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Sustainable Finance: A review of the impact of Responsible Investment (RI) practices on the environment
Report to DEFRA by RiskMetrics Sustainability Solutions Group
July 2009
www.defra.gov.uk
Department for Environment, Food and Rural AffairsNobel House17 Smith SquareLondon SW1P 3JRTelephone 020 7238 6000Website: www.defra.gov.uk
© Crown copyright 2009Copyright in the typographical arrangement and design rests with the Crown.
This publication (excluding the royal arms and departmental logos) may be re-used free of charge in any format or medium provided that it is re-used accurately and not used in a misleading context. The material must be acknowledged as crown copyright and the title of the publication specified.
Information about this publication and further copies are available from:
DefraArea 5CErgon HouseHorseferry RoadLondonSW1P 2AL
Tel: 0207 238 1650
Email: [email protected]
This document is available on the Defra website:
http://defraweb/environment/business/scp/evidence/theme4/sustain-business0708.htm
Published by the Department for Environment, Food and Rural Affairs
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Table of ContentsChapters
EXECUTIVE SUMMARY............................................................................................................................................... 5
1. INTRODUCTION....................................................................................................................................... 13
1.1 CONCEPTUAL FRAMEWORK...........................................................................................................................141.2 OBJECTIVES OF STUDY..........................................................................................................................................171.3 METHODOLOGY..................................................................................................................................................18
2. ENVIRONMENTAL INVESTING STRATEGIES...............................................................................................20
2.1 WHAT IS RESPONSIBLE INVESTING?.........................................................................................................................202.2 RI TECHNIQUES AND THEIR INFLUENCE ON CORPORATE BEHAVIOUR...............................................................................222.3 PERFORMANCE OF ENVIRONMENTAL INVESTING STRATEGIES........................................................................................32
3. LITERATURE REVIEW OF ENVIRONMENTAL EFFICACY IN INVESTMENTS....................................................36
3.1 OVERALL FINDINGS..............................................................................................................................................363.2 RI AND ENVIRONMENTAL PERFORMANCE.................................................................................................................373.3 APPROACHES TO MEASURING ENVIRONMENTAL PERFORMANCE....................................................................................423.4 CONCLUSIONS.....................................................................................................................................................44
4. SURVEY OF FUNDS WITH ENVIRONMENTAL INVESTMENT ELEMENT........................................................46
4.1 SURVEY METHODOLOGY........................................................................................................................................464.2 OVERALL FINDINGS..............................................................................................................................................474.3 CONCLUSIONS.....................................................................................................................................................57
5. BEST PRACTICES IN MEASURING ENVIRONMENTAL PERFORMANCE.........................................................60
5.1 SELECTED CASE STUDIES........................................................................................................................................61
6. TRENDS IMPACTING INVESTOR STRATEGIES............................................................................................70
6.1 GLOBAL INITIATIVES.............................................................................................................................................706.2 RI INDICES.........................................................................................................................................................766.3 COMPANY LEVEL TRENDS......................................................................................................................................77
7. CONCLUSIONS......................................................................................................................................... 79
8. REFERENCES............................................................................................................................................ 81
9. ANNEX.................................................................................................................................................... 85
A. SUMMARY OF LITERATURE REVIEW.........................................................................................................................86B. LIST OF FUNDS CONTACTED IN SURVEY....................................................................................................................93C. SURVEY QUESTIONNAIRE......................................................................................................................................96D. EcoValue 21™ Rating Methodology.............................................................................................................102
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Figures
FIGURE 1 SUSTAINABLE ENERGY FUNDS BY TYPE AND ASSET CLASS........................................................................21
FIGURE 2 ORIGIN OF STUDIES IN LITERATURE REVIEW............................................................................................37
FIGURE 3 NUMBER OF CORRELATIONS BETWEEN RI AND ENVIRONMENTAL PERFORMANCE...................................38
FIGURE 4 BASIC FUND INFO.................................................................................................................................... 48
FIGURE 5 ENVIRONMENTAL INVESTMENT STRATEGY OF FUNDS.............................................................................49
FIGURE 6 ENVIRONMENTAL OBJECTIVES OF INVESTMENT STRATEGIES...................................................................50
FIGURE 7 ENVIRONMENTAL TARGETS..................................................................................................................... 51
FIGURE 8 RI TECHNIQUES USED IN INVESTMENT STRATEGIES..................................................................................52
FIGURE 9 SOURCES OF ENVIRONMENTAL INFORMATION ON INVESTEE COMPANIES...............................................54
FIGURE 10 NUMBER OF FUNDS MEASURING ENVIRONMENTAL IMPACTS...........................................................55
FIGURE 11 PROGRESS OF RESPONDENTS IN MEETING ENVIRONMENTAL TARGETS.............................................56
FIGURE 12 SUMMARY OF BEST PRACTICES OF SELECTED FUNDS.........................................................................60
FIGURE 13 ANALYSIS OF EFFECTIVENESS OF RI VOTING POLICY AT MORLEY........................................................67
FIGURE 14 GLOBAL REPORTING INITIATIVE - ENVIRONMENTAL PERFORMANCE INDICATORS FOR THE FINANCIAL SERVICES SECTOR..................................................................................................................................................... 73
FIGURE 15 PERCENTAGE OF COMPANIES IN FTSE EUROTOP 300 WITH ABOVE AVERAGE ECOVALUE 21 RATINGS 78
FIGURE 16 SCHEMATIC OF MAJOR ECOVALUE 21TM ANALYSIS FACTORS..........................................................103
Figure 17 RiskMetrics’s Rating Scale...................................................................................................................... 105
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Executive Summary
Defra commissioned RiskMetrics to look at the impact of responsible investment practices
on the environment and how the environmental performance of environmentally-focussed
investment strategies is currently assessed.
