Socially ResponsibleInvestmentA Global Revolution

Russell Sparkes

JOHN WILEY & SONS, LTD

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‘‘The Ethical Investor (1995) changed my views on what could done to harnessinvestment to social responsibility in the UK context. This book now moves theagenda to the world stage and is essential reading for all those who can see theneed to harness capitalism to SRI objectives in the post Sept. 11th world, andthat after the Enron and Worldcom scandals, SRI can deliver the better worldwe need’’Tony Colman MP, House of Commons International Development SelectCommittee

‘‘The growth of SRI has been one of the most important - but oftenmisunderstood − investment trends of the past decade. Russell Sparkes providesan invaluable analysis of the main SRI developments and issues for bothprofessional and private investor alike, writing with true authority and insight’’Stuart Bell, Research Director, PIRC Ltd

‘‘Russell Sparks has filled a huge need. In this magisterial volume, he hasbrought together the history, language and lore of shareholder activism andresponsibility into coherence. For everyone searching for ways for owners tomake corporations part of the solution for global problems, this book is a mustread’’Robert A.G. Monks, Chairman, Lens Investment Management and Publisherof http://www.ragm.com concerned with corporate governance and shareholderresponsibility

‘‘. . . a useful tool for investors and managers. Not the untested ideals ofsomeone wishing to jump on the ethical band wagon but the considered andtested observations of a successful institutional investor of conviction’’

‘‘. . . having compared Socially Responsible Investment to an iceberg, RussellSparkes explains many of those aspects of the subject not obvious on thesurface.’’J.E. Rogers, Chief Executive, UKSIP The Society of Investment Professionals

Socially Responsible Investment

PUBLISHED AND FORTHCOMING TITLES IN THE UKSIP SERIES

BRANDS: VISIONS AND VALUESJohn Goodchild and Clive Callow (ed.)

PROFIT AND THE ENVIRONMENT: COMMONSENSE ORCONTRADICTION?Hilary Stone and John Washington-Smith

THE BRITISH FILM BUSINESSBill Baillieu and John Goodchild

MOBILE TELECOMMUNICATIONSChristopher Nicholson

SOCIALLY RESPONSIBLE INVESTMENT: A GLOBAL REVOLUTIONRussell Sparkes

ASSET MANAGEMENT: EQUITIES DEMYSTIFIEDShanta Acharya

Series Editors: John Goodchild and Clive Callow

Socially ResponsibleInvestmentA Global Revolution

Russell Sparkes

JOHN WILEY & SONS, LTD

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Library of Congress Cataloging-in-Publication Data

Sparkes, Russell.Socially responsible investment : a global revolution / Russell Sparkes.

p. cm.---(UKSIP series)Includes bibliographical references and index.ISBN 0-471-49953-6 (alk. paper)1. Investments---Moral and ethical aspects. I. Title. II. Series.

HG4515.13 .S63 2002332.67′8---dc21 2002027205

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

ISBN 0-471-49953-6

Typeset in 11/13pt RotisSerif by TechBooks, New Delhi, IndiaPrinted and bound in Great Britain by TJ International, Padstow, Cornwall, UKThis book is printed on acid-free paper responsibly manufactured from sustainable forestryin which at least two trees are planted for each one used for paper production.

http://www.wileyeurope.comhttp://www.wiley.com

To Rosemary, without whose constanthelp and support this book could

never have been written

Contents

Foreword by Tim Smith xv

Series Preface xix

Preface xxi

Part I Exploring Socially Responsible Investment 1

1 Socially Responsible Investment Comes of Age 3A historic date 4The UK SRI Pensions Regulations 5The road to regulation 7The pressures for change 13Political recognition of public interest in SRI 17References 20

2 What Is Socially Responsible Investment? 21A definition of socially responsible investment 22Is there more to SRI than screening? 27The role of shareholder activism 29Advocacy contrasted with activism 35A theoretical justification for SRI 40References 42

