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August 02, 2011
Book Review: Dilemmas in Responsible Investment
    by Robert Kropp

Authors Celine Louche and Steve Lydenberg seek to prepare mainstream investment professionals for navigating the increasingly complex practice of sustainable investment.

Currently, signatories to the United Nations' Principles for Responsible Investment (PRI) number 920 asset owners, investment managers, and professional service partners, 129 of which are based in the US. Of the Principles to which signatories agree to commit, the first states, "We will incorporate ESG (environmental, social, and corporate governance) issues into investment analysis and decision-making processes."

Also in the US, according to the 2010 Trends Report of The Forum for Sustainable and Responsible Investment (US SIF), more than $3 trillion, or nearly one out of every eight dollars under professional management in the US, is invested in sustainable assets.

Taken together, the above numbers strongly suggest that sustainable and responsible investment is increasingly being taken up by the mainstream investment community. But how can money managers and other investment professionals, whose only focus until now has been on maximizing financial returns, effectively incorporate social and environmental considerations into investment decision-making on behalf of the growing numbers of investors requesting it?

A new book, entitled Dilemmas in Responsible Investment, seeks to provide such guidance to investment professionals. It does so not by purporting to respond to complex issues with simple solutions, but by offering hypothetical case studies to help professionals navigate a path towards successful sustainable investment.

The book's co-authors bring a wealth of experience in sustainable investment to their task. Celine Louche is an assistant professor of corporate responsibility at Vlerick Leuven Gent Management School in Belgium, and has worked as a sustainability analyst for socially responsible investment (SRI).

Steve Lydenberg, currently a Partner for Strategic Vision at Domini Social Investments, co-founded KLD Research & Analytics, an ESG investment research firm, in 1988.

Before proceeding to the 12 case studies, the authors provide an overview of the evolution of sustainable investment, from its origins in religious communities to its growing acceptance by the mainstream. For the early adopters, the process was relatively straightforward; they did not want their money used to support corporate activities with which they were not in ethical agreement. They therefore refrained from including companies in such industries as tobacco, alcohol, and armaments in their portfolios.

This approach of negative screening enjoyed its greatest success in the 1980s, with the campaign to divest from companies doing business in South Africa when the country was still under apartheid. The flight of capital has been given considerable credit for helping dismantle the system of apartheid.

While ethical considerations remain paramount for many sustainable investors, the practice has grown in complexity over the years. As increasing numbers of institutional investors have adopted sustainable investment policies, portfolios have become more diversified. As ESG research became more sophisticated and most large corporations began publishing annual sustainability reports, investors selected companies that outperformed their industry peers in areas pertaining to society and the environment. The emergence of quantitative key performance indicators (KPIs) in ESG research allowed investors to make meaningful comparisons of corporate performance.

Of course, mainstream acceptance of sustainable investment could not have occurred if financial returns from the practice did not match or exceed those gained by traditional methods. The authors write, "Advocates have argued that societal and environmental performance can affect a company's overall reputation and that companies with stronger reputations can command higher price-to-earnings ratios in the stock markets and borrow at lower rates in the bond markets."

"Considerable research indicates that, in general, societal and environmental screening as recently practiced does not hurt a fund's financial performance," the authors continue. As an example, they point out the performance of the MSCI KLD 400 Social Index, whose returns over the last 20 years have exceeded those of the S&P 500.

Notwithstanding the growing emphasis on satisfactory financial returns, the authors remind us, "It is in fact in the grappling with the often difficult questions about the relationship between business and society, between the process of investment and its societal and environmental implications, that responsible investment adds its greatest value."

The hypothetical case studies provided by the authors, supplemented with information gained from interviews with 35 fund managers, researchers, and analysts, address many of the often complex issues that are likely to be faced by investment professionals. The issues include how to address the ethical priorities of investors, whether engagement or divestment is a proper course to take, and whether investors should form public partnerships with other key stakeholders in an effort to pressure companies to change their behavior.

None of the case studies included, it should be noted, are prescriptive in nature. Instead, the authors deliberately leave them open-ended and generalized, thereby allowing professionals to account for the number of factors that could come into play.

"For students of business and finance unfamiliar with the field, these cases can provide an introduction to RI's (responsible investment) various practices," the authors write. "For finance professionals entering the field, they can provide an opportunity to explore some of the challenges they will face daily."

While most sustainable investors are as concerned with financial returns as their mainstream counterparts, the authors conclude, they have important characteristics of their own that must be accounted for by investment professionals. In addition to a focus on ESG factors in their decision-making, these characteristics include a long-term investment horizon and a willingness to engage in ongoing communications with corporate managers and key stakeholders.

These characteristics, the authors state, imply "a world of investors with far broader thinking and more systemic views than those of many investors in the mainstream."

"In other words," the authors add, "Responsible Investment implies a paradigm change."


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