Working Capital
Can Socially Responsible Investing Make a Great Green Leap Forward?
The basic premise of socially responsible investing is simple: If money makes the world go "round, greener, more humane investments can improve the way it spins. Want sustainably managed forests? Provide loans or capital to eco-minded timber companies. Want Monsanto to get out of the genetic engineering business? Buy Monsanto stock and put forward a shareholder resolution demanding the company cease and desist. This isn’t just wishful thinking; social investors can point to many positive efforts like these. And their strength is building. Yet before hailing a new era of green capitalism, it’s also important to understand some of its limitations.
Socially responsible investing (SRI) is something of a curious hybrid. Part capitalist outlet, part activist tool working within constraints that are mostly oblivious to anything non-financial, it is often misunderstood, even by those who support it. Its not-quite-fish, not-quite-fowl status leaves some wanting it to do more and others to overestimate what it can do. And in its own way, each view prevents social investing from fulfilling its potential.
The Three-Legged Stool
Traditionally, socially responsible investing has been described as a three-legged stool made of stock screening (avoiding the stock of bad-actor companies), shareholder activism (exercising your rights as a stockholder to make positive changes), and community investing (banking with institutions that loan money to worthwhile projects). Presumably, this stool is built to realign and hold an enlightened economy. It’s an appealing metaphor, but a bit misleading.
For starters, an image of a stool suggests that each leg is of equal strength and that they all work together in some coordinated way. In fact, some legs are considerably more developed than others and each strategy works independently of the others. There can even be some tension between SRI tactics (but not the goals of its practitioners, who sometimes work on all three fronts). For example, stock screening requires avoiding or divesting yourself of companies you don’t like, while shareholder activism demands investing in public corporations whose actions you’re trying to change.
Another problem with the stool analogy is it implies that the three SRI pillars are strong enough to support a sustainable, truly healthy economy. Alas, this doesn’t seem possible. That will require deeper, more fundamental changes and legislative action.
So is there a better analogy than a stool? We think so, but before offering an alternative metaphor and some ideas about how SRI might become even more effective, let’s look more carefully at the three main tools available to social investors.
Portfolio Screening
Although ethical investing can be traced back to 17th century Quakers who refused to invest in businesses selling armaments, the modern SRI movement was launched in 1971 with the Pax World Fund, essentially as a vehicle for stock screening. Started by ministers protesting the Vietnam War, Pax investors felt it was wrong to own stock in companies like napalm-maker Dow Chemical. So they created a mutual fund that screened out what they considered unsavory companies—including tobacco, alcohol, gambling and weapons makers. Over time, filters and research on corporate responsibility have grown more sophisticated to include environmental responsibility, women’s and gay rights, racial equality and animal testing. Almost 20 percent of SRI mutual funds use some kind of environmental screening, either as one of many screens or as their most important one.
The gist of screening your investments is summed up with the maxim: Invest your principal with your principles. That guideline can be applied to both stocks and bonds, and take the form of positive or negative screens. Intuitively, screening seems like the best way for an investor to express disapproval or support for a public company. If, for instance, you’re angry with Procter & Gamble for testing its products on animals, you’d either avoid their stock or, if you already owned it, sell it. For a positive screen, you might consider adding Ballard Power Systems to your portfolio if you look forward to the days when automobiles are powered by fuel cells.
It’s easy to see why this approach appeals to investors with a conscience. And indeed, stock screening is by far the most popular form of SRI. The question that has long dogged ethical investors is: Do stock filters hurt returns?
In 1984, when socially conscious investing was taking shape as an industry, Social Investment Forum (SIF) in Washington, D.C. did its first inventory of the movement. The grand total of money managed with a social conscience came to $40 billion. While that’s a substantial chunk of change, compared to the whole universe of invested funds it was still a boutique market. Back then, social investing pioneers struggled to be taken seriously. Mainstream media stories on SRI often ran with headlines such as, "Good Intentions, Bad Results" or "It’s Not Easy Being Green." Although, few came right out and said it, the implication was that socially concerned investors were good-hearted saps, destined for sub-par returns.