3 From the Beginning 45A precursor 46American beginnings 48

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Contents

South Africa: a defining issue 52Growing environmental concerns 58Ethical consumerism 63Fears over globalisation 65References 67

4 Profiling the Investors 69Identifying the issues 70Profiling the investors 76How important is financial return? 81References 86

5 Screening in Practice 89Screening in practice 89Calvert Social Investment Fund 90Friends Provident Stewardship 95Citizens Funds 104Standard Life Ethical Funds 109References 114

Part II Issues for Institutional Investors 117

6 From Environmental Risks . . . 119Why the environment is fundamental 119The investing public and the environment 120Nuclear power 121Ozone-depleting chemicals 124Water pollution 125Hazardous chemicals 125Tropical hardwoods 127Smog and acid rain 130Biodiversity 131Genetically modified foods 134Environmental liability 137References 142

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Contents

7 . . . To Sustainable Development 145An integrated approach to the environment 145The case for sustainability 146Evaluating the threat of climate change 150Rio, Kyoto and beyond 154The rising cost of natural disasters 157New markets for renewables 160Wind power 162Solar power 164Fuel cells 165The Rio Resolution 1992 167Emissions trading 168Investment vehicles 169Environmental management and accounting 171The Global Reporting Initiative 172References 174

8 Human Rights 177The need for SRI performance metrics 177The UN Declaration of Human Rights 178Oppressive regimes 180Burma 183Sudan 187China 192Human rights at work 193Human rights: verification and analysis 200References 205

9 Corporate Social Responsibility 209Growing expectations 209The history of corporate governance 211Corporate governance in the UK 213Corporate governance in the US 219Corporate governance in Asia and Europe 226The link between corporate governance and SRI 230References 238

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Contents

10 Investment Returns 241Why investment returns are crucial 241The difficulties of back-testing 243Analysis using restricted indices 244SRI unit trusts in practice 248Institutional SRI investment 254The need for deeper analysis 266Investing in smaller companies 267Green investing 268Establishing a theoretical framework 270References 275

Part III A Global Revolution 277

11 Information Services 279The need for SRI research 279The Council on Economic Priorities 280The Ethical Investment Research Service 282Kinder, Lydenberg and Domini 284Innovest 287Pensions and Investment Consultants 291Two global SRI networks 293SRI market indices 295The Domini Social Index 296The Dow Jones Sustainability Index 300FTSE4Good 305References 308

12 Alternative Approaches: Canada and Australia 311Canadian beginnings 311SRI mutual funds in Canada 315The Australian approach to SRI 323Growth of SRI unit trusts 326Socially responsible pensions 330References 337

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Contents

13 Into the Mainstream 339The UK: great changes after July 1998 340Pension funds: growth in SRI activity 344A quantum leap in UK SRI assets 347The question of engagement 350The US: a major market for SRI 354Shareholder activism in the US 359References 364

14 A Global Revolution 367Japan: a new market for SRI 367SRI in the Pacific 371SRI in continental Europe 372Scandinavian pioneers 375Other European markets 380Socially responsible pensions 384The SRI universe in Europe 387The global revolution begins 388References 390

Index 393

xiii

Foreword by Tim Smith

(Tim Smith is Senior Vice President at Walden Asset Management,a Boston based money management firm involved in socially respon-sible investing for over 25 years. Walden is involved in screening,community development investing, public policy and shareholder ad-vocacy. Before joining Walden, in October 2001, Tim worked at theInterfaith Center on Corporate Responsibility for 30 years. In 2002he was elected as President of the Social Investment Forum, the U.S.trade association for social investors.)

