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Financial Planning > Charitable Giving > SRI Impact Investing

Investing with Standards

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Disasters like BP’s oil spill last year and Japan’s nuclear crisis have increased the public’s awareness about investing in companies that adhere to certain ethical, environmental and moral standards.

Today, there’s approximately $100 billion in mutual funds that use socially responsible investing (SRI) strategies. Part of this includes ETFs linked to indexes that screen for companies committed to certain religious values, environmental standards, social ethics and corporate governance.

“Sustainable investing” is an offshoot of traditional SRI. The strategy involves selecting companies that aren’t just socially acceptable — but ones that are responsive to employees, customers and communities. According to theory, this should create more loyalty and higher long-term profitability.

Joe Keefe, president and CEO of Pax World Investments, spoke with Research about SRI and sustainable investing and where those fields are heading. Keefe was nominated to the “100 Most Influential People in Business Ethics” in 2008 by Ethisphere, a New York-based international think-tank dedicated to best practices in business ethics.

How do you define socially responsible investing (SRI)?

We don’t really use that terminology anymore at Pax World. We refer to our investment approach as sustainable investing, by which we mean the full integration of environmental, social and governance (ESG) factors into investment analysis and decision making.

How is “sustainable investing” different from SRI?

SRI traditionally defined itself in terms of investing with “values,” often religious in origin, typically through the use of exclusionary screens — shunning alcohol, gambling, tobacco, firearms, usury for the Muslim investor, contraceptives for the Catholic investor, and so on. This exclusionary approach meant that SRI historically became defined in the popular mind more in terms of what it didn’t invest in than what it did invest in.

Sustainable investing, by contrast, is a positive discipline that defines itself in terms of what it does invest in: companies with superior ESG or sustainability performance. Sustainable investing maintains that ESG criteria have financial materiality, and that taking them into account — not only through portfolio construction but also through proxy voting, shareholder engagement and related strategies — is a smarter way to invest over the long term. I don’t consider sustainable investing an alternative investment strategy but rather a better investment strategy.

Many SRI funds got caught holding BP stock just as its Gulf of Mexico oil spill turned out to be an environmental disaster. What changes have occurred in the processes behind SRI funds to avoid these kinds of situations?

In fact, prior to the Gulf oil spill Pax had placed BP on a “watch” list and we were just concluding a full review of the company at the time of the spill. Why? Because of a series of safety issues (and resulting OSHA fines) that our research team determined warranted a full review. As it turned out, we didn’t happen to get out [of] the stock before the disaster occurred but we were in the process of doing so precisely because our investment approach — unlike most traditional investment approaches — actually looks at issues such as workplace safety, OSHA violations and the like. It doesn’t guarantee that we will never be invested in any company that ever has a controversy but it does help to mitigate risk and it does help us uncover issues and potential liabilities that other investment approaches will miss if they choose to ignore ESG issues. Is it perfect? No. Is it better? Yes.

SRI has long carried the stigma of being good for the environment and for society, but not a very profitable way to invest. Is that true?

No, it’s an old canard that’s not true at all once you actually look at the evidence. But the negative or exclusionary approach was partly responsible for the skeptical reception that SRI received in mainstream financial circles, as the notion that you could deliver market performance by shrinking the investment universe — for non-financial reasons — was considered counterintuitive. Moreover, the strongest performance case that SRI made in the old days was that you could invest with your values without sacrificing performance — again, a negative formulation.

So, even though the numbers suggest otherwise, it’s not totally surprising that SRI was misunderstood and plagued by this myth of underperformance — it was partly a result of the way SRI defined and positioned itself. Unlike SRI, which made the case that one needn’t sacrifice performance in order to invest with their values, sustainable investing makes the case that integrating ESG analysis can be a strategy for reducing risk and attaining outperformance.

Do you think corporate governance has improved since the financial crisis?

Perhaps only at the margins, and then only because of investor pressure and/or regulatory action (e.g., “say on pay”). Our largest financial institutions that were bailed out by taxpayers have become even larger, and more profitable, and I fear emboldened once again to take on more risk. The problem of moral hazard has perhaps become worse. And the special interests and their allies in Congress, led as always by the Chamber of Commerce, are again preaching deregulation and seem determined to undo or render ineffective the Dodd-Frank financial reforms.

Are ESG Shares to be used as a core portfolio strategy or in a complimentary or satellite role?

The first two ETFs in our ESG Shares series — the Pax MSCI North America ESG Index ETF (NASI) and the Pax MSCI EAFE ESG Index ETF (EAPS) — which are based on broad-market sustainability indexes, are essentially index funds that can serve as core holdings for investors looking for broad diversification across global developed markets.

The Pax FTSE Environmental Technologies ET50 Index ETF (ETFY) is based on a global environmental or clean technology index. Given the nuclear issues in Japan, this seems like an investment area that could get a boost. Can you talk about that?

We may in fact launch our third ETF based on FTSE’s Environmental Opportunities 100 Index rather than the ET50; it is still in the planning stages.
In any event, we believe clean technologies broadly defined — not only alternative energy but energy efficiency, water, pollution control, waste and resource management, etc., what are sometimes called “environmental markets” — will have a very favorable growth trajectory in the years ahead, for all the obvious reasons: climate change; global population growth coupled with rapid GDP growth in emerging markets and the concomitant increased demand for and pressure on limited resources; the need for greater energy and resource efficiency; the inevitable long-term increase in the price of oil, and so forth. We believe a global clean tech ETF is an important component in an ETF family like ESG Shares, which strives to provide investors with broad diversification across ESG themes and markets.


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