Invest for the best

Amanda Leek asks if responsible investing truly is incompatible with good financial returns

The socially responsible investing (SRI) tug of war between financial returns and ethical principles was illustrated in September when the Norfolk Pension Fund, an independent fund valued at £2 billion, was found to have invested £25.9 million in tobacco firms while Norfolk County Council, who run the fund, launched anti-smoking campaigns across the borough.

Norfolk Pension Fund decided not to exclude cigarette firms from its portfolio after its pensions committee found more than £167 million was invested in tobacco by county councils across the East of England.

Norfolk County Council leader and chair of the pension fund committee Derrick Murphy said that, while there is a duty to review the right thing to do, it was his role to get the best deal possible for people who receive a local government pension.

But while examples like this will always be found, First State global head of responsible investment Will Oulton says public pension funds are generally leaders in responsible investment. “Public pension funds tend to come under greater public scrutiny and have therefore come under greater pressure to adopt policies that include specific references as to how they will manage ESG factors in their investments,” he says.

And while general awareness of the importance of SRI has increased, this year’s Investment Management Association figures show a total of £17 million was withdrawn from green and ethical investments since last November, whereas more than £100 million was invested into these funds the year before. Tough economic times are driving investors to seek returns, which may mean they are avoiding ethical funds on the mistaken belief that such funds will provide them with lower returns.

Analysis, such as research by Frankfurt AfU Investor Research and RepRisk AG, in fact shows there is no significant difference in financial performance between conventional funds and those with sustainability claims.

Bestinvest managing director of business development and communications Jason Hollands says investing in a sustainable way, and being a responsible shareholder engaging with companies, should not impair long-term performance.

“In fact, over the long term, this should protect shareholder value as businesses that are sensitive to ESG issues are inherently doing a better job at managing their risk profile, both in terms of reputational risk, and in terms of real penalties and fines,” he says. “It’s important to understand the companies in which you’re invested are alive to the reputational, and real, risks that can arise.”

In addition, the UK Stewardship Code has made pension schemes more attuned with considering environmental, social and governance (ESG) factors. The Code aims to enhance engagement between institutional investors and companies to improve corporate governance and long-term returns for shareholders. Currently 250 funds have signed up to the code, including public service pension schemes the London Pensions Fund Authority, the Greater Manchester Pension Fund, the Environment Agency Active Pension Fund and the Pension Protection Fund. Published in 2010 by the Financial Reporting Council, it operates on a ‘comply or explain’ basis and the FSA requires asset managers to report their status.

“That is the tug of war essentially involved,” says Hollands. “It is intuitive that if you are going to have a more restricted investment universe it makes the job of delivering the best returns tougher, all things aside. There’s no doubt about that.”

He explains: “That’s particularly the case in challenging markets because quite a lot of the most defensive sectors, those that hold up better at tougher points in the economic cycle, are some of the areas which ethical funds generally won’t invest in. Tobacco companies and distillers are cash-generative businesses that pay high levels of dividends as well as being less sensitive to downturns.”

So what do SRI funds invest in?
Responsible investing covers a range of investments. F&C Investments head of SRI research Alexis Cheang says there are three types of SRI funds. The first, historic, model focuses on excluding, or screening out, businesses or ‘sin’ sectors such as tobacco, alcohol, gambling and arms or defence. The second focuses on positive investing, selecting companies built around sustainable themes. Thirdly a newer family of funds has emerged, focused primarily on engagement.

The F&C global climate opportunities fund, for example, started as a thematic fund but now focuses more on engagement. Wind and solar developments were its initial focus but now it invests in companies that help society adapt to climate change, such as technology companies that improve energy efficiency or smarter metering to help consumers use less energy, and regulated utilities, supporting services, and agriculture.

Such funds, Bestinvest’s Hollands explains, may well invest in an oil company, but they favour companies which have a high degree of transparency that are very alert to the risks their businesses will have, “particularly when they are operating in environmentally sensitive areas or countries with poor human rights or endemic corruption”.

The type of fund ultimately chosen by a pension fund, however, will depend on how far trustees are willing to exclude and restrict their investments.

“You will find certain types of institutions, particularly in the charity space, where they may feel far more able and comfortable to exclude types of activity, particularly if it doesn’t match with their aims and objectives,” says Jupiter Asset Management’s sustainable investment and governance director Emma Howard Boyd.

“Similarly, with corporate pension funds where the corporate sponsor, the company itself, has a strong long-term focus on sustainability issues, they may feel it is increasingly important to reflect what they are doing as a business in how their portfolios are managed,” she adds.

Part of Howard Boyd’s role is to ensure companies meet the criteria for the Jupiter Ecology Fund. She says it has developed in the last 10-20 years to focus on listed companies in areas such as energy efficiency, green technology, solar and wind, waste management and organic food. At the end of the day, however, does it all still come down to returns?

“It is not that profitability in the short term and investment in sustainability and sustainable practices exclude each other”, says MuZinich managing director Tatjana Greil Castro. “In our investment philosophy they go hand in hand. You can only stay the leader in your sector if you make the necessary improvements or investments in the business. That may not mean being expansionary, but maybe staying up to date on technology so they are competitive.”

In fact, the dichotomy between profits and ethical investing has now turned on its head. When banks are withholding loans and the cost of borrowing has increased, investors can and should use the power of money to influence corporate agendas.

Oulton explains: “Trustees need to be conscious of the fact they are the asset owners – even though the actual fund management activities may be delegated – and as such they have obligations to act like owners. This means having due regard to their stewardship activities over the long term, being active owners and having clear, strong policies outlining the fund’s investment beliefs.”

Castro adds that this also means they have strong powers to influence: “You can get the ear of companies more readily by saying ‘we want to buy some of your debt but we have concerns about x, y and z’. You can point to areas where they are weak in ESG terms and try to bring about a change in behaviour. If you simply exclude them they have no incentive to do better but if you say ‘I will invest, lend you the money you need, if you do this’ you can have a positive influence.”

Cheang concludes: “Using our influence as an investor, we try and improve companies rather than accepting them as they are. One of the things, above financial return, that clients get from adopting an SRI or ESG strategy is to be part of a positive tide influencing companies to improve their governance and sustainability practices.”

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