It’s been a while since social investors have had to endure such teasing (though old myths die hard: in July 2003, the New York Times ran an article by investing newsletter watchdog Mark Hulbert, who used highly selective fund comparisons to conclude screening for social factors hurts performance). Extensive research and history shows that investing according to social screens doesn’t harm returns and may even improve them. These findings have been clearly borne out by the success of the Domini Social Index (DSI), which is a screened, slightly trimmed-down cousin of the S&P 500 (a roster of 500 large companies that represents the stock market as a whole). For the 10 years through July 31, 2003, the DSI gave 11.17 percent annual returns, besting the S&P 500’s 10.29 percent.In the U.S., there are now 200 individual mutual funds (grouped in 35 SRI fund families), handling $151 billion, that incorporate social screening. And many are doing quite well, thank you. A few years ago, Jon Hale and Emily Hall of Morningstar did a study of SRI funds with a three-year track record, and found that an impressive 21 percent earned the coveted Morningstar five-star rating. That’s twice the rate of the overall fund universe, the researchers said. During the period of the study, 40 percent of SRI funds earned a four- or five-star rating from Morningstar, compared with 33 percent of all funds. So the idea that you lose money through SRI is simply wrong. The truth is, these funds have generally done better than average.
That message has gotten around, making SRI the fastest-growing sector of the financial services industry. From that $40 billion first surveyed in 1984, socially oriented portfolios had climbed to $2.1 trillion by the end of 2002—a more than 5,000 percent increase. You don’t need a degree in economics to be impressed by $2.1 trillion, but for those made numb by such large figures, consider that it’s roughly the combined 2000 gross domestic products (GDP) of Canada, Mexico and Italy. And it means that roughly one out of every nine dollars that are professionally managed are invested with some kind of social focus.
Almost all SRI mutual funds do negative screening (avoiding irresponsible corporate players); less do positive screening—seeking out good-guy companies. For eco-minded investors, there are a half-dozen funds (see sidebar) that emphasize or focus on environmental issues. For example, Portfolio 21, run by Progressive Investment of Portland, Oregon, seeks out sustainable corporations worldwide (such as Electrolux of Sweden, which has made environmental sustainability central to its business strategy). As co-founder Carsten Henningsen says, "The goal of Portfolio 21 is to identify those companies that recognize the deepening ecological crisis and are positioning themselves to benefit from a new approach to business."
What screening does is align your portfolio with your values. While this makes instinctive sense and can strengthen your convictions, there is a common misunderstanding about its ability to directly bring about social change. It’s an easy mistake to make; after all, the unifying motto for the green money movement has been "vote with your dollars." As a general rule, this is a good slogan to remember when spending on most products and services: buying organic produce, taking your clothes to a nontoxic dry cleaner, or purchasing a gas-electric hybrid car not only reduces your own ecological footprint, it directly supports important new industries. Conversely, boycotting Citibank (and writing the company about it) until it stops underwriting environmentally destructive construction projects is an effective method of protest. But simply boycotting Citibank’s stock or even selling your shares doesn’t have the same effect.
Here’s why: in most cases, putting money in the stock market isn’t investing in the truest sense of the word, but actually speculating. Buying shares in Ford, for example, doesn’t mean Ford gets the money and uses it to fund operations. It’s more like you’re buying a 1998 Taurus; the money goes to the previous owner of the car, not Ford itself. The only time companies get your money is when they issue new stock—which they do through initial or secondary public offerings. But among the Dow Jones Industrials, only a handful of corporations have sold any new stock in 30 years. More than 99 percent of stock market activity is purely speculative.
Do They Care?
So the question is, does social screening—that is, refusing to buy the stock of certain companies—really make any difference to those companies? Basically, no. If a large number of Monsanto shareholders, outraged over the company’s genetically modified products, dumped all their shares at the same time, the stock would drop—but only briefly. As soon as other investors realized nothing had changed about the corporation’s financial condition, they would scoop Monsanto’s shares right back up.
