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January 13, 2005
World Economic Forum and AccountAbility Report on Mainstreaming Responsible Investment
    by William Baue

The report, based on three roundtables convened by the report sponsors, is particularly illuminating in representing attitudes and perceptions toward social and environmental issues of roundtable participants from the mainstream investment community.


While it is difficult to imagine investment firms or pension funds describing themselves as "irresponsible" (mutual funds scandals notwithstanding), very few fit into the category of "responsible investment" defined by the rigorous analysis of social and environmental issues. The World Economic Forum (WEF) and AccountAbility, a London-based sustainable development think tank, posed the question, "What could propel responsible investing from the boutique to the mainstream?" To find answers, they convened three roundtables in 2003 and 2004 gathering mainstream asset managers, pension fund trustees and executives, and buy- and sell-side analysts.

Today, WEF and AccountAbility released a report entitled Mainstreaming Responsible Investing that details roundtable discussions on the obstacles to more widespread analysis of social and environmental factors amongst the mainstream investment community. The report also provides an extensive list of recommendations for systemic changes that could "tip" the mainstream toward more socially and environmentally responsible investment.

"We found that the issue is decidedly not the personal values of these market participants but rather the framework of industry customs, structure and regulation in which they operate," said Richard Samans, managing director of the WEF's Global Institute for Partnership and Governance. "It is the combination of available information, participant competencies and, most of all, institutionalized incentives that drive behavior."

The availability of corporate social and environmental information, for example, can be impeded by lax regulation, as in the case of the US Securities and Exchange Commission (SEC) failing to enforce requirements for companies to disclose material environmental liabilities. Part of this problem traces back to the definition of materiality: "matters about which an average prudent investor ought reasonably to be informed," according to SEC Regulation S-X rule 1-02 (o).

It is a chicken-and-egg dilemma--currently, average prudent investors are not demanding social and environmental information, because they do not understand how social and environmental management impacts valuation and share price (which bears in on the competency issue.)

"As one corporate risk manager put it, 'materiality appears a scientific matter, but actually has more to do with herding: something becomes material when enough people think it should be,'" the report states.

Another problem with information is the lack of verification and auditing of corporate social and environmental reporting, according to Francis Condon, head of European steel research for ABN AMRO Equities, in one of three chapters written by market participants. These chapters prove especially valuable in glimpsing the mainstream investment community's perceptions of social and environmental issues, as do the comments of actual roundtable participants sprinkled throughout the report. Yet another problem is the lack of historical benchmarks for such information due to its relatively recent arrival on the scene, Mr. Condon contends.

Another chapter, written by Mehdi Mahmud, executive vice president of US-based investment Jennison Associates, lucidly summarizes how incentives have become institutionalized.

"Fund managers must act in demonstrable compliance with the performance objective of optimizing clients' financial returns, which is typically defined in their contracts relative to certain benchmark indices, at specific levels of risk, and/or with respect to pre-defined peer groups," Mr. Mahmud writes.

Fund managers having to prove that they are investing in line with their stated performance objective seems reasonable. But they will likely be more risk averse and take well-known approaches that are easily defended. Combine that with shorter evaluation periods for fund performance, a wider use of benchmark indices, and compensation that rewards shorter-term performance, and the result is a driving force that discourages the adoption of a long-term perspective.

Elsewhere, the report cites evidence of this dynamic in the words of roundtable participants.

"As one fund manager argued, 'As long as client [e.g., pension fund trustees] mandates require us to deliver performance benchmarked against short-term market tracker indexes, we will of course remain short-term in our outlook,'" states the report. "As [another] analyst commented in one of the roundtables, 'We do look at long-term factors, but they are strictly background to the dominant variables like free cash flow and, to be frank, rumors on the street about the company.'"

It is illuminating (albeit distressing) that the long-term impacts of social and environmental performance are lower on the radar screen of mainstream investment analysts than hearsay and gossip regarding corporate financial performance.

The report also steps back to take a broader look at the landscape of mainstream investment, and sees a tectonic shift in shareownership from the hands of the few to those of the many. The aging population in developed countries holds shares in literally thousands of companies through mutual and pension funds and insurance, a trend that expands the interests of investment beneficiaries beyond myopia of financial performance.

"The real owners of capital in today's markets are you and me, the intended beneficiaries of the pension funds, mutual funds and insurance companies," said Simon Zadek, chief executive of AccountAbility. "The responsibility of institutional investors must be to meet our intrinsic interests, which go far beyond near-term returns since we have long-term needs and depend on the long-term vitality and health of our societies' economies, communities and the natural environment."

"Our interests must be that trustees and fund managers acting on our behalf take into account material social and environmental aspects of corporate performance," concluded Mr. Zadek.

 

 
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