A Natural Capital Institute report criticizes SRI for lack of standards and transparency on screening and holdings for shareowner action.
What exactly is socially responsible investing (SRI)? This is the question posed by a recent report written by the research staff of the Natural Capital Institute (NCI) and its founder, renowned ecologist/entrepreneur Paul Hawken. The report critiques the global SRI industry for lacking transparency of how it screens its investments and which companies it holds specifically for shareowner action, among other things. To what degree are the report’s criticisms founded, and to what degree do they rest on shaky ground?
"The term ‘socially responsible investing’ is so broad it is meaningless," states Mr. Hawken in a Common Ground magazine article based on the report. In the report, he adds, "SRI mutual funds have no common standards, definitions, or codes of practices "
The Social Investment Forum (SIF), the SRI industry organization in the US, admits that the SRI community is indeed inclusive of a broad diversity of values and investment styles.
"[Mr.] Hawken is correct that there are no rigid standards dictated for SRI funds to follow in the United States," said Alisa Gravitz, vice president of SIF. "SRI funds offer a wide range of options for investors in order to meet diverse ethical and investing criteria."
The diversity of SRI provides options for investors across a broad spectrum of ideological beliefs ranging from social progressivism to cultural conservatism, as well as a wide range of tolerance for the degree of stringency of screening. For example, some social investors prefer screens that exclude "sin" sectors such as gambling, while others prefer best-in-class screening that invests in companies with the best practice on corporate social responsibility (CSR) in all sectors, including sin sectors.
Mr. Hawken takes more of a purist approach, dismissing best-in-class screening.
"What does it matter if one fast food company is singled out as ‘best in its class,’ which is the rationale employed by KLD Research & Analytics?" writes Mr. Hawken in the report. "As a friend once put it, if you are going the wrong way, it doesn’t matter how you get there."
While many social investors might share Mr. Hawken’s definition of what is "wrong," others value using the best-in-class approach to try to encourage better corporate citizenship in all sectors.
The report stands on less subjective ground when it calls for transparency in how SRI firms screen, so that investors can make their own informed decisions.
"Although funds will publish their criteria in general terms, they do not publish the analysis of how those criteria were applied to a given corporation," the report states.
The report, which is based on a year-long compilation of a database of all retail mutual funds that describe themselves as socially responsible or variants thereof, has generated some controversy around its stance on shareholder advocacy.
"Our report recommends that if funds hold a company for purposes of shareholder action, they should clearly and explicitly state that they’re doing so," said Hilary Mandel, NCI’s lead researcher on the report. "Otherwise, investors have no idea about whether the company in question is one that passed the screens or flunked so badly that it needs to be addressed in this fashion–again, the issue here is transparency."
In recommending that SRI funds become more transparent, it acknowledges that achieving greater transparency is not simple or simply done. It does, however, provide suggestions. For example, it suggests labeling funds that hold problem companies specifically for conducting shareowner action with them "Hold-Your-Nose-We-Are-Going-In Funds." While this particular suggestion lends a light touch to an otherwise heavy report, it may actually be self-defeating.
"I don’t think it would be productive for a fund to invest in a company solely for the purposes of conducting shareholder action," said Bob Walker, vice president for sustainability at Vancouver-based Ethical Funds. "In my view this approach would allow the target company to use this information to discredit the shareholder in front of the SEC (exclude the proposal from the proxy circular and submit a no-action request), Institutional Shareholder Services (which would likely recommend against shareholder proposals filed by those holding ‘action shares’), and other shareholders (who would likely see the shareholder as a flake)."
Returning to the issue of standardization, the report recommends the institution of a rating system for SRI research and SRI mutual funds. The authors concede, though, that such a goal could not be achieved "without significant effort." Such effort is already under way in Europe with regard to SRI research. The Association of Independent Corporate Sustainability and Responsibility Research (AI CSRR) was founded earlier this month to promote standards for firms that provide CSR research to SRI firms.
It remains to be seen if similar standards or ratings will be adopted for SRI mutual funds.