Meir Statman, chair of Santa Clara University’s finance department, who has studied the effect socially responsible investors have on stock prices, explains that this is because what registers in the stock market are earnings and prospects for future earnings; the market is blind to social concerns (except as they affect earnings; for example, in the form of a lawsuit or lost sales).
Consider what would happen, for instance, if nearly all investors boycotted Wal-Mart’s stock because the company sells products made from polyvinyl chloride (PVC). Let’s say, hypothetically, the stock dropped so much you could buy the whole company for $1 million or, since this is theoretical, for $10,000. As long as Wal-Mart’s sales stayed strong, whoever bought it could take the company private and get the financial bargain of the century. Such investors would actually be rewarded for ignoring social concerns. Of course, Wal-Mart’s stock would never even approach such amazing prices since bargain hunters would have long before stepped in and gobbled up shares. In other words, the stock market is driven by financial concerns and if an issue doesn’t register financially in some way, stock prices won’t be noticeably effected.
Statman’s theory is borne out by the performance of tobacco stocks. Did tobacco divestment actually contribute to their declines? "Probably a little, but not a lot," says Doug Cogan, director of the tobacco information service for the Investor Responsibility Research Center (IRRC), an institutional investor information service in Washington, D.C. He estimates that at most two to five percent of tobacco shares have been sold through divestment. But to actually affect prices, he says you’d need divestment of 60 to 70 percent of shares.
Research seems to indicate that, if anything, Cogan’s estimate was generous. A 1998 Social Investment Forum study on South African divestment—written by Siew Hong Tech, Ivo Welch and C. Paul Wazzan—showed that when 16 large pension funds in 1985 announced divestment from U.S. firms with large South African operations, there was no measurable negative impact on stock prices. If the goal is to hurt stock prices, "divestment is not the best tool," the researchers wrote. The bright news in this, SIF pointed out, is that it means socially concerned investors aren’t penalized financially. True enough. Still, it makes one wonder what’s the point?
Essentially, as already noted, the reason is to be aligned with your principles. Obviously, you can’t put a price tag on moral consistency—nor should we underestimate its real-world power. It’s a strength that fueled Gandhi’s success against the British, Nelson Mandela’s against apartheid, and Mother Teresa’s ability to create an institution and inspiration with global reach. Applied in a more practical way, it allows us to make activist efforts without conflicts of interest. If, for example, much of your net worth were invested in McDonald"s, you’d be unlikely to protest a new store opening in your neighborhood or be as eager for the company to use unbleached paper if it impacted earnings. The paper written by Tech, et. al. concluded that, while divestment didn’t hurt stock prices, it did help "raise public moral standards and awareness of the repression of the apartheid regime." Call it public pressure, call it the buzz factor at work—but don’t minimize it.
Since it works in a big picture kind of way, the impact of screening is hard to measure. "What social investors do is bring social and environmental issues into business decision-making," says Alisa Gravitz, executive director of Co-op America and vice president of SIF. One way SRI does this is by demonstrating that socially oriented companies are well-managed firms that can get excellent returns.Stock screening also adds to a more civilized business climate by creating watchdogs that monitor corporate behavior. "The whole process of screening creates a need for social and environmental information on companies," says Simon Billenness of Trillium Asset Management in Boston. He notes that it helped create organizations such as KLD Research & Analytics, the social research firm in Boston that developed the Domini 400 Index, and the Investor Responsibility Research Center (IRRC) as information providers. "It helps set the tone," Billenness says. "Just to have investors continually ask questions of companies on social activities can have a real impact." KLD, SIF, IRRC, the Interfaith Center on Corporate Responsibility and the Coalition for Environmentally Responsible Economies (CERES) are just a few of the institutions that have sprung from the demand
for social screening. And those institutions help keep social issues continually on the corporate agenda.