I am pleased to provide this foreword to a book that is both timelyand extremely relevant. I am also pleased that Russell felt comfort-able in asking someone from the United States to add some thoughtsleading into this important book. In a sense, this symbolizes the factthat ethical investing or socially responsible investing is increas-ingly a global reality, as relevant in London or Paris as in New Yorkor Sydney. It’s not just a global reality that we watch from afaras independent observers, but it is an evolving process where in-vestors are working together to insure that their investments mirrortheir value and that corporations are being held accountable for theirsocial and environmental impact.

Russell Sparkes is not only a commentator on this reality, he hasbeen involved in its creation for many years as a leader in the faithcommunity in the U.K. He also represents the bridge, personally andinstitutionally, between the money management world and that ofa values based organization. In that sense we have walked a simi-lar path. I moved to Walden after 3 decades at ICCR, a remarkableInterfaith organization that co-ordinated the work of 275 Protestant,Roman Catholic and Jewish institutions. I served as the ExecutiveDirector but I was but one of scores of remarkable religious leaders

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Foreword by Tim Smith

who worked passionately for economic justice and for greater cor-porate accountability and business responsibility.

No ordinary activists here, no labels of anti-corporate criteriacould stand. Instead, they worked as people of faith, committed tomaking changes in the world, reflective and spiritual yet tireless ad-vocates for economic and social justice. What were the faith foun-dations that led to this work and sustained people in this journey?A passion for justice -- whether expressed in the Old Testament orthe New Testament (Amos or Matthew), we were led not just to be ofservice but to challenge and change unjust systems. The contradic-tion of patience blended with a great sense of urgency -- the issuesneed to be addressed now and solved yesterday. Blended with thiswas a conviction that we needed to persevere even when our workdid not result in immediate success. A global vision -- a commit-ment to have our work on corporate responsibility focus on globalissues.

Inevitably as we looked at the systems impacting our lives, welooked at the power and influence of the business community. Butnot from a distant, prophetic vantage point sitting on a mountain topas a comfortable prophet. The leaders representing the faith com-munity looked at their institutions and their institutions and theirinvestment decisions and observed that we were connected. Theywere participating in the policies and decisions of the global corpo-rate community, not removed from it. These religious organizationsfrom ICCR owned a piece of the rock -- their investment portfolioswere worth $100 billion plus. Thus they could not sit as moral out-siders. It forced them as participants in the economic system to gettheir hands dirty and get involved in interacting with companiesand the marketplace. It led us all to some very strange places to cor-porate board rooms, stockholder meetings, to dialogues with CEOs.The religious community played an essential role planting seeds inthe 1960’s and 1970’s -- seeds regarding ethical investing and corpo-rate social responsibility. Without these prophets involved in profitsthe marketplace might be much different.

What is the landscape of this debate about ethical investing andcorporate social responsibility in 2002? Let me wear my new hats, asPresident of the Social Investment Forum (SIF), a trade associationof socially concerned investors and Senior Vice President of Walden

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Foreword by Tim Smith

Asset Management who manages money for individuals and institu-tions in a socially responsible manner. While not using the words ofthe faith community, Walden and other social investors, mirror thesame values and passion for change. We work to make a differencewith our invested assets. What does this SRI landscape in the U.S.look like now?

A recent SIF Trends report discloses that individuals and institu-tions with over $2 trillion, are now involved in some way shape orform in social investing e.g. tobacco screening e.g. shareholder reso-lutions e.g. community investing. Players in the U.S. now include theCity of New York and State of Connecticut and California pensionfunds -- foundations, unions, mutual funds, money managers andindividuals. Moral voices merged with words like ‘fiduciary respon-sibility’ urge companies to be good corporate citizens. The acousticschange when the City of New York, with $100 billion, gets involved.

