Edited by Cary Krosinsky and Nick Robins

‘From sin stocks to cleantech, ESG to GHGs, portfolio tilt to the prudent man rule, Krosinsky and Robins guide the reader through a rapidly shifting landscape of risk and opportunity. Essential reading, whether you are an investor, a CEO or simply someone wanting to enjoy both a pension and a world fit for future life.’John Elkington, co-founder of ENDS, SustainAbility and Volans, and co-author of The Power of Unreasonable People

‘A significant contribution to a rapidly growing field; the editors have brought to the public important themes and thought-provoking arguments on topics that will dominate the 21st Century. This is a must-read book for practitioners and investment analysts alike.’Gordon L. Clark, Oxford University

‘As the roles of business and the capital markets shift to directly address global challenges, practitioners can no longer ignore the growing momentum in sustainable investing. This book fills an important gap, pulling together the best thinking from contemporary experts. An excellent overview of past notions, current best practice and future trends.’ Cheryl Hicks, World Business Council for Sustainable Development ‘Krosinsky and Robins have managed to assemble a unified publication that brings to light the financial innovation occurring on a massive scale. This book puts forth an image of the world where capital markets have the potential to provide solutions to our most pressing environmental problems.’Bryan Garcia, Yale University

‘Sustainable investing is vital for the future of our planet. This book richly deserves to be read by everyone in the investment community – and many beyond.’Rob Lake, APG Investments, The Netherlands

‘An excellent volume that puts sustainable investing front and centre in the debates about building a more equitable global economy and providing retirement security for working people.’Michael Musuraca, Designated Trustee, NY City Employees Retirement System

Edited

by K

rosinsky &

Robins

SustainableInvesting The Art of Long-Term Performance

SustainableInvesting

‘Buy and read this book. Without it, you are playing yesterday’s game.’Robert A. G. Monks

Cary Krosinsky is a long-standing expert on the intersection of equity ownership and Sustainable and Responsible Investing, and is now Vice President, North America of Trucost Plc. Nick Robins, former Head of SRI research and SRI funds at Henderson Global Investors, is now Head of the HSBC Climate Change Centre of Excellence.

Contributors include:Ray Cheung, World Resources Institute Sean Gilbert, Global Reporting Initiative Dr Julie Fox Gorte, Pax World Gordon Hagart, onValues Katherine Miles Hill, Global Reporting InitiativeEmma Hunt, Mercer Abyd Karmali, Merrill Lynch Ivo Knoepfel, onValuesMatthias Kopp, WWFRitu Kumar, Actis Valery Lucas Leclin, SGCIBSteve Lydenberg, DominiDr Paul McNamara, PRUPIM Sarbjit Nahal, SGCIB Professor Gary Pivo, University of ArizonaRod Schwartz, Catalyst Fund Management & Research Dan Siddy, Delsus Tessa Tennant, ICEBjörn Tore Urdal, SAM Stephen Viederman Dr Steve Waygood, Aviva Investors Rachel Whittaker, Mercer

Environmental Market Insights Series

Sustainable Investing is fast becoming the smart way of generating long-term returns. With conventional investors now scrambling to factor in issues such as climate change, this book captures a turning point in the evolution of global finance. Bringing together leading practitioners of Sustainable Investing from across the globe, this book charts how this agenda has evolved, what impact it has today, and what prospects are emerging for the years ahead. Sustainable Investing has already been outperforming the mainstream, and concerned investors need to know how best to position themselves for potentially radical market change.