SRI has also provided an immeasurable service from the attention it has created in the culture at large. One of the great successes of SRI has been to get people to realize that ethical and environmental issues can be part of a corporation’s mission. This has paved the way for some of America’s largest organizations to adopt progressive issues. For example, pension plans at General Motors, the Gap and Hewlett-Packard (among many others) now offer ethical investing options for retirement plans. Hundreds of businesses have extended benefits to same-sex partners. And businesses now compete to offer the best family-friendly policies, hoping to get onto the list of Best Companies for Working Mothers, or working to win Environmental Protection Agency (EPA) recognition for their green practices.
For many companies, it has become a regular practice to issue reports on environmental stewardship, racial equality and diversity, and animal testing. Some Fortune 500 companies have added whole departments to address these concerns. "You can go to the websites of companies such as BP Amoco and Ford and see a real change in attitude," says Tim Smith, former executive director of the Interfaith Center on Corporate Responsibility (ICCR), a coalition of religious organizations that has coordinated shareholder resolutions for 30 years. More than 70 companies, including Sunoco, General Motors, Arizona Public Service and Bank of America have accepted the CERES principles, a rigorous 10-point constitution of environmental accountability put forward by CERES—a nonprofit group formed by investors in reaction to the Exxon Valdez oil spill.
Companies don’t necessarily change overnight after they sign CERES. GM, for instance, has come under fire from the group for failing to increase fuel efficiency. CERES board member Ariane Van Buren of ICCR says, "We want to see GM apply the same "can-do" spirit [it used in developing new environmental technology] to increasing the fuel economy of the many cars it’s putting on the road now."
Organizations like CERES are poised to play an ever-larger role, as more and more corporations grasp that social issues must in fact be integral to business itself. Recent evidence for this trend comes from the Millennium Poll released by The Conference Board in New York, based on interviews with 25,000 citizens across 23 countries. Among its major findings: two out of three people want companies to go beyond their historical focus on profits to contribute to broader societal goals as well. And further, it found that in forming their impressions of companies, people these days focus less on traditional measures like brand reputation or financial factors, and more on corporate citizenship.
Shareholder Activists
If stock screening contributes to changing corporate behavior in an undefinable, bigger-picture way, shareholder activism offers the opportunity for what SIF’s Gravitz calls a "laser-beam focus" on particular companies. This allows investors to see clear results from their efforts.
One of the best-known cases of effective shareholder activism is Rainforest Action Network and cohorts" drive to have Home Depot commit to phasing out the sale of old-growth lumber (see sidebar). But shareholder activists have had other notable successes for the environment. They’ve influenced General Electric to allot $150 to $250 million for cleaning up polychlorinated biphenyls (PCBs) polluting the Housatonic River in the Northeast; they’ve motivated Universal Health Services of Pennsylvania, the country’s third-largest hospital management company, to formally request that its suppliers phase out the toxic PVC in medical products; and they have persuaded Ford, DaimlerChrysler, General Motors and Texaco to quit the Global Climate Coalition—an organization that undermined efforts to curb global warming.
Shareholder activism has been described as the muscle in SRI. Or as Peter Kinder of KLD Research & Analytics once noted, shareholder activism works like the two-by-four whacked against an Ozark mule in old farmer jokes: it gets a corporation’s attention. Alisa Gravitz of Co-op America and SIF agrees: "I’ve had CEOs of Fortune 500 companies tell me that they get pressure from all kinds of sources, but when the investors get involved they know the issue is not going to go away."
Shareholder activism works best in conjunction with other activist efforts such as consumer boycotts and letter-writing campaigns, and it is an excellent complement to these efforts because the corporation is being "attacked" from within. Since all shareholders are part owners of the company, they have limited rights to comment on corporate policies. So even if you own only one share of Microsoft (the equivalent ownership stake of Bill Gates" closet door knob), you’re allowed to attend annual shareholder meetings, ask questions at that meeting and vote on any issues before shareholders (which can be done via mail or the Internet).