Key Findings
RiskMetrics conducted a literature review which highlighted that there is limited
research into the link between Responsible Investment and the environmental
performance of portfolio companies.
The literature review concluded that there was a positive correlation between
responsible investment and improved environmental performance although the
studies provided rather weak evidence and the approaches to measuring
environmental performance differed greatly. Very few studies could provide empirical
evidence to support their conclusions and instead relied on qualitative indicators.
RiskMetrics conducted an online survey to identify the extent to which environmental
investment strategies seek to improve the environmental performance of investee
companies, and if so, how these improvements are measured. Overall, the results
indicate that RI and environment-themed funds are not measuring the environmental
performance of their investment strategies.
40% of respondents to the survey measured the environmental impact of their funds
in some manner, although this was mainly in a qualitative manner looking at process
outcomes; 25% of respondents had measurable targets to meet their environmental
objectives; and 15% of respondents reported on their progress on meeting
environmental objectives in the survey.
Reporting on environmental performance of funds is typically qualitative in nature. It
is therefore very difficult to establish an accurate and verifiable measure of a
company’s progress over time.
5
Based on a company-level analysis of environmental performance over time, more
FTSE 300 Eurotop companies had better environmental performance in 2008
(63.6%) than in 2003 (50.2%).
Introduction and objectives
Responsible Investment is understood as integration of ESG issues into investment
process in order to enhance investment assessment, while traditional socially responsible
investing (SRI) consists of “elaborated screening strategies systematically impacting
portfolio construction and often implying a values-based approach. In this report,
“Responsible Investments” or “Responsible Investing” (RI) is used throughout, as it
composed of broader investment strategies rather than screening.
In the past decade, SRI has seen tremendous growth in the UK. There are now more than
80 SRI funds available with an estimated total fund value of GBP 8.9 billion; a decade ago
there were just a dozen with a value of GBP 2.2 billion. ‘Green funds’, or RI funds with an
environmental focus, in particular have gained greater attention recently. In 2007 alone, at
least 10 funds were launched in the UK focusing on an environmental issue such as climate
change or clean technology.
Most of the focus of RI and environmental investing has been on enhancing returns or
developing new investment ideas and products. However, very little attention has been
given to the end goal of having a positive impact on the physical environment. In order to fill
this gap, Defra set out to analyse the potential for investment strategies to deliver enhanced
environmental outcomes and of the effectiveness of different environmental investing
strategies.
As a first step to answering this question, Defra has commissioned RiskMetrics to conduct
a study to understand how the environmental performance of environmentally-focused
investment strategies is currently assessed.
The research consisted of both primary and secondary research over six months.
Preliminary data collection began with a comprehensive literature review on the link
6
between RI techniques and environmental performance of investment strategies and
approaches to measuring environmental performance. This was followed by a survey of
environmental-focused funds. This was conducted to gather additional data and information
on the current practices of fund managers. Finally, the research evaluated key RI initiatives
set up by investors, intergovernmental organisations and civil society, and industry to
gather information about how they assess environmental performance.
Literature review
We have carried out a literature review of the most relevant studies published over the past
fifteen years, during the period 1993 to 2008. The literature review was global in scope, and
looked at studies published by academia, think tanks, industries and consultancies.
