Ethical Performance
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analysts witness birth of new SRI approach

February 2007

A new investment style has emerged during recent months, say two leading analysts.

Meg Brown and Mike Tyrrell, sustainable investment analysts at Citigroup, say they have observed more socially responsible investment managers adopting what they call a 'financially weighted best-in-class' approach.

This differs from conventional best-in-class analysis, under which fund managers identify environmental and social risks and opportunities in an industry sector and draw up a short list of the companies responding most effectively to them.

By contrast, those using the new approach weight environmental and social factors based on their potential financial effect and not according to their environmental or social impacts.

Brown and Tyrrell say that the conventional best-in-class approach enables an investor to identify, for example, power generation companies with superior environmental and social performance relative to their peers. The same is true of a financially weighted best-in-class approach, but throughout the assessment process 'considerably greater prominence' is given to those social and environmental issues most likely to affect the investment performance of the companies. In power generation these might be carbon trading and nuclear waste disposal.

Brown and Tyrrell, outlining their findings in a research note, say they have seen the trend emerging at company briefings in which SRI analysts and investors have devoted about half their time to 'broad sustainability governance' and half to specific investment themes. Brown said the financially weighted best-in-class approach seems to be testing the 'broad assumption' that 'companies that outperform on environmental and social grounds will outperform financially'. This suggested either that investors were sceptical that companies with superior social and environmental performance were better investment prospects, or reflected their 'desire to unpick the constituent parts of the thesis in the search for even more value creation'.

Brown added: 'Either way it lends weight to our broader [theory] that sustainability analysis will become ever more integrated into financial analysis.'

The emergence of this new approach highlights the growing gap between sustainability aims and materiality requirements in investment analysis. Christophe Butz and Stephen Barber of Pictet Asset Management recently noted in a research paper that 'materiality for the company has strictly nothing to do with the sustainability [of a company's] actions.'

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