3mm

100mm 159mm 25mm 159mm

3mm

100mm

9 781844 075485

ISBN 978-1-84407-548-5

publ ishing for a sustainable future

www.earthscan.co.ukBusiness / Finance

Sustainable Investing FINAL.indd1 1 25/9/08 18:50:17

Contents

List of Figures, Tables and Boxes ix

List of Contributors xi

Foreword by Steve Lydenberg xix

Introduction xxi

Acknowledgements xxvi

PART I — THE RISE OF SUSTAINABLE INVESTING

1 The Emergence of Sustainable Investing 3

Nick Robins

2 Sustainable Equity Investing: The Market-Beating Strategy 19

Cary Krosinsky

3 Investors: A Force for Sustainability 31

Julie Fox Gorte

4 Sustainability Analysis 41

Valery Lucas-Leclin and Sarbjit Nahal

PART II — CONFRONTING NEW RISKS AND OPPORTUNITIES

5 Observations from the Carbon Emission Markets:

Implications for Carbon Finance 59

Abyd Karmali

6 Carbon Exposure 75

Matthias Kopp and Björn Tore Urdal

7 Clean Energy Opportunities 85

Emma Hunt and Rachel Whittaker

8 Water 97

Katherine Miles Hill and Sean Gilbert

PART III — SUSTAINABILITY ACROSS THE

OTHER ASSET CLASSES

9 Fixed Income and Microfinance 107

Ivo Knoepfel and Gordon Hagart

10 Sustainable and Responsible Property Investing 117

Gary Pivo and Paul McNamara

11 Private Equity: Unlocking the Sustainability Potential 129

Ritu Kumar

12 Social Businesses 137

Rod Schwartz

PART IV — FUTURE DIRECTIONS AND TRENDS

13 China 149

Ray Cheung

14 India 165

Dan Siddy

15 Civil Society and Capital Markets 177

Steve Waygood

16 Fiduciary Duty 189

Stephen Viederman

17 The Global Agenda 201

Tessa Tennant

18 Conclusion: Sustainable Investing – The Art of Long-Term

Performance 205

Nick Robins and Cary Krosinsky

Glossary 211

Appendix A: Sustainable and Responsible Initiatives and Resources 221

Appendix B: Equity Returns Study Methodology –Determination of Annualized

Five-Year Return for the Period 31 December 2002 to 31 December 2007 229

Index 233

viii Sustainable Investing

1

The Emergence of

Sustainable Investing

Nick Robins

THE ORIGIN OF THE SPECIES

It is said that it takes a generation for a potent idea to become common practice.In the case of sustainable development, it is now two decades since theBrundtland Commission first launched the concept onto the global stage, callingfor a new pattern of growth that ‘meets the needs of the present withoutcompromising the ability of future generations to meet their own needs’(WCED, 1987). This poetically simple phrase contained within it three profoundimperatives that challenged the prevailing models of economic performance:first, the identification of ecological constraints that human activity must respect(ecology); second, the concept of needs, particularly those of the poorest, towhom ‘utmost priority must be given’ in the commission’s words (equity); and,third, the principle of intergenerational justice, adding a time dimension to thedelivery of development so that long-term durability is not compromised byshort-term speculation (futurity).

Looking back, the birth of sustainability was timely, coming as it did in theyear that analysts believe that the global economy first entered a state of ecologi-cal debt – whereby resource extraction and pollution exceeds the carryingcapacity of the planet, a deficit that has only deepened in succeeding years (WWF,2007). Just as significant was its coincidence with the collapse of state commu-nism, with the symbolic fall of the Berlin Wall, taking place just two years later.Critically, this meant that the realization of a sustainable economy would hence-forth take place within the context of market-based capitalism. And if globalcapitalism is to become sustainable, then it makes sense to start with capital.

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Yet, while some thought was given to the role that industry could play in thetransition to sustainable patterns of development, the role of finance and invest-ment was strangely absent, making investors the missing stakeholder in manysubsequent negotiations to translate theory into practice. Indeed, when the thenBusiness Council for Sustainable Development (BCSD) came to write itslandmark report, Changing Course, for the 1992 Earth Summit, it acknowledgedthat ‘little is known about the constraints, the possibilities, and the interrelation-ships between capital markets, the environment, and the needs of futuregenerations’ (BCSD, 1992; see also WBCSD, 1997). At the time, ethical investingwas already practised by a growing number of individual and institutionalinvestors in Europe and the US. But only a handful of the world’s institutionalinvestors had begun to include considerations of sustainability within theirinvestment strategies. These included Bank Sarasin in Switzerland and Jupiter inthe UK, both of which continue to be among the leading practitioners today.Nevertheless, a group of pioneers – led by Tessa Tennant and Mark Campanalein the UK, Peter Kinder in the US, Marc de Sousa Shields in Canada, and RobertRosen in Australia – drafted the Rio Resolution, which sought to ‘draw to theattention of investors worldwide the link between investment policy and sustain-able development’ (cited in Sparkes, 2002, p168).

Investment provides the bridge between an unsustainable present and asustainable future – placing finance squarely at the heart of solutions to issuessuch as climate change and human rights. Across each of sustainability’s threepillars of ecology, equity and futurity, the need for investment strategies thatserve this transition is increasingly evident. Put simply, the world’s capitalmarkets fail to tell the ecological truth. According to Ernst von Weizsäcker: ‘thesystem of bureaucratic socialism can be said to have collapsed because it did notallow prices to tell the economic truth’ (von Weizsäcker, 1994). And despite theprogress that has been made, he adds, ‘market prices are a long way from tellingthe ecological truth’. Negative environmental externalities remain significant,accounting for almost half of the US GDP, according to Redefining Progress(Talberth et al, 2006). In many cases, these externalities continue to grow. This isparticularly stark in the case of climate change, where less than 10 per cent ofglobal emissions are covered by carbon pricing mechanisms. Even where pricinghas been introduced, this still undervalues the cost of greenhouse gas emissions,estimated by the Stern Review at some US$85 per tonne of carbon dioxide(CO2) equivalent (Stern, 2006). Carbon has still only been marginally integratedwithin asset valuations. Thus, the share prices of oil, coal and gas companiesremain buoyed up by the expected future returns from their reserves of fossilfuels, ignoring the huge carbon liability that is attached to each barrel of oilequivalent. As a result, hundreds of billions, if not trillions, of dollars in capitalare still being routinely misallocated. Yet, in spite of these market failures, agrowing body of sustainable investors have anticipated the future direction ofpolicy and allocated increasing amounts of capital to environmental solutions.

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In terms of equity, the challenge is for the investment industry to be an engineof social cohesion rather than social division. Much of today’s investment industryhas its roots in the post-war welfare settlement that gave rise to the modernpension and mutual fund industry (see, for example, Bogle, 2005). More recently,however, in a process described as ‘financialization’, a growing share of globaloutput is taken by the finance sector and its employees. In the US, for example,finance-sector profits rose from 14 per cent in 1981 to 39 per cent of the total in2001; over a similar timeframe – between 1980 and 2000 – average compensationfor a US securities analyst tripled; for the average US worker, it doubled(Blackburn, 2006). Former investment banker Philip Augar has calculated that, as aresult, US$120 billion was diverted from shareholders and customers to invest-ment banking employees alone over the past two decades (Augar, 2006). Excessiveremuneration and bonuses within the finance sector have attracted increasingpublic criticism not just for the social divisions that these create, but the perversesignals they often send for short-term profit-making. All of this has contributed tothe wider rise in inequality, described as the emergence of a new Plutonomy byAjay Kapur, until recently the chief global equity strategist at Citigroup (seeAuthers, 2007). In addition, the allocation of private capital for vital social infra-structure lags behind the surge in clean tech investing. As the unfolding sub-primedebacle in the US has demonstrated, conventional financial innovation has tendedto progress without consideration of social impacts. The great challenge ahead isto harness the ingenuity of financial markets for social business, an issue addressedby Rod Schwartz in Chapter 12.

