Socially Responsible Investing

SOCIALLY CONSCIOUS INVESTORS MAKE DECISIONS by screening for positive and negative issues, shareholder advocacy, community investing and providing social venture capital. Screening is usually the first step to make sure companies don’t produce objectionable products or engage in practices such as discrimination or environmental pollution.

AT ONE TIME THERE WAS CONCERN THAT SOCIALLY responsible investing would hurt performance. But several studies laid those concerns to rest. From 1990 to 1998, the Domini 400 Social Index returned 18.54% vs. 16.95% for the S&P 500. Another study found companies that adhered to strict environmental standards created greater market value.

EVEN FINANCIAL ADVISERS WHO DON’T SCREEN for social issues are concerned today about corporate governance. Many prefer to avoid companies that are the subject of an SEC inquiry or where there has been a change in senior management. Corporate scandals erode shareholder value, a commodity that’s difficult to restore.

INVESTORS WITH MORE CUSTOMIZED SOCIAL screens will find buying individual stocks, as opposed to mutual funds, makes it easier to satisfy their concerns. Mutual funds do their best work in broad screening. For example, it would be difficult to use mutual funds to support companies with good animal rights practices.

Screening for positive and negative issues.
Shareholder advocacy.
Community investing.
Social venture capital.

Screening. Research services track and sell information on companies’ socially responsible characteristics just as they do for financial data. CPAs can use this research to screen companies to make sure they don’t produce objectionable products such as tobacco, alcohol or weapons. CPAs similarly can look for positive qualities such as equal opportunity employment and a lack of discrimination. CPAs should use these social screens after they have looked for stocks with the client’s desired financial characteristics, such as a low price-to-book ratio or a high percentage of revenue growth.

Shareholder advocacy. Proponents frequently communicate the need for change in a company’s policies or corporate governance by way of shareholder resolutions and verbal and written campaigns. For example, ExxonMobil investors voted their consciences and pocketbooks at the company’s 2002 annual meeting. The case study on page 55 describes the details of this groundbreaking action. For a list of some shareholder resolutions that confronted other corporations last year, see exhibit 1 , below.

CPAs will find that screening is by far the most common selection strategy, but the other three techniques are gaining favor. Financial advisers typically focus on the first two because bad social policy and inadequate corporate governance have the most immediate effect on investments in stocks, bonds and mutual funds.

WHAT INVESTORS WANT
“A socially concerned investor cares about a company’s record on social issues and about the credibility of the marketplace,”says Tim Smith, president of the Social Investment Forum and vice-president of Walden Asset Management in Boston. “Investors need to know there are rules for corporate governance and for social and environmental issues and that companies follow them.” Walden Asset Management is a $1.2 billion subsidiary of U.S. Trust Co. and invests solely in socially responsible companies. The Social Investment Forum’s 500 members consist of individual investment practitioners and institutions, which include financial advisers, analysts, portfolio managers, banks, mutual funds, foundations and community development, research and educational organizations

Even early converts couldn’t fully commit to investing solely according to a client’s values. “When I started my business 15 years ago, there weren’t that many resources available to guide me,” says Frazer. “Those that were available focused more on social responsibility than on the financial returns. Now the whole situation is different. Today these financial products perform just as well or better than their counterparts.” For a list of current resources on socially responsible investing, see exhibit 2 , at right.

Both advisers find their specialty provides a unique marketing niche. Of the clients at Frazer’s firm employing a socially responsible strategy, more than two-thirds sought out its services. Potential clients find Frazer through her firm’s affiliation with the FAFN, through the booth it sets up at the local renewable energy fair or by attending one of the firm’s public seminars. Dreizler mentions his specialty in a yellow-pages ad, but interested clients more often find him through his ads in an alternative monthly newspaper in Sacramento and at the local natural food co-op.

Steve Schueth, spokesperson for the Social Investment Forum and president of FAFN, reports that new advisers who become members say they’d been searching for help with socially responsible investing for some time. “Most just don’t have the tools,” says Schueth.

STOCKS VS. MUTUAL FUNDS
CPAs will find that the choice between a mutual fund program and a separately managed account takes on a new dimension with social investing. When buying individual stocks, clients rate customized screens on how they reflect their unique requirements. “Mutual funds do their best work by broadly screening and highlighting the best and the worst of the group,” explains Dreizler. “The advantage of owning individual stocks is that I can be very specific in the screens I select.” This means CPAs can help clients purchase—or avoid—virtually any kind of investment. Mutual funds don’t offer that kind of specificity.

Tobacco, environmental issues, human rights, employment equality, gambling, alcohol and weapons form the basis of almost all screening programs. Some less common issues are important but difficult to isolate. “If clients are interested in investing in companies with good animal rights practices, they’d be ill-served by buying mutual funds,” says Dreizler. For a look at some of the screens investment managers apply in selecting investments, see exhibit 3 , above.

ExxonMobil’s attitude toward climate change is fraught with “unnecessary risks and missed opportunities” that could jeopardize more than $100 billion in long-term shareholder value, according to a study released in May 2002 by Claros Consulting of London, England. According to Claros, here are the risks the company faces:

Reputation risk. The hit on ExxonMobil’s direct brand value could be some $2 billion to $3 billion. Of even greater concern are the broader consequences of a damaged reputation in areas such as staff motivation and political access. These could amount to some $10 billion to $50 billion of market value.

Litigation risks. ExxonMobil’s current strategy exposes the company as an obvious potential defendant in climate-change-related litigation as damage mounts. In years to come, the legal costs alone could amount to $200 million to $1 billion a year. If ExxonMobil is found liable, the damages would be vast—potentially exceeding $100 billion.

Risks from sudden policy changes. If global warming triggers legislation inhibiting the use of fossil fuel, ExxonMobil would miss profit opportunities by not having transformed itself into a total energy business that includes renewable sources.

The report also outlined five action steps ExxonMobil investors could take to protect their ownership stakes. They include

Supporting shareholder resolutions on renewable energy sources and on linking executive compensation to social and environmental performance—such as those that appeared on ExxonMobil’s 2002 proxy card.

Pressing the board-of-directors’ public issues committee to improve the company’s strategy on climate change.

Asking ExxonMobil for full disclosure of climate-change-related data.

Requesting financial analysts to evaluate climate change risks at the company.

Other companies, particularly those in the so-called extractive industries, find themselves subject to similar scrutiny from shareholders and advocates for their environmental policies.