Socially Responsible Investing Has Become a Mainstream Practice

May 27, 2004 | Read Time: 8 minutes

Related articles: View all of the advice and commentary from this special supplement on endowments
By MARIA MARKHAM THOMPSON

To those of us involved in socially responsible investing on a daily basis, the question of whether institutions should include social screening and corporate-governance issues in their investment policies seems most peculiar. The question we ask in turn is, If an organization can align its moral and financial compasses, why in the world wouldn’t it want to?

The issue probably arises, in part, because of an implied trade-off that was assumed in yesteryear but has since been debunked. When the first socially screened mutual funds were started, in the early 1970s, socially responsible investing was still a somewhat intuitive process. Organizations that let their consciences guide their wallets were regularly warned that such screening and corporate activism would diminish returns and could even be considered a breach of fiduciary responsibility. Living up to both their moral and their fiscal duties was a delicate balancing act.

The conventional wisdom was wrong. Returns on socially conscious funds stand up against their unconstrained competitors and sometimes surpass them. Now it is investing without any regard to social impact that carries the risk of breaching new fiscal sensibilities and, in some cases, protocols. Screening portfolios and, just as important, taking an active role in corporate governance should be part of every organization’s policy and practice.

A growing body of research by academic, corporate, and nonprofit organizations has found that companies with sound environmental practices and diverse work forces are outperforming companies that do not emphasize those goals. A growing number of mutual funds select or screen investments using nonfinancial criteria like excluding tobacco manufacturers and seeking companies that use recycled materials. The Social Investment Forum compared performance between socially screened and unscreened mutual funds and found a higher percentage of the screened funds within the top two Morningstar rating categories (four and five stars) in each six-month period from the beginning of 2001 through the second quarter of 2003. Similar findings have been published in respected academic journals and investment-industry reports, like the Journal of Investing and The Financial Review.

The Social Investment Forum, an advocacy and professional association in Washington, has been preparing biennial reports on socially responsible investing since 1995. Socially responsible investment assets had grown to $2.16-trillion by 2003, according to the 2003 SIF report, a 240-percent increase since the first report. Total assets, both “socially responsible” and other, under professional management grew 174 percent in the same period. At 11 percent of all assets under professional management, socially responsible holdings are clearly well established.

At a minimum, endowment managers at nonprofit institutions have a responsibility to participate in corporate governance to protect the value of their holdings. They are obligated to cast votes on the proxies through which corporations elect directors, select auditors, and approve plans for stock options, mergers, and so on. The U.S. Department of Labor made the requirement to vote proxies a matter of law in 1988. Although the department has the legal authority to set investment standards only for employee-benefit plans covered by the Employee Retirement Income Security Act, its directives are a benchmark by which foundations and other nonprofit organizations can be measured. Due consideration and voting of proxies is also one of the ethical standards for investment managers who are members of the Association for Investment Management and Research.

How corporate-governance obligations are carried out can vary. An institution’s board members or investment committee might want to establish policies for voting proxies, or seek direct dialogue with the company’s board and management, or even offer corporate resolutions, as did 224 organizations in the most recent SIF report. The appropriate level of involvement, dictated by the resources and interests of the organization’s board, can mean something very different for a small community-college foundation than for the California Public Employees’ Retirement System.

An institution’s investment committee can provide an endowment manager with guidance on how it wants certain issues to be handled. At the least, the committee should review and explicitly accept the manager’s proxy-voting policies. Particularly under the heightened scrutiny that has followed recent corporate scandals, a policy of automatically voting in support of management is not sufficient. It is essential to duly consider how each vote will affect a stock’s value and whether the vote is consistent with the investment committee’s policies.

For smaller institutions that invest primarily in mutual funds, new Securities and Exchange Commission regulations will make it easier to keep track of the funds’ practices. Beginning this summer, mutual funds will be required to report their proxy-voting records, policies, and procedures. Those reports, particularly about votes on shareholder propositions regarding social and environmental activities, should help investment committees weigh share ownership and determine their own priorities. The mutual funds’ reports are also bound to increase the demands for similar disclosures of proxy policies and voting records by the boards of universities and other institutions.

Legislatures and other governing bodies can also provide guidance on making investment and proxy decisions, drawing on experiences in controversies like those over apartheid and tobacco products. Religious organizations might consult, as a model, the detailed proposals published by the U.S. Conference of Catholic Bishops. Many health-care organizations, too, publish their investment guidelines, like the American Medical Association’s policies regarding tobacco stocks.

While some organizations follow traditionally liberal prohibitions against investing in, say, companies accused of using sweatshop labor, conservative institutions often exclude the “sin stocks” of companies profiting from alcohol and gambling, or even firms that provide benefits to same-sex couples, a practice that those investors consider detrimental to family values. Ultimately it is up to every institution to tailor its investments to its underlying worldview and mission.

Some screening is easy. Excluding “sin stocks,” identifiable by industry codes and well-known products, is fairly straightforward. Companies’ environmental practices can be monitored through regulatory filings. Both factors can be considered on absolute terms or in comparison to the behavior of industry peers, in a search for the “best in class.”

But too often, in other areas, institutions’ instructions to investment managers are murky. For instance, a manager will be asked to invest in companies that provide opportunities for women and members of ethnic minorities — but what exactly does that mean, and how can it be appropriately measured? More helpful would be setting the bar based on the numbers of cases filed with labor or equal-rights agencies, and the sizes of awards that result, or to look at the representation of women and ethnic minorities on the board or among top managers. That kind of gauge, or comprehensive reviews of labor practices, child welfare, animal rights, or other areas of concern can often be done through a database, like those compiled by KLD Research & Analytics or Institutional Shareholder Services.

An institution might want to survey its members or constituents as to just where to draw the boundaries. Some organizations that exclude tobacco products will also eschew manufacturers of cigarette-rolling paper, while others don’t worry about such ancillary products. If one branch of a company is involved in military activities, emits pollutants, or takes a certain percentage of hotel receipts from gambling, should that make the entire company an unacceptable investment? How about the conglomerate that owns that company? There are gray areas, but a consensus can be sought.

With more options and more help than ever, there is no excuse for not including relevant social concerns in an investment policy. As the number of institutions that weigh those concerns grows, fiduciary standards rise. In 2003 the Social Investment Forum listed 505 universities, health-care facilities, unions, and other for-profit and nonprofit groups that applied social screens to their investments. Internationally, the forum found trade organizations dedicated to socially responsible investing in Europe, Asia, and Australia.

Socially responsible investing practices are now proven ways for institutions to achieve both societal and financial goals.

Maria Markham Thompson is vice president of marketing and sales for MTB Investment Advisors Inc., in Baltimore.

ONLINE RESOURCES

Here are sources of online information about socially responsible investing:

GENERAL INFORMATION

Institutional Shareholder Services:
http://www.issproxy.com

Interfaith Center on Corporate Responsibility comprises 275 faith-based institutional investors that sponsor more than 100 shareholder resolutions a year:
http://www.iccr.org

KLD Research & Analytics:
http://www.kld.com

Social Investment Forum, which provides a wide range of information and data on socially responsible investing:
http://www.socialinvest.org

SPECIFIC POLICIES

American Medical Association policies on tobacco stocks:
http://www.ama-assn.org/apps/pf_new/pf_online?f_n=browse
&doc=policyfiles/HnE/H-490.983.HTM

U.S. Conference of Catholic Bishops guidelines on socially responsible investing:
http://www.usccb.org/finance/srig.htm

U.S. Securities and Exchange Commission regulations requiring mutual funds to report their proxy-voting records, policies, and procedures:
http://www.sec.gov/news/press/2003-12.htm