Ethical Performance
inside intelligence for responsible business
 
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investment

maximizing returns by taking an SRI approach

May 2007

Mainstream investors are now adapting SRI investment techniques to help satisfy their clients’ overriding need for good financial returns. EP talks to Neil Brown, head of governance and responsible investment at Threadneedle, about how this works in practice

At 8.30am each weekday, a small group gathers at Threadneedle Investments in the City of London to review the latest developments that may affect the value of its European and UK holdings. Threadneedle has total assets under management of £72.2billion ($144bn) on behalf of institutional and retail investors. For half an hour, analysts and researchers chew over financial information, AGM updates, broker research, and press reports. Among them sits Neil Brown, Threadneedle’s head of governance and responsible investment.

‘My role at these meetings is to provide feedback on any governance or socially responsible investment news,’ he says. ‘Generally it’s a mix of corporate governance issues and socially responsible investment. Last month, for example, we discussed Tesco’s latest results and their ethical consumer approach.’

The meetings lend themselves more readily to consideration of corporate governance than SRI issues, the latter tending to affect the value of companies over a longer term. But Threadneedle seeks to incorporate social, environmental and ethical concerns into the review of all its investments – something that only a handful of mainstream investment managers attempt at present. ‘We routinely feed the SRI and governance information we gather on equities to the pan-European equity teams within Threadneedle. Our views will be known to the bond teams too.’

Threadneedle does not boycott tobacco or arms makers. ‘We don’t exclude, but focus on SRI issues that will impact on earnings. If it has nothing to do with returns, then it may be interesting but as far as we are concerned it is not SRI. We are here to make money for our clients and we do this by focusing on what is material. Management of the risks and opportunities presented by social, environmental and governance factors is integral to our investment decision-making process.’

Review of a particular company will often be prompted by a low assessment from an SRI ratings agency or sell-side analyst. ‘If, say, Innovest had a triple C rating for a stock, that would have triggered an SRI performance review. My job is to find out what is driving the low rating and whether it is material to the stock price.’

The information-gathering includes the views of sell-side analysts at Citigroup and Deutsche Bank. Brown and Threadneedle’s researchers also talk to company CSR teams and other interested parties. ‘In an ideal world I wouldn’t be needed because these things would have already been identified as material and so looked at by our sector analysts. But SRI is in a transition phase, and I am an intermediary. If the sector analyst thinks SRI is not material to the value of a stock, one of us has got the wrong idea of what is material. So the focus is always on SRI issues that will have an impact on earnings.’

Threadneedle is shifting its approach in this area. ‘Rather than knowing a little about a lot, we are focusing on a small number of stocks that we believe have potential, for example identifying 20–50 companies that can really benefit from climate change and then feeding that information to all our investment managers.’

This approach is applied both to product areas, such as biofuels, and to industry sectors. Brown and his colleagues have recently met mining companies to build up a detailed picture of the likely winners and losers. ‘A great deal of engagement goes on, but the outcomes are not widely known because it goes on behind closed doors – and those doors are closed for a reason. There is real commercial advantage to the company in having shareholders apply that pressure in private. It often relates to opportunities, not risk management. SRI engagement enables us to identify a stock where we think there is value but also a clear impediment to releasing that value.’

Investor engagement forces companies to make the business case for their CSR activities. Brown cites the example of a mining company’s cost-benefit analysis of its HIV/Aids programme. ‘That sounds callous, but it’s presenting the business case, which within companies is the biggest single driver of change.’ But what of unquantifiable risks and opportunities? ‘It’s the approach that counts. Marks & Spencer may not be able to say what percentage of its new footfall is coming from its advertising campaign rooted in responsible business practice, but it is part of a coherent strategy – and the stock is now doing well,’ says Brown.

The stress on materiality is unlikely to endear Threadneedle’s stance to all ethical investors. Conceivably, companies making money because the costs of the pollution they cause are not borne by the business could be excellent investments. Brown claims that ‘if a company conducts itself inappropriately, its earnings will be materially impacted. Take child labour in the retail sector – companies involved are highly likely to be caught out at some point.’

Threadneedle is taking a pioneering look at incorporating environmental, social and ethical issues into mainstream investment decision-making. The carbon footprint of Threadneedle’s UK Fund, as measured by the environmental research company Trucost, however, is one of the largest among UK investment funds. Threadneedle’s disclosure practices are also weak. This puts it in a similar position to many companies in which it invests: doing interesting work, but open to challenge.



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