Sandra Haurant explores how SRI investors’ strategies have evolved from exclusion to an engaged approach with companies' ESG credentials

It was back in July 2000 that an amendment to the UK's 1995 Pensions Act made it a legal requirement for trustees of occupational pension schemes to make public their policy on ethical investment. At the same time, and partly because of that change in the law, FTSE Group launched the FTSE4Good index, which listed only those UK companies that met its environmental, social or corporate governance criteria.

More than a decade later, the investment landscape has changed drastically, with a growing emphasis on transparency and disclosure across industry, and social responsibility, sustainability and good corporate governance becoming core investment criteria. Funds invested with socially responsible criteria have increased four-fold, rising to $10 trillion according to the FTSE and Eiris report, FTSE4Good, Ten years of Impact and Investment.

Financial institutions vary in the way they approach ethical investment, but one thing is clear: socially responsible investment is no longer the preserve of specialist funds - it has very much become mainstream. "The question is no longer about whether it is alright to have these commitments. It is generally accepted that corporate and social responsibility is good for a company," says Niaz Alam, chief operating officer at UK Sustainable Investment and Finance (UKSIF).

Ten years ago, it was not just attitude but approach that was different. The focus for social responsible investing, in the UK at least, was more often than not placed on negative screening and exclusion, with investors having clear lists of companies and sectors that should be avoided. Tobacco and alcohol were frequently on the exclusion list, along with weapons manufacturers and environmentally questionable areas such as mining.

Newton Investment Management SRI officer Amanda Young says: "There has been a shift. Ten years ago the emphasis was on sin stocks, and on ethical funds. Now there is a far greater emphasis on understanding the positives a company can bring. You might get a mining company doing an enormous amount of work around AIDS, for example."

Young says that approaches have changed, along with attitudes. "Investors are more pragmatic. Ultimately we are a shareholder. There is a greater understanding that managing these risks can contribute to long-term investor returns. Often a good CSR policy will be a very good indicator of how a company is managed."

Newton has never favoured the exclusion approach, Young says, but still has starting points when looking at companies: "We begin with publicly available information. We look at CSR reports, news articles, NGO reports and information from a wide variety of stakeholders.

"We tend to focus on where we have a large exposure, and the work we do is proactive," says Young. She adds: "It's about risk management. It's not a moral thing."

Erik Breen, head of the corporate governance and sustainability department at Robeco, agrees that socially responsible investing has moved on. The emphasis on working with companies to improve their environmental, social and corporate governance (ESG) is now pervasive. "It has become far more sophisticated," he says. "There are now very measurable targets for engagement. Engagement is really a favoured instrument if you are looking for positive change. If you lose a stock you potentially lose contact with that company - the link is stronger when you have shares."

Breen says one of the reasons engagement has grown is that it is becoming more effective. Greater collaboration between stakeholders, whether that means working with competitors, with NGOs or other parties, leads to more participation, more voting at meetings and more positive changes to management decisions.

Collaboration has become a key force in engagement for institutional investors. Member groups such as the Institutional Investors Group on Climate Change (IIGCC) for example, encourage investors to take an active stance on ethical and environmental issues. IIGCC counts asset managers and pension funds from across Europe among its members. It encourages investors to make changes to their own investment processes, and, crucially, the way in which they engage with companies. Members who sign up to the group's "Statement on Climate Change" are committing to issuing an annual report on their behaviour relating to climate change.

Another huge influence in recent years has been the introduction of the Stewardship Code, published in June 2010 by the Financial Reporting Council. The aim of the Code is to "enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities." It homes in on "purposeful dialogue on strategy, performance and the management of risks".

"It's the latest thing that has really hammered this home," says Young. "Newton has done this for a long time, but the Stewardship Code really reinforces responsible investment policies and principals."

For BNP Paribas Investment Partners head of sustainable and responsible investments Eric Borremans though, too much emphasis on engagement can hold up the investment decision making process. "Exclusion is very clear, but it is also antagonistic. Engagement, on the other hand, is not confrontational. But it also has little or no impact on investment decisions." After all, it is perfectly possible - maybe even desirable in some ways - to remain invested in a company, or to delay investing, while you wait for your positive engagement to make a change to the company's management. "You need dialogue," says Borremans, "but you also need to make investment decisions."

Engagement, then, is often combined with a best in class investment approach, choosing the companies in a certain sector with the best ESG record. Best in class is still widely used and Alam of UKSIF says: "Often our members do both, they are not mutually exclusive."

And of course, that is not to say that exclusion has been thrown out of the decision-making process. It still plays an important part, and some areas of potential investment are completely written off if they are in breach of many broadly accepted standards on human rights and environmental issues. Swisscanto portfolio manager SRI Gerhard Wagner explains: "We have fairly strict exclusion criteria for our SRI funds. However, there are certain realms which are very sensitive for all Swisscanto investment funds", says Wagner. "For example if a company is involved in big topics such as tropical deforestation, we would address that issue with them to make them more sensitive to ESG topics."

But while this sort of investment criteria may in the past have been confined to the specialist ethical and green funds, the market has changed drastically. "The big trend is about integration," says UKSIF's Alam. As Wagner puts it: "We cannot say that a company is fine for one of our funds but not for others. Therefore, it is important for us to engage. Our engagement for sustainable investing goes beyond SRI funds."

But while SRI has become a common cause in investment, the preoccupations of different analysts and fund managers remain deeply individual. And this is one of the reasons FTSE has now launched a ratings system that allows investors to see exactly how well companies are performing on a range of environmental, social and corporate governance targets. The ESG ratings system assesses the performance of all eligible companies, around 2,400, and gives ratings according to their performance in each of the three categories, environmental, social and governance. This allows investors to drill down and see how companies match up to their own investment criteria.

While FTSE4Good gives investors an idea of who is in and who is out when it comes to responsible investment, the rating system will give a far greater understanding of what goes on beneath the surface. "The landscape has definitely changed dramatically over the past decade," says David Harris, director of responsible investment at FTSE Group. "And it is set to change hugely again over the next 10 years."

Written by Sandra Haurant, a freelance journalist

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