Reporting.  You can download a copy here.  The Christian Science Monitor did a good article on it, here.

Jeff MacDonagh posted on this last fall, but here is a link to the PriceWaterhouseCoopers study of analysts' estimates and CSR information.