And on the corporate side is the message being heard? Look atthe websites of Shell, BP, Sun Oil or Ford Motor Company and yousee declarations and progress not seen a decade ago. New energyon the environment, diversity, human rights, sustainability work-place safety and enhancement. But we also see hundreds of com-panies that don’t think it and don’t get it! Whose focus is solelyon the bottom line whatever the price paid. Thus the urgent need formoral voices to be raised by individuals and institutions, by investorsand consumers, citizens and advocates. The corporate community ismore powerful, more global than ever before. The acts of leadershipin business -- in small companies and large corporations are vital.Whether our voices are mandated by faith or values like decencyand fairness, they need to heard. But they need not simply be voicesof moral urgency. To be effective in this marketplace, they need tobe instruments of economic clout and power as well.

Russell Sparkes has created a powerful tool in this new book. Itdescribes well the new reality in the U.K. as investors assess new real-ities as they make investment decisions. In fact, the U.K. communityof socially concerned investors may well have grown larger than itsU.S. counterpart. This book is one more step in the mainstreaming ofSRI that we have seen over the last decade. It is an issue discussed incorporate boardrooms, investment houses and mutual funds, in pen-sions funds and around family dinner tables. It is significant that a

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Foreword by Tim Smith

prominent business publisher like Wiley understands the importanceand is publishing this book.

Russell and I were both caught in the aftermath of September 11,both of us marooned at a conference on SRI in Tucson, Arizona,unable to travel because of the closing of airports. There and uponour returns to London and Boston, we reflected on the meaning ofSeptember 11 for the work we did. Both of us felt our work in en-couraging corporate responsibility globally was more important thanever. It is my hope that this book will help illuminate the mindsand breech the myths surrounding social investing while warmingour hearts to be even more active leaders in this important socialmovement.

xviii

Series Preface

When The Ethical Investor was published in 1995 it marked an im-portant step towards a wider recognition of socially responsible in-vestment within the fund management industry. Russell Sparkes’new book outlines the changes that have occurred since the mid1990s and examines their significance for the professional and thelay person. As in the earlier work, his ideas are presented with styleand clarity.

This is the fourth title in the John Wiley/UKSIP series. Future sub-jects that are being considered include the effect of general (andpresidential) elections on stock markets and the ‘structure’ of foot-ball finance in Britain. The aim of the series is to provide a challeng-ing perspective on current investment themes. Socially ResponsibleInvestment meets that criterion.

John Goodchild and Clive CallowMay 2002

xix

Preface

Eight years ago I wrote the first UK book on socially responsible in-vestment (SRI) to be produced by a mainstream publisher. When JohnWiley first suggested I should write another book on the subject, myfirst thought was to update the earlier work. I quickly realised, how-ever, that this would be impossible and that I would have to write atotally new book.

There were two reasons for this. First, socially responsible invest-ment has changed beyond all recognition since the previous bookwas written. Then it was a small fringe activity carried out by a smallnumber of unit trusts and mutual funds in the US and the UK. Now ithas become a core part of mainstream investment management. Asthe book’s subtitle indicates, there has been a global revolution andSRI has spread out around the world. Even the name has changed.When I wrote my first book ‘ethical investment’ was the stan-dard term, but this has now been replaced by ‘socially responsibleinvestment’.

The second reason for writing a completely new book is a per-sonal one. My thoughts on the subject have changed significantlyfrom what they were in 1993--94. I hope they are deeper and morewide-ranging, and I hope this change is reflected in the scope of mynew book. If my thoughts on socially responsible investment havedeepened, this is largely due to what I have learned over the last eightyears from Bill Seddon and other colleagues at the Central FinanceBoard of the Methodist Church (CFB).

This book is written in a personal capacity and should not beinterpreted as a reflection of the views of the CFB. For this reason theCFB is described in the third person in Chapter 10. It has been writtenfor anybody who feels that they need to understand the concept of

xxi

Preface

socially responsible investment for professional or personal reasons.They may include trustees of pension funds and charitable trusts,financial advisers, pension consultants, company executives, policymakers and investment managers. I often describe SRI as resemblingan iceberg whose visible surface is only 20% of the total. The visibleportion of SRI consists of unit trusts and mutual funds. However,these form only a small fraction of the global SRI universe.