As for the core principle of futurity, the mainstream investment industrycontinues to foreshorten its time horizon when what is called for is the reverse.Technological innovation, financial deregulation and the rapid growth of hedgefunds have served to make trading cheaper, easier and superficially moreprofitable – and so encourage short-term trading on the world’s equityexchanges. In the UK, for example, the average holding period for shares on theLondon Stock Exchange has slumped from 9 years in 1986 to 11 months in2006, suggesting that investors cannot wait between one annual report and thenext before trading (Montier, 2005; see also Montier, 2007). Short-term perfor-mance measurement is a major profound driver of this behaviour, leading toextra costs and perverse results for the end investor. Indeed, there is a strongcorrelation between the time horizon of investment strategies and financialperformance (see Chapter 2). Keynes’s 70-year-old epitaph for the long-terminvestor still stands the test of time today. Writing in his groundbreaking General

Theory of Employment, Interest and Money on the dynamics of investment practice,Keynes (1978) observed that ‘it is the long-term investor, he who most promotesthe public interest, who will in practice come in for the most criticism whereverinvestment funds are managed by committees or boards or banks’.

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THE EVOLUTION OF THE SPECIES

Since the embryonic initiatives of the early 1990s, sustainable investing hasbecome one of the most creative areas of investment practice developing newways of thinking and shaping an agenda for others to follow. It has attractedrapidly growing flows of assets and created new models for assessing fundperformance. Many different streams have contributed to its rise. One of theseis the pioneering ethical and socially responsible investment community, whofirst attempted to bring social and environmental values to the world’s stockmarkets. In practice, ethical investing represents a merger between age-oldprinciples of stewardship inherent to many of the world’s religions and the moremodern trend of ethical consumerism, as active individuals integrate theirpersonal beliefs within their shopping and investing decisions.

Over the past 35 years, sustainable and responsible investing (SRI) hasgenerally been characterized by the application of positive and negative screensto investment selection – on issues such as alcohol, environmental protection,gambling, human rights, military involvement, nuclear power, pornography andtobacco – as well as shareholder activism and community investing (see Dominiand Kinder, 1986; Sparkes, 1995; Domini, 2001; Sparkes, 2002; Hudson, 2006;Kinder, 2007).

Equally important has been a host of new entrants who have responded tothe investment challenges created by growing environmental constraints,increased public expectations of business social performance, new value driversand heightened understanding of impacts up and down extended supply chains.Practitioners of sustainable investing share an interest in many of the sameissues as ethical investors. But there are also important differences. While theprimary spur for ethical investing is the internal value system of the investor, theprompt for sustainable investing is the external realities of an economy out ofbalance: water stress is thus not a question of belief, but of fact.

In essence, sustainable investors recognize that physical, regulatory, competi-tive, reputational and social pressures are driving environmental and social issuesinto the heart of market practice and thus the ability of companies to generatevalue for investors over the long term. Sustainable investors therefore incorporatethese factors both within their choices over the selection and retention of invest-ment assets and within the exercise of their ownership rights and responsibilities.It is this alignment with the forces shaping the planet that gives sustainableinvestors a far better chance of delivering outperformance than traditionalinvestors. Indeed, much of the secret of sustainable investing’s recent growth hasbeen in its ability to sniff out critical trends before the ‘electronic herd’ ofconventional investors, to stay one step ahead of the pack and to do things thatseem to be eccentric at first, but then become perfectly normal. It was sustainableinvestors who first raised climate change as a financial issue, building understand-ing and expertise in advance of an often dismissive mainstream, who are now

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hastily playing catch-up. Matching this is the downside potential of anticipatingtrends too far ahead of the market – of being right too early.

Five main forces are at work in this arena, fusing with the efforts of sustain-able investing pioneers to create tangible outcomes in terms of scale, diversity,financial and non-financial performance, analytical rigour and market norms(see Figure 1.1).

Rising social expectations around environmental protection, health andsafety, and equal opportunities at work have formed the basis for a significanttightening in policy frameworks across the world during the past two decades.These have combined to create new value drivers for business success, whereintangible assets have assumed ever greater importance. Thus, in the pre-sustain-ability mid 1980s, financial statements were capable of capturing 75 to 80 percent of the risks and value creation potential of corporations. By the early 21stcentury, this had collapsed to less than 20 per cent (cited in Kiernan, 2007).Factors such as human capital and resource efficiency, along with brand andreputation are now critical to business success. Yet, mainstream investors havelong ignored these and other issues, leaving it to the more nimble far-sighted

The Emergence of Sustainable Investing 7

Source: Nick Robins

Figure 1.1 The dynamics of sustainable investment

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sustainability investors to start the quest to understand the extra-financialaspects of performance. The financial success of many sustainability-focusedfunds at the end of the 1990s – such as NPI’s Global Care range in the UK –helped to create the basis of evidence for amending financial regulation toreflect these new realities. Thus, in 2000, the UK introduced new requirementsfor pension fund trustees to consider the extent to which social, ethical andenvironmental factors were part of their investment strategies, paving the wayfor similar reforms across Europe and internationally.

