Counting companies in is preferable to shutting them outApril 2008
Ethical investment is going back to the past. The earliest ethical funds, such as the Friends Provident family of Stewardship funds in the UK and the Pax World fund family in the US, grew out of the desire of investors to avoid banks operating in apartheid South Africa or arms destined for Vietnam. From this initial exclusionary impulse sprang a host of investment approaches and styles, from best in class to engagement.
Now negative screening is coming back on both sides of the Atlantic, with investment managers shedding stocks in various sectors, including defence, oil and gas and aviation, on ethical grounds (see pages six and eight).
Changing investment fashions are part of the explanation. Negative screening is a relatively simple method, attractive to fund managers dipping a toe into responsible investment for the first time. It is also fairly cheap, which helps when times are hard. Moreover, the international political climate is right: in asking what Chinese companies are doing in Sudan, ethical investors have won support in high places. The Sudan Accountability and Divestment Act, adopted at the start of this year in the US, clarifies the position of state and pension funds wishing to divest without breaching their fiduciary obligations. The drip-drip of evidence on investment performance based on data now stretching back three decades – broadly speaking, that ethical screens increase volatility but otherwise make little difference over the long term – has further eased trustees’ concerns.
In truth, negative screening as an investment approach has co-existed with best in class and engagement for years. In the US it remains easily the most popular of all responsible investment approaches. Yet counting out companies, as opposed to counting them in, feels against the long-term trend. Major financial institutions are now busy integrating environmental, social and governance factors into their investment analysis. Goldman Sachs alone has 50 analysts working in this area. What’s more, FTSE, the equity index provider, has a long-term policy against outright exclusions from its FTSE4Good ethical index family – recognition of the need for errant companies to be within rather than beyond the pale.
Screening out the bad boys makes investors feel virtuous, but that is hardly the purpose of responsible investment. Exclusion can work against other responsible investment approaches: why engage with companies in which one holds no stock? It is of doubtful effectiveness in encouraging companies to take their social and environmental responsibilities more seriously. Most importantly, exclusionary policies deny responsible investors the reward of a rising share price when the company has a change of heart. Back in 2002, when Premier Oil pulled out of Burma, funds engaging benefited from the share price rise. Exclusion funds did not.
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