Up your ownership stake to $2,000 worth of stock and, if you follow the proper protocol, you can propose a non-binding corporate resolution—a shareholder referendum for a policy change. Or, as a mutual fund investor, your fund can do this for you. Recently, for example, Calvert Funds—a family of socially screened funds with excellent environmental criteria—worked with others to file a resolution with Hewlett-Packard, asking the company to prepare a report on the feasibility of a comprehensive product take-back policy. And after a Green Century Balanced Fund resolution, PepsiCo agreed to roll out a new lid that will save 25 million pounds of aluminum annually. As a shareholder in such proactive funds, you get a representative for these kinds of discussions with companies.
One of the most significant ways ethical investors could leverage their strength is to engage in more shareholder activism. "Up until recently, the ICCR has done most of the heavy lifting themselves," says Conrad MacKerron, "but within the last few years we have seen funds step up to the plate." Led largely by Domini and Calvert, socially concerned mutual funds have come to recognize the importance of shareholder activism.
But the industry hasn’t made full use of its strength. According to the Social Investment Forum’s 2003 survey, only 20 percent of SRI money is used in shareholder advocacy. This is actually a decrease from almost 40 percent in 2001—though there were more resolutions filed (from 261 in 2001 to 320 in 2003) and the resolutions introduced got more votes (from 8.7 percent in 2001 to 11.4 percent in 2003). It seems those practicing shareholder activism recognize its power: they’re using it more and getting better at gaining support for the issues they raise. Environmental questions and ethical employment issues were the most frequently raised proposals/resolutions.
Some funds and most money managers who handle individual portfolios don’t do any shareholder activism at all. "Some of these funds are what I call "SRI Lite,"" says First Affirmative Financial Network President Steve Schueth. For instance, the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), which handles roughly $291 billion in pension funds, manages more than $5.4 billion in its Social Choice account, the country’s bigg
est socially screened portfolio. But Schueth adds, "TIAA-CREF only avoids the worst of the worst; it’s not about social change. Vanguard is another one; its new social index emulates one from Calvert, but this is not a fund that will do shareholder activism or community development."
Smaller funds and many money managers contend that they can’t afford it. Domini and Calvert each have a billion or more under management and can hire a staff devoted to shareholder activism, they say. "Shareholder activism is very time-consuming and expensive," says Kathy O"Connor, a fund manager at Towneley Capital. "I personally don’t have time to be a shareholder activist."
There are possible solutions to address the challenges a smaller SRI money management firm faces to engage in shareholder activism. Either they could pool resources and share activist coordinators, or perhaps they could contract with an independent nonprofit to do it for them. This outside agent could coordinate efforts with other social investors and nonprofit groups that use grassroots non-financial tactics. The most obvious candidates for such a coordinator would be the Social Investment Forum, As You Sow—a nonprofit that promotes progressive social and environmental policies by representing the interests of socially concerned investors, or ICCR, which has 30 years of experience waging shareholder advocacy campaigns and orchestrating coalitions of investors.
Fund managers can also communicate with companies without using formal resolutions. Progressive Investment, which manages Portfolio 21, is relatively small with $148 million in assets. Yet in 2002 it wrote many letters, including to AstroPower urging that it use recycled semiconductor wafers, to senators voicing opposition to garbage burning, and to the Securities and Exchange Commission (SEC) to encourage a roundtable on environmental and social transparency. As an investor, your fees can help support this activity. You have the right to insist your mutual fund or management company be in active dialogue on your behalf.
Perhaps what’s needed is an independent agency that certifies money management firms are making shareholder activist efforts appropriate to their size. So while a large SRI fund might have a department devoted to activism, a small operation might just donate a percentage of its management fees or client assets to support groups that do shareholder advocacy. Ironically, the SRI industry is only likely to adopt such a scenario if ethical investors create a grassroots effort to let money managers know this matters to them—and then vote with their dollars by supporting firms that are willing to move in that direction.