The end of the equities boom and the revelations of egregious corporatepractices in companies such as Enron exposed the need for traditionally inactiveinstitutional investors to behave as real owners of corporations and to take alonger-term approach to investing. As a result, the historically conservativecommunity of pension funds became among the most innovative in the devel-opment of strategies to integrate environmental, social and governance (ESG)factors within investment and governance decision-making (UNEP FI and UKSIF, 2007). Rejecting the pure values-based focus of the original SRI fundmanagers, the entry of pension funds has been pivotal in creating ‘responsibleinvestment’, essentially a brand of enlightened self-interest for the 21st century(for an overview of responsible investing, see Mackenzie and Sullivan, 2006).The rapid maturity of this movement was symbolized by the launch of theUnited Nations Principles for Responsible Investment in April 2006; by June2008, these principles had attracted over 300 signatories with US$13 trillion ofassets under management.

Brokering these dynamics have been a small but growing group of sustain-able investing practitioners – notably, fund managers and rating agencies – alongwith a range of catalytic initiatives. One of the first research agencies establishedwith the explicit aim of understanding the investment relevance of sustainabilitywas Innovest Strategic Value Advisers, founded in 1995 with the mission of‘integrating sustainability and finance by identifying non-traditional sources ofrisk and value potential for investors’ (see www.innovestgroup.com, accessed 12May 2008). Others have joined the quest to unlock new sources of investmentadvantage – for example, Trucost in the UK and Vigeo in France. Importantly,the first generation of ethical research organizations, such as EIRIS and KLD, aswell as corporate governance agencies, such as PIRC and RiskMetrics, have alsoexpanded their services to incorporate the sustainability dimension. Tradeassociations and investor alliances have grown in stature and clout, notably thenetwork of national and regional social investment forums (SIFs) acrossEurope, North America and Asia-Pacific, as well as specialist groups such asCERES and the Marathon Club. Internationally, the United NationsEnvironment Programme’s Finance Initiative (UNEP FI) has been instrumentalin building confidence and competence among leading banks, insurers and assetmanagers on issues such as fiduciary duty and investment performance. Inemerging markets, the International Finance Corporation (IFC) has been an

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active exponent of underwriting sustainability investment research and backinginnovative public and private equity funds.

All of this has produced tangible results. Over the past decade, the size andscope of the social, responsible and sustainable investment universe has grownconsistently ahead of the wider investment market (see Figure 1.2). As this bookdemonstrates, sustainability investing is spreading out from the public equityarena to influence fixed income, private equity and property. Significant regionaland national differences exist – and the world still lacks common standardssimilar to those governing organic agriculture to enable rigorous analysis. Theterms ‘social’, ‘ethical’, ‘responsible’, ‘socially responsible’ and ‘sustainable’ areall used in a multitude of overlapping and competing ways to the frustration ofpractitioners and observers alike. As UNEP FI recently commented: ‘This is notmere semantics, but a true reflection of the major shift in thinking associatedwith the huge environmental and social challenges our world is now facing, thecorporate downfalls in recent memory, and the increasing belief that thesechanges have impacts on investment performance’ (UNEP FI, 2007).Nevertheless, some broad observations can still be made.

The US remains the home of traditional social screening, with over US$2trillion in assets applying one or more ethical factors in stock selection. In all,US$1 out of every US$9 under professional management was involved in SRI in2007 (US SIF, 2008). Shareholder advocacy expressed in terms of stockownersfiling and voting for SRI resolutions is on the rise, notably around climatechange and human rights. The US is also home to a thriving, community invest-ing market, whose assets under management rose by nearly one third between2005 and 2007. Major state pension funds, such as CalPERS and CalSTRS inCalifornia, have not only set the standard for corporate governance, but havealso launched new mandates for environmentally focused public and privateequity, as well as property funds. In relative terms, however, the advances inCanada have been the most pronounced, with almost one fifth of the combinedretail mutual fund and institutional investment market covered by SRI strategiesin 2006 (SIO, 2007). This has largely been due to the adoption of responsibleinvestment by some of Canada’s leading pension funds.

It is in Europe, however, where most progress has been made in terms ofsustainable and responsible investing. This is perhaps no surprise as it is in theEuropean Union (EU) where the imperative of sustainable development hasbeen most deeply integrated within broader economic policy from the early1990s onwards.1 In the investment world, the early pioneers in Switzerland andthe UK were joined in September 1999 by the launch of the Dow JonesSustainability Index (DJSI) series, underpinned by the work of Sustainable AssetManagement. This provided the first independent benchmark of the financialand non-financial performance of companies with regard to sustainability. Thiswas followed in July 2001 with the FTSE4Good Index, although this was morefocused on corporate social responsibility than sustainability. By the middle of

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the decade, major European pension funds such as ABP and PGGM in TheNetherlands, the FFR in France, Norway’s Government Pension Fund, and USSand the Environment Agency in the UK had come to the forefront of individualand collaborative efforts to make ESG factors an increasingly normal part ofmainstream investment practice. 2005 was also the year in which the EU’sEmissions Trading Scheme (EU ETS) was introduced, the most forceful expres-sion in the world of the global effort to implement the 1997 Kyoto Protocol. Farmore effectively than repeated exhortation by government ministers or volun-tary codes with business, the EU ETS symbolized a determination toprogressively drive environmental costs into market prices. Alongside assertiverenewable energy policies, notably in Denmark, Germany and now Spain, theEU’s climate change convictions stimulated a sea change in clean tech, climatechange and environmental investing. The previous wave of clean tech publicequity investing at the turn of the century had been hit hard by the ending of thedot.com boom. Now, policies, markets and technologies were in alignment.According to New Energy Finance, public equity funds investing in climatesolutions soared from US$1.4 billion in 2000 to US$24 billion in 2007, withBlack Rock’s New Energy and Impax’s Environmental Market funds in thevanguard. By late 2007, the Financial Times reported that over 15 per cent offlows into European equity funds were targeted at ecological or environmentalfunds up from 2.6 per cent in 2006 and 0.6 per cent in 2005 (Johnson, 2007).