The book is divided into three parts. Part I describes the visibleportion of the iceberg, looking at screening in practice, and pro-filing the typical investor in SRI retail funds. Part II examines theissues that are increasingly dominating SRI discussion: the envi-ronment, human rights and corporate social responsibility. Part IIIconcentrates on the institutional side of socially responsible invest-ment, something which has received relatively little coverage untilnow. Anyone who is sceptical about the importance of SRI to pen-sion funds, charitable trusts and insurance companies is encouragedto read Chapter 1, which sets out the ‘paradigm shift’ travelled bySRI as it has moved from the fringe to the mainstream.

Russell SparkesLondon, March 2002

xxii

PART I

Exploring SociallyResponsible Investment

Part I describes the essence of socially responsible investment (SRI).It analyses SRI into its structural components and explores its histor-ical development. One chapter profiles the typical investor in sociallyresponsible funds, while another looks at screening, the best-knownSRI technique. However, it starts with the British SRI pension fundlegislation that came into force in July 2001, the moment when SRIcame of age.

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1

Socially ResponsibleInvestment Comes of Age

My aim in writing this book has been to document the major changesthat have taken place in the field of socially responsible investment(SRI) over the last few years. Until recently SRI was essentially afairly fringe activity carried out by a limited number of unit trustsor mutual funds. The relatively small amounts of money invested inthese funds meant that they had little impact on business and society.I suspect that most people still think of SRI like that.

That view is now quite outdated. Socially responsible investmenthas become something that pension advisers, charity trustees, andindeed corporate executives need to know about. There are two rea-sons why this is so. SRI has entered the vocabulary and conscious-ness of mainstream finance, while it has moved from on its originsin the UK and US to become a global movement. Up to now bookson SRI have been written for retail investors; I produced one my-self in 1995 called The Ethical Investor. However such books are oflittle use to pension fund trustees or their advisers struggling to com-bine social responsibility concerns with the legal duty of fiduciaryduty. They are also not much good to corporate executives wonder-ing why they are becoming bombarded with requests for informa-tion on their company’s social and environmental performance, orindeed, why major shareholders are increasingly filing shareholderresolutions on these issues.

The aim of this book is to fill that gap. Rather than looking atindividual funds, it considers particular topics in a structured waybased upon evidence from the UK and the US. The first part examines

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Socially Responsible Investment

the history and development of SRI before moving on to profilethe typical investor in socially responsible retail funds. It then de-scribes some leading SRI unit trusts and mutual funds. The mainsection of the book examines the main issues of concern to insti-tutional investors considering socially responsible investment: theenvironment, human rights, corporate governance, and financialperformance. The final part of the book looks at American and Britishevidence of ‘the mainstreaming of socially responsible investment’,followed by an examination of its increasingly global reach.

A HISTORIC DATE

The normal trend in financial markets is for US-based innovations --hedge funds, risk arbitrage, private equity, etc. -- to be copied in therest of the world. However, by issuing the 1999 socially responsi-ble pension fund regulations, the UK took a lead that was followedelsewhere. This chapter therefore concentrates on Britain, whereasthe rest of the book examines SRI issues from a structural perspec-tive looking at each issue from the combined viewpoint of US andUK experience. It examines the new SRI pension fund regulationsand explains the process of consultation and discussion that led totheir declaration.

Since I was an eyewitness to these developments, and indeed ac-tively involved in the discussions leading up them, I thought it im-portant to put them down on record. In fact, it is my belief thathistory will consider the day the UK’s SRI pension fund regulationscame into effect, 3 July 2000, as a momentous day in the evolutionof investment management. It was a date of global rather than oflocal importance. For the first time ever pension funds, the buildingblocks of the world’s capital markets, were legally obliged to considernon-financial issues in setting their investment policy.