We identified only 23 studies that discuss environmental performance of investment
strategies in some manner. A total of 18 studies evaluated the link between RI and
environmental performance either directly or indirectly. Nine of these studies focused
explicitly on environmental outcomes, while the remaining studies discussed environmental
impacts together with social and governance issues. The studies were roughly split
between quantitative and qualitative analyses. There were 14 positive correlations, 2
neutral relationships and 2 negative correlations. This means that in 78% (14 out 18) of
cases, there is evidence from the studies to suggest that green investments are linked to
good environmental performance. These studies do not distinguish between environmental
improvement of the investee companies that are due to RI and those that are due to
adopting a stock selection approach that favours investee companies that perform better
environmentally. However the studies present rather weak evidence and the small sample
of studies makes it difficult to generalize.
While 14 out of 18 studies concluded that there was a positive link between RI and
environmental performance of portfolio companies, only three studies provided empirical
evidence that this was the case (Koellner, Holden and TruCost). In addition, the studies
differed greatly in how they measured environmental performance. Many studies looked at
7
the processes of the fund managers with very few reports explicitly citing specific
environmental outcomes.
In sum, very little research has been carried out to examine the link between RI and
environmental performance. In addition, the overwhelming majority of indicators are of a
purely qualitative nature. Consequently, coherent quantitative time series of RI data are still
scarce, and it is therefore very difficult to establish an accurate and verifiable measure of a
company’s progress over time.
Survey of funds
In order to assess actual practices in fund management, RiskMetrics conducted an on-line
survey of RI funds with an environmental component. The aim of the survey was to identify
the extent to which environmental investment practices seek to improve the environmental
performance of portfolio companies, and if so, how these improvements are measured.
Reportedly there are over 80 RI funds in the UK but the survey specifically targeted RI
funds that have environmental objectives stated in their publicly available literature. The
sample universe focused primarily on UK funds, but also included some European and US
funds. In total 55 funds were contacted to participate in the survey, and 20 funds responded
to the survey (36.4% response rate).
Nine (45%) of the respondents are RI funds with integrated environmental objectives and
11 (55%) funds are primarily focused on the environment. Most funds have multiple
environmental objectives covering a wide range of issues. The funds also employ an array
of investment strategies to achieve their environmental objectives.
Overall, the survey results indicate that RI and environment-themed funds are not
measuring the environmental impacts of their investment strategies. The environmental
outcomes of the investment strategy do not appear to be considered a priority. For
instance, only 5 funds (25%) have measurable targets for achieving their stated
environmental objectives, and only 1 of these funds has targets that are quantitative. Eight
8
(40%) respondents monitor the environmental impact of their fund in some manner, but
mainly in a qualitative manner looking at process outcomes.
Only 3 (15%) funds reported their progress on meeting environmental objectives in the
survey. No fund releases a stand-alone report discussing its environmental performance;
any environmental impact reporting is integrated into quarterly updates, annual reports or
newsletters.
The survey results provide some evidence to suggest that financial performance, not
environmental performance, is the key measure against which RI and environmentally-
focused funds benchmark their success. Moreover, while all the funds have environmental
objectives, some funds responded that they are not marketed as environmental funds, and
therefore do not have environmental targets. Some funds also cited their fiduciary
responsibility limiting the ability for them to pursue environmental targets.
Furthermore, it does not seem that particular types of funds are performing better in
environmental terms or are more likely to measure environmental impacts than others.
However, it does not seem that the pure-play funds or private equity funds monitor
environmental performance. This may reflect the fact that these thematic funds
automatically assume that their funds will have positive environmental outcomes since they
focus exclusively on companies that contribute to environmental solutions.
The qualitative responses in the survey also highlighted several issues about measuring the
environmental performance of funds. Several respondents mentioned that it is difficult to
pinpoint what to measure and to develop an appropriate measurement methodology. Some
respondents questioned the validity of measuring environmental impact at a fund level
versus an institutional level. Some respondents also have reservations about the correlation
between environmental investment strategies and positive environmental outcomes at
companies.
Another issue that was raised in survey responses was that measuring environmental
performance was not relevant to some of the funds that are passively managed, particularly
tracker funds, or even thematic funds. This implies that any policies developed around 9
measuring environmental performance at the fund level must be nuanced enough to
encompass a variety of fund types and investment strategies.
Best practices
Based on our survey, we identified five institutions to highlight innovative practices in
measuring environmental performance and improving environmental outcomes. They are
Banco Fonder, the Environment Agency, Jupiter, Morley and Quadris Environmental
Investments. Each of the institutions incorporates environmental objectives slightly
differently in their fund management. They utilise a wide range of investment strategies and
all engage directly with portfolio companies to varying degrees on environmental issues.
Four