Japan’s leadership in environmental technologies has been reflected in theinvestment world. Nikko launched the country’s first Eco Fund in 1999, andover 50 SRI mutual funds were open to investors at the beginning of 2008.Elsewhere in Asia, South Korea has led the way in terms of integrating SRIwithin pension fund mandates, while Malaysia has over 80 Shari’ah-compliantfunds. Australia has witnessed particularly rapid growth. The launch of AMP’sSustainable Future range in 2001 marked a new focus on sustainable investingstrategies, and the market as a whole has grown strongly through this decade.Core SRI funds under management grew by 43 per cent in 2007 and representaround 1.8 per cent of the total market; alongside this, one quarter of allmanaged funds in Australia subscribe to the United Nations Principles forResponsible Investment (RIAA, 2007).

In the emerging world as a whole, South Africa and Brazil stand out as thetwo trailblazers. Since the struggle against apartheid, South Africa had alwayshad a special place in SRI strategies. In 2002, the publication of the second KingReport on corporate governance set a new benchmark for corporate standardsglobally – for example, requiring companies to report on the social, economicand environmental performance using the Global Reporting Initiative’s disclo-sure framework. This was followed in May 2004 with the launch of theJohannesburg Stock Exchange’s Socially Responsible Investment Index, the firstin an emerging economy. The JSE SRI Index evaluates the environmental, socialand economic sustainability practices and corporate governance of listed

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companies. Although the index has helped to raise the profile of SRI, theJohannesburg Stock Exchange remains disappointed at the slow uptake ofsustainable investing practices (JSE, 2007). Among the fast-growing Brazil,Russia, India and China (BRIC), it is Brazil that is furthest advanced, symbolizedby the launch of the Corporate Sustainability Index by the São Paulo stockexchange, Bovespa, in December 2005. Brazil’s pension fund community hasalso been among the most committed to the United Nations Principles forResponsible Investment. The two Asian giants, China and India, are currentlypoised to enter the world of sustainable investing as Ray Cheung and Dan Siddyillustrate in Chapters 13 and 14.

The impacts of this surge in sustainable and responsible investing extendbeyond the substantial growth in assets to real consequences for financial andnon-financial performance. Conventional financial theory has generally beendismissive of, first, socially responsible and, now, sustainable investing strategies.The assumption is that the introduction of non-financial factors will harm diver-sification and thereby incur penalties in terms of risk and returns. The broadspread of extra-financial investing styles – as well as the diversity of academicapproaches – makes it difficult to draw definitive conclusions. Yet, it is clear thatconventional financial theory and practice do need to be updated in light of thesustainability imperative. In general, studies show that investments selected onthe basis of identifiable ESG factors – such as eco-efficiency, employee engage-ment and corporate governance – do tend to outperform, confirming thevalidity of investors integrating extra-financial factors within the research

The Emergence of Sustainable Investing 11

Source: EUROSIF (2006); RIAA (2007); SIO (2007); US SIF (2008)

Figure 1.2 Key markets

3000

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2003 2005 2007 2003 2005 2007

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process (see, for example, Bauer et al, 2006; Edmans, 2007; Association ofBritish Insurers, 2008). The evidence in terms of fund performance is less clearcut. A 2007 review of the academic literature analysing the performance offunds adopting SRI screening suggests that out of 11 studies, 3 identifiedpositive results, 2 were negative and 6 were generally neutral (UNEP FI, 2007). A2008 paper from Sweden surveyed 16 studies between 1992 and 2007 andconcluded that 2 showed a positive relationship, 1 identified a negative relation-ship, with the remainder concluding that SRI funds did not exhibit anysignificant difference in performance from regular funds; this same study thenconcluded that in the Swedish context, SRI funds did underperform (Stenstromand Thorrell, 2007). At present, it appears that these performance evaluationsare comparing very different investment strategies, requiring a more discriminat-ing approach. New analysis conducted for this book for the first timedisaggregates ethical from sustainable and responsible investment funds andsuggests that ethical funds do underperform as a whole, while funds with asustainability focus tend to outperform (see Chapter 2).

Part of the essence of contemporary sustainable investing is the realizationthat investors need to understand, measure and promote superior financial and

non-financial performance. Climate change has been a focal point for recentinvestor activism, combining both a strategic awareness of the coming transitionto a low-carbon economy as well as a more tactical engagement with companiesto raise standards of disclosure, governance and performance. Central to thishas been the Carbon Disclosure Project (CDP). Established in 2001, theinvestor-led CDP has won the support of 385 investment institutions with overUS$57 trillion in assets under management to promote comprehensive andcomparable corporate reporting of climate change risks and opportunities. TheCDP has created the largest public register of climate change reporting, provid-ing the basis for climate exposure to be integrated within regulated disclosures tothe market. Alongside the CDP, regional initiatives such as the InstitutionalInvestors Group on Climate Change (Europe), the Investor Network on ClimateRisk (US) and the Investor Group on Climate Change (Australia) have mobilizedinvestors to commit capital to climate solutions, frame policy frameworks andengage with corporate management.

Underpinning these outcomes is the growth in a compelling body ofresearch showing when and how sustainability becomes a driver of investmentreturns. SRI research has moved a long way from the early days of screeningthrough the ‘best in class’ era when sustainability performance was viewed as anindirect proxy for management quality to the current growth boom in sell-sideinvestment analytics. As more and more funds adopt conviction sustainabilitystrategies as well as pragmatic responsible investment overlays, so the market forhigh-quality analysis has grown. Much of this research is hidden from publicview; but the Enhanced Analytics Initiative (EAI) has brought together leadingasset owners and asset managers to reward investment research that takes

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account of the impact of extra-financial issues on long-term performance. Inthe six-month period between May and October 2007, the 30 EAI membersrecommended an impressive 158 reports for appraisal. London’s claim to berecognized as the global capital of sustainable investment came to fruition withthe London Accord: a unique collaboration between investment banks, researchhouses and academics to produce the first ‘open source’ resource for investors inclimate change solutions. Released at the end of 2007, the result was a collectionof 25 research papers with contributors including ABN AMRO, Barclays,Canaccord Adams, Chevreux, Credit Suisse, JPMorgan Chase, Merrill Lynch,Morgan Stanley, Société Générale and WestLB.

TAKING STOCK OF SUSTAINABLE INVESTING

Sustainable investing expresses a convergence of forces, bringing together thosein the financial sector committed to the sustainability imperative, along withthose simply happy to ride the investment opportunities that the ongoing shift inregulations and market practices are creating. Perhaps the best expression of thecurrent model of change is contained in The New Capitalists, written by threeleaders in corporate governance and responsible investment. Drawing out theconsequences of the democratization of ownership represented by pension andmutual funds, the authors describe an emerging civil economy in which ‘institu-tional owners accountable to their savers push corporations towards sustainableprosperity through responsible management’ (Davis et al, 2006). In a similarfashion, the Twenty-First Century Investment report outlined the new realism ofsustainable investing (see Figure 1.3).

This reversal of the traditional chain of value creation – where the planethas been seen purely as a source of materials or a sump for pollution – hasprofound consequences for the investment profession, many of which have stillto be worked through. The case for sustainable investment has also beenstrengthened by the entry of respected mainstream investment professionalsinto the field. A case in point is Generation IM, a specialist fund manager estab-lished in 2004 by ex-Goldman Sachs executive David Blood and former USVice-President Al Gore. For Generation, sustainable development will be aprimary driver of industrial and economic change over the next 50 years. As aresult, Al Gore believes that ‘integrating issues such as climate change intoinvestment research is simply common sense’ (see www.generationim.com).

Yet, for all the sense of achievement that this progress brings, there isequally a need for a healthy sense of proportion. Initiatives such as the CDP arestarting to attract majority attention among asset owners and asset managers.But the actual allocation of capital still lags far short of either the enlightenedself-interest of responsible investment or the conviction commitments ofsustainable investing. In addition, it is still fair to say that the SRI movement, as a

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whole, is not yet fully signed up to the goal of sustainability. While there arestrong linkages between the ethical, responsible and sustainable styles of invest-ing, it is important to recognize the issues that separate, as well as unite. Thus,the classic negative screens for ethical funds were designed during the 20thcentury and do not automatically make these portfolios well positioned for thesustainability issues of the 21st century. This creates the real threat of a ‘firstmover disadvantage’ for traditional ethical funds as they are overtaken in thepursuit of higher-performing sustainable assets by more aggressive opportunity-driven investors. Equally, promoters of the new generation of clean tech andclimate change funds – implicitly riding the sustainability wave – are often atpains to distance themselves from what went before in terms of socially respon-sible or ethical investing. Indeed, there are the first signs of a push-back againstthe perceived opportunism of this new surge of capital (see, for example,Novethic Etudes, 2007).

Others have called on the SRI community to avoid a slide into mere pragma-tism. ‘Best in class’, for example, has proved useful as a technique to rate ESGperformance within sectors. But it remains only a tool and needs to be comple-mented by a searching analysis of the sustainability of the ‘class’ itself. Unlessthis is done an Alice in Wonderland situation can emerge where ‘everyone winsprizes’, and relative benchmarking ensures there is always a sector leader, even ifneither business model nor behaviour warrant such an outcome. Such an

14 The Rise of Sustainable Investing

Source: Centre for Tomorrow’s Company (2000)

Figure 1.3 The constituents of 21st century investment

Successful investment

depends upon

identifying targets which can provide a good return

which depends upon

a vigorous population of enterprises

which depends upon

a healthy macro-economy

which depends upon

a healthy civil society

which depends upon

a sustainable planet

ES_SI_22-9 22/9/08 16:31 Page 14

approach, of course, mirrors the benchmark hugging, tracking error-aversestrategies of the investment mainstream. But here, the mainstream can be a falsefriend. On occasion, it seems that the understandable desire by advocates of SRIto be taken seriously by the mainstream has lead to a suspension of its criticaledge. In a coruscating critique, Paul Hawken found that investment portfolios ofSRI mutual funds were ‘virtually no different’ from conventional funds. Hawkenalso posed uncomfortable challenges for SRI, arguing that ‘striving to attain thehighest rate of financial return is a direct cause of social injustice and environ-mental degradation as it consistently leads to externalization of costs on theenvironment, the future, workers and others’ (Hawken, 2004).

One source of the problem, according to Christoph Butz and Jean Laville, iswhat they call ‘the materiality trap’. By this, they mean the tendency of SRIinvestors to address ESG issues only to the extent that they are financially mater-ial, adopting a narrow and formalistic interpretation of fiduciary duty. ‘In viewof this kind of reasoning’, they write, ‘we wonder whether the long struggle toput sustainable development on investors’ agendas has not been futile’, callingfor the SRI community to ‘go back to its roots’ (Butz and Laville, 2007). Anotherweakness of many SRI funds has been an inability to evolve their strategies inlight of changing circumstances. In a landmark review of climate change invest-ing in the UK, leading financial advisers Holden & Partners found that manySRI funds are surprisingly badly positioned for climate change, arguing that‘investors in SRI funds who were hoping to be buying into the low carboneconomy may find that they are largely exposing themselves to multinationalswhich are more part of the problem than part of the solution’. In a witheringconclusion, the report stated that ‘SRI and ethical funds perform just as well (ifnot slightly better) than their mainstream counterparts because in most casesthey are, in fact, mainstream’ (Holden & Partners, 2008).

Another perhaps surprising weakness has been in the area of transparency.The absence of objective standards, publicly reported upon, remains one of thegreat weaknesses of the SRI phenomenon. The introduction of transparencyguidelines for retail SRI funds in Australia and Europe is a positive first step. Inaddition, the reporting requirements under the United Nations Principles forResponsible Investment (PRI) could, over time, produce the kind of compre-hensive comparable information for savers that investors so often ask ofcompanies. Yet, in spite of the massive mobilization of investor effort to presscompanies to report on climate change, it remains shocking that only a handfulof SRI funds have voluntarily published their own ‘carbon footprints’.2 Withoutthe discipline of external reporting, SRI funds have been able to avoid hardquestions about the environmental and social outputs that they are generatingalong with financial returns.

To conclude, sustainable investing has arrived. It has proved itself to be intune with investors’ needs for attractive returns – and also to be acutely alignedwith the reshaping of the investment landscape as a result of deepening ecologi-

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cal, social and economic shocks. If it is to avoid the fate of being just anotherinteresting niche in the panoply of investment styles, sustainable investing willneed to overcome the temptations of pragmatism and opportunism, and toreassert its strategic mission of structural change. Just as corporate socialresponsibility (CSR) is increasingly being seen as a phase en route to the moreserious practice of sustainable enterprise, so today’s focus on SRI looks set tobecome a staging post for the more profound task of ensuring sustainablepatterns of global investment. And as the rest of this book amply demonstrates,there is already a wealth of experience in the sustainable investing arena – point-ing to further transformations to come.

NOTES

1 By contrast, prior to the 2008 presidential elections, the high tide of sustainable develop-ment in US policy-making was achieved during the late 1990s in the Clintonadministration. See, President’s Council on Sustainable Development (1999).

2 See, for example, the carbon audits of Henderson Global Investors’ Global Care Incomeand Industries of the Future funds (www.henderson.com/sri, accessed 12 May 2008).

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Augar, P. (2006) The Greed Merchants, Penguin, LondonAuthers, J. (2007) ‘Bankers are taking over where Marx left off ’, Financial Times, 17–18 March Bauer, R., Derwall, J., Guenster, N. and Koedijk, K. (2006) The Economic Value of Corporate

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Cambridge, MABlackburn, R. (2006) Age Shock: How Finance is Failing Us, Verso, LondonBogle, J. (2005) The Battle for the Soul of Capitalism, Yale University Press, New Haven, CTButz, C. and Laville, J. (2007) Socially Responsible Investment: Avoiding the Financial Materiality

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Tomorrow’s Company, London Davis, S., Lukomnik, J. and Pitt-Watson, D. (2006) The New Capitalists: How Citizen Investors are

Reshaping the Corporate Agenda, Harvard Business School Press, Boston, MADomini, A. (2001) Socially Responsible Investing: Making a Difference and Making Money, Dearborn

Trade, Chicago, ILDomini, A. L. and Kinder, P. D. (1986) Ethical Investing, Addison-Wesley, Reading, MAEdmans, A. (2007) Does Stock Market Misvalue Intangibles? MIT, Cambridge, MAEUROSIF (2006) European SRI Study, EUROSIF, ParisHawken, P. (2004) Socially Responsible Investing: How the SRI Industry has Failed to Respond to People

Who Want to Invest with Conscience and What Can Be Done to Change It, Natural CapitalInstitute, Sausalito

Holden & Partners (2008) Guide to Climate Change Investment, Holden & Partners, London

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Hudson, J. (2006) The Social Responsibility of the Investment Profession, CFA Institute,Charlottesville

Johnson, S. (2007) ‘Fears over rush into green funds’, Financial Times, 24 September JSE (Johannesburg Stock Exchange) (2007) The JSE’s SRI Index Challenges Investors to Invest

Responsibly, Johannesburg, South AfricaKeynes, J. M. (1978) The General Theory of Employment, Interest and Money, Macmillan, LondonKiernan, M. (2007) ‘Capturing next-generation alpha drivers’, in The Working Capital Report,

UNEP FI, Geneva, SwitzerlandKinder, P. (2007) Socially Responsible Investing: An Evolving Concept in a Changing World, KLD,

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LondonMontier, J. (2005) Seven Sins of Fund Management: A Behavioural Critique, DrKW Macro

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PRAISE FOR SUSTAINABLE INVESTING:

‘This splendid book provides up to date analyses of virtually the entire spectrumof socially related investment possibilities. The field is in a rapid state of change– Steve Viederman’s lovely piece on the Fiduciary remains a constant guide – Irecommend to everyone that you buy and read this book. Without it, you areplaying yesterday’s game.’Robert A.G. Monks, shareholder activist and leading founder of the practice ofCorporate Governance