The SRI pension regulations were important in their own right, butit is essential to try to uncover the various forces that encouragedthe UK government to issue the new measures. Many people workingin financial markets have historically taken a fairly jaundiced viewof socially responsible investment, regarding it as a fringe productfor a niche ‘green’ customer base. This opinion can no longer be

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Socially Responsible Investment Comes of Age

justified. The new UK pension fund regulations were not some trivial,superficial measure drafted for party political reasons; rather theyreflected political awareness of growing pressure from a variety ofsources for such policies to be implemented. Since similar forcesfor change were also obviously present in other countries, it wasonly a matter of time before authorities elsewhere copied them. Infact, within a year of the UK measures coming into force, similarregulations had been passed in Germany, Sweden, and Australia andwere actively under consideration by the European Parliament.

For the sake of argument it will be assumed (here) that the twoterms ‘ethical investment’ and ‘socially responsible investment’ aresynonymous. Chapter 2 considers whether there is any meaningfuldifference between them. SRI has always been the normal descrip-tion in the US, and it is increasingly replacing ‘ethical investment’as the standard term in the UK. In any case the basic meaning isan investment philosophy that combines social and environmentalobjectives with financial objectives.

Social scientists sometimes talk of ‘a paradigm shift’ in publicawareness, when a belief that is generally accepted becomes obvi-ously outmoded and rejected. A good example would be the rel-ative importance of the Earth and the Sun; before Galileo it wasuniversally accepted that the Sun rotated round the Earth, after himeverybody knew that the reverse was true. I believe that we are nowin a similar situation regarding institutional investment, and thatultimate beneficiaries such as pension schemes and charitable foun-dations are now starting to question the conventional wisdom thatthe sole purpose of investment is the maximisation of short-term fi-nancial returns. A comparable paradigm shift in investment wouldbe that resulting from Markowitz’s assertion in the 1950s that in-vestors should analyse the overall risk of a portfolio, rather thanseeking gains from individual stocks.1

THE UK SRI PENSIONS REGULATIONS

The new measures oblige all UK private sector pension funds to con-sider socially responsible investment and voting rights as part oftheir overall investment policy. (Equivalent regulations were drafted

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Socially Responsible Investment

by the Department of Environment, Transport and the Regions(DETR), which at that time was the regulatory body for local au-thority pension schemes.) This came about under a regulation issuedby the Department of Social Security (DSS) under section 35 of the1995 Pensions Act, which provides a statutory obligation for all pri-vate sector pension schemes to have a Statement of Investment Prin-ciples (SIP). These statements must cover the types of investment, thebalance between investments, risk, return and realisations. The newregulation required all trustees to add the following two considera-tions to their fund’s SIP:

(i) The extent (if at all) to which social, environmental orethical considerations are taken into account by trusteesin the selection, retention, and realisation of investments;and

(ii) the policy (if any) directing the exercise of the rights(including voting rights) attaching to investments.

At first sight these clauses do not look particularly dramatic. It isimportant to stress that they do not force pension funds to investalong SRI lines; the new rules simply oblige them to take social andenvironmental considerations into account and disclose their policyabout this. It is worth repeating that the regulations are about con-sideration and disclosure, not about compulsion. Nevertheless, theirissuance was a major watershed in the evolution of investment man-agement, even from a global perspective. To the best of my knowl-edge, the new SRI requirements represented the first time anywherein the world that a government had obliged pension funds to con-sider environmental and social factors in their investment policy. Asis shown in Chapter 13, the new regulations gave a powerful stim-ulus to the growing number of UK pension funds that consideredsocially responsible investment to be a normal part of their invest-ment strategy.

Similar shifts occurred in the attitude of most pension funds toinvestment in emerging markets around 1990, or to venture capi-tal in the early 1980s. In each case something that had previouslybeen regarded as a ‘fringe’ part of the potential investment universebecame suddenly accepted as ‘core’ or ‘mainstream’. It would be un-thinkable now for any significant investment management company

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