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November 17, 2005
Radical/Conservative: Innovest Integrates Sustainability Factors into Financial Analysis
    by William Baue

Innovest Strategic Value Advisors reconciles socially responsible investing research with traditional investment research by fusing social, environmental, and financial considerations.


Socially responsible investing vernacular distinguishes between SRI research, which factors social and environmental considerations into investment decisions, and "mainstream" research, which focuses on financial factors. Since its founding a decade ago by CEO Matthew Kiernan, the investment research firm Innovest Strategic Value Advisors has defied convention by straddling this divide, integrating social and environmental sustainability considerations directly into financial analysis.

"The approach we take is to be radical in a very conservative fashion," Dr. Kiernan told SocialFunds.com. "In contrast to what I would call the 'neoclassical' SRI space, where the factors influencing conclusions and investment choices are pretty heavily influenced by values, we've always had a complementary but different objective of trying to influence and mobilize the 90-odd percent of the investment world that is not self-consciously SRI."

"Rather than conceiving of ourselves as having both feet in the neoclassical SRI tradition, which I see as a vertical slice of the investment universe, we see ourselves as a horizontal slice across the board--really representing what we firmly believe to be the leading edge of where the mainstream is going," explains Dr. Kiernan. "The social logic behind this decision was that I felt if we could deflect the trajectory of the $40 trillion mainstream investments toward sustainability by even one degree, we would have mobilized an awful lot of capital--maybe even more capital than the traditional SRI space."

To accomplish this goal, Innovest employs a "best-in-class" approach: instead of screening out so-called sin sectors, Innovest seeks to identify the best performers on environmental, social, and governance (ESG) as well as financial factors across all sectors.

"We use the subset of the SRI gene pool which gives us some critical information about the management quality and the sustainability of the competitiveness of firms, and we overlook the subset of SRI tactics that don't give us any such information," says Dr. Kiernan. "For example, if you tell me you're the CEO of a firm that makes contraceptive devices, that would tell a lot of neoclassical SRI firms all they need to know--you would either be out of Vatican-sponsored portfolios or in a lot of others."

The production of contraceptives represents just one of many factors Innovest would take into account in assessing the sustainability of the company. However, Dr. Kiernan does not consider Innovest's approach and that of the so-called neoclassical SRI camp as mutually exclusive.

"For us to critique traditional SRI is a bit like criticizing an apple for not being a banana, and vice versa," Dr. Kiernan says. "We have enjoyed a relationship of creative tension with the neoclassical camp--our objectives are very similar, our tactics to get there are quite different."

"I regard us as being on the same 'side,' and I don't think it should be an either/or--there's a place for both," he adds. "We have tried to build from the very beginning a firm that could compete on as close to a level footing as possible with mainstream firms like Goldman Sachs."

Dr. Kiernan is hard-pressed to identify Innovest's direct competitors--not traditional SRI research firms such as KLD Research & Analytics or the Ethical Investment Research Service (EIRIS). Generation Investment Management and Sustainable Asset Management (SAM) both integrate sustainability factors into financial analysis, but neither truly compares to Innovest.

"Unlike SAM or Generation, our model in creating and delivering asset management products has always been to partner," Dr. Kiernan states. "We have the legal ability to manage money directly, and internally we have the skill set and people, but in order to get traction in the institutional markets, we've always preferred to partner with a traditional mainstream partner."

This strategy allows Innovest to circumvent the so-called "tyranny of the track record," whereby institutional investors judge investment vehicles by at least a three-year track record--a phenomenon that effectively prohibits innovative strategies. For example, Innovest identified emerging markets as "the obvious battleground of sustainability," and sought to develop an emerging markets sustainability fund to capitalize on the inefficiencies of emerging markets on both a financial as well as a sustainability basis.

"The only way we felt we could attract institutional money into an emerging markets sustainability fund was to build it on the back of a traditional fund that already had a successful track record, so we worked with one of the State Street affiliate companies called Rexeter, which used to be the emerging markets team for Kleinwort Benson," Dr. Kiernan explains. "By beginning with a strategy that has stood the test of time, we could then tilt that product by adding the sustainability factors in, at least the skeptic has a starting point for assessing something that by definition isn't going to have a track record."

Another Innovest product--an eco-enhanced S&P 500 index fund run in partnership with ING that tilts the portfolio based on sustainability factors--has a bona fide three-year track record that "produced something like 40 basis points of outperformance," according to Dr. Kiernan.

One of Innovest's most recent product launches is the Global Compact Plus analytical tool, which allows investors to assess the sustainability performance of companies participating in the United Nations Global Compact, a voluntary framework of social and environmental commitments. Three factors distinguish the new tool. First, it focuses on the materiality of sustainability risks. Second, it focuses not on what companies say they're doing, but on what they are doing ("there's always going to be a gap between what they say and what they do, so if all you know is what they say, you're really investing with one hand tied behind your back," Dr. Kiernan points out.) And third, it rates and ranks companies directly against their same-sector competitors.

The market for this product is also threefold: institutional investors; corporations (for benchmarking against both themselves and their competitors); and, interestingly, nonprofits such as UNICEF to use "as a means of screening either their donors or their partners," says Dr. Kiernan.

 

 
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