‘Sustainable Investing does two things brilliantly: it lays bare a financial system thatis currently not fit for purpose, and then it draws a blueprint, with added operat-ing instructions, for a transformational redesign.’Andrew Simms, Policy Director, New Economics Foundation

‘If you want to understand how finance can offer practical solutions for sustain-able development – rather than being criticized for being an obstacle – read thisvery clear, comprehensive and persuasive book.’Antoine de Salins, Fonds de Réserve pour les Retraites

‘Krosinsky and Robins have assembled authors expert in their disciplines whocollectively describe a dynamic force which is both effecting change and beingaffected by it. A generation of investors will look first to Robins and Krosinskyfor answers about sustainable investing.’Peter D. Kinder, President and Founder, KLD Research & Analytics, Inc.

‘This book is packed with valuable insights into an area of growing importance.’Akitsugu Era, Corporate Governance Manager, Equity Fund ManagementDept, leading Japanese financial institution

‘SRI is morphing into sustainable investing. Is this just “brand refreshment” or isit, as this rich collection of essays from the leading experts in the field argues,something more fundamental? So, whether you didn’t like SRI first time roundor whether you are worried about the SRI baby being lost with the bathwater,buy this book and read it!’Raj Thamotheram, Director, Responsible Investment, Axa InvestmentManagement

‘This timely and thought-provoking collection of essays, written by some of theindustry’s leading experts, is essential reading for all those who want to under-stand how sustainability has influenced investment practice. It clearlydemonstrates the potential for sustainable investment to become the new“mainstream”.’Emma Howard Boyd, Head of SRI, Jupiter Asset Management

‘The thought leaders in this global framework on sustainable investment providereaders with a high-quality, topical mosaic of how to find capital appreciation ina sustainable manner.’Mary Jane McQuillen, Director, Socially Aware Investment, ClearBridgeAdvisors, a unit of Legg Mason

‘An excellent volume that puts sustainable investing front and centre in thedebates about building a more equitable global economy and providing retire-ment security for working people.’Michael Musuraca, Designated Trustee, NY City Employees Retirement System

‘Krosinsky and Robins have captured an inflection point in the history of invest-ment. We have truly moved from the socially responsible investment movementof the ‘60s to issues of sustainability. This is good for both society and theinvestor. Krosinsky and Robins have assembled a tremendous cast of authors todiscuss the forefront of this movement. The result is a great book on the currentand future state of sustainable investing.’Donald H. Schepers, Associate Director, Robert Zicklin Center for CorporateIntegrity, Baruch College, Zicklin School of Business

‘Sustainable Investing succeeds in its goal of portraying the current generationalshift in what has been a long-term effort to recast global capital markets and toachieve reliable risk-adjusted financial returns in the 21st century through theincorporation of environmental, social and corporate governance factors. Thesweep of its view is comprehensive, from the effort of critical self-knowledge inPart I, through the well-reasoned advocacy and predictions in Part IV and theeditors’ concluding thoughts.

This is the book I now will recommend to quench the increasing thirst ofmy mainstream colleagues for an understanding of this important phenomenon.I will recommend it as well to the younger generation as a source providing bothhistorical context and the emerging requirements for the practice of the subtleart and science of securities and investment analysis.’Anthony Ginsberg, Ginsberg Consulting and Chair of Socially ResponsibleInvesting Committee, NY Society of Security Analysts

‘An extremely useful collection … on various aspects of this important subject.A collective thanks should go to all the contributors, many of whom are practi-tioners from the investment community. This volume goes a long way to sortingout the confusion among terms such as socially responsible investing (SRI),ethical investing, responsible investing and sustainable investing. Contributionsrun the gamut from background and contextual information regarding sustain-able investing, to arguments as to why sustainable investing has to dateperformed better than the market as a whole, as well as better than SRI investing.

The interested reader would be well advised to read this collection, whichprovides an excellent summary of the state of the art thinking on these topics.’James P. Hawley, Professor and Co-director, Elfenworks Center for the Study ofFiduciary Capitalism, Saint Mary’s College of California

‘From sin stocks to cleantech, ESG to GHGs, portfolio tilt to the prudent manrule, Krosinsky and Robins guide the reader through a rapidly shifting landscapeof risk and opportunity. Essential reading, whether you are an investor, a CEOor simply someone wanting to enjoy both a pension and a world fit for futurelife.’John Elkington, co-founder of ENDS, SustainAbility and Volans, and co-authorof The Power of Unreasonable People.

‘A significant contribution to a rapidly growing field; the editors have brought tothe public important themes and thought-provoking arguments on topics thatwill dominate the 21st century. This is a must-read book for practitioners andinvestment analysts alike.’Gordon L. Clark, Oxford University

‘As the roles of business and the capital markets shift to directly address globalchallenges, practitioners can no longer ignore the growing momentum insustainable investing. This book fills an important gap, pulling together the bestthinking from contemporary experts. An excellent overview of past notions,current best practice and future trends.’Cheryl Hicks, World Business Council for Sustainable Development

‘Krosinsky and Robins have managed to assemble a unified publication thatbrings to light the financial innovation occurring on a massive scale. This bookputs forth an image of the world where capital markets have the potential toprovide solutions to our most pressing environmental problems.’Bryan Garcia, Yale University

‘Sustainable investing is vital for the future of our planet. This book richlydeserves to be read by everyone in the investment community – and manybeyond.’Rob Lake, APG Investments, The Netherlands