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September 24, 2004
Institutional Investors Can Now Hedge Climate Risk With New Investment Strategy
    by William Baue

The strategy combines the investment algorithms of State Street Global Advisors with an environmental overlay from Innovest Strategic Value Advisors.


Institutional investors concerned about the impact of climate change on portfolio performance gained a new tool yesterday when State Street Global Advisors (SSgA) and Innovest Strategic Value Advisors launched their US Core Environmental strategy. The strategy grows out of an SSgA study finding benchmark outperformance by applying its own proprietary investment algorithms, and further outperformance by adding a tilt based on Innovest's sector-specific environmental ratings.

"SSgA believes that its process adds value to the benchmark, and the study showed it does, but what the study also showed to their satisfaction is that Innovest's process is accretive, so you get a double hit," said Innovest CEO Matthew Kiernan. "I like to call it a 'double alpha' strategy."

State Street, which has about a three percent ownership stake in Innovest, focused the study on a broad universe comprising the Russell 1000. The study examined a five-year period running from December 1998 to February 2004.

"We found 1.81 basis points in incremental annual performance improvement when we incorporated Innovest environmental information relative to the same quantitative strategy without environmental inputs," said Kimberly Gluck, a principal at SSgA. "We ran simulations using a number of different techniques, all of which added value."

Mainstream investors have long responded to studies finding SRI outperformance by attributing it to other factors, such as overrepresentation of technology stocks (during the tech boom) or exposure to interest rate fluctuations.

"What this study did, importantly, is to normalize away all of those potentially intervening variables and isolate the SRI effect," Dr. Kiernan told SocialFunds.com. "We think precisely because this strategy combines sustainability with a disciplined traditional process that it is likely to resonate much more strongly with institutional investors, who are understandably concerned with their fiduciary responsibility."

In fact several members of the Investor Network on Climate Risk (INCR), a coalition of institutional investors representing over $800 billion in assets, are currently gearing up to apply eco-efficiency screens to portions of their portfolios.

The California Public Employees Retirement System (CalPERS), the largest US pension fund with $166 billion in assets, is perhaps furthest advanced in translating INCR principles into concrete actions over and above shareowner action. In April 2004, the CalPERS Board approved implementation of the "Green Wave Initiative" proposed by California Treasurer Phil Angelides. Earlier this month, CalPERS issued a call for investment managers to manage up to $500 million in environmental investment strategies.

Asked whether CalPERS is considering employing the SSgA/Innovest US Core Environmental strategy, CalPERS spokesperson Brad Pacheco told SocialFunds.com that "it's too early for us to comment."

The Green Wave Initiative inspired Maine Treasurer Dale McCormick to develop a similar model.

"I am in the process of formulating a proposal to accommodate my 'Two Percent Initiative,' which is investing 2 percent of the Maine Trust Funds in securities that would hedge against climate change risk and leverage the competitive advantage of eco-efficient companies," Treasurer McCormick told SocialFunds.com. "The announcement of this strategy is very timely--I was expecting State Street would apply, though when I formulated my initiative, they hadn't launched their fund yet."

Now, details on the fund are available.

"SSgA's US Core Environmental Strategy seeks to outperform the S&P 500 Index by 2 to 4 percent annually regardless of market conditions," Ms. Gluck told SocialFunds.com. "Unlike many socially responsible strategies, the US Core Environmental Strategy does not eliminate whole industries or individual companies from the investable universe, thus removing a major obstacle to institutional acceptance of an environmentally-sensitive strategy."

Interest will likely not be limited to INCR members, as a wide range of institutional investors are shifting from the traditional view that fiduciary duty prohibits consideration of environmental issues to the view that prudence requires such consideration.

"We believe there has been a tectonic shift in the US institutional market over the last nine months whereby formerly divergent issues--sustainability on the one hand, and corporate governance and fiduciary duty on the other--are beginning to converge here," said Dr. Kiernan.

"For endowments and foundations that value the environment, this strategy gives them an opportunity to make the investment side of their operation congruent with their program activities," Dr. Kiernan added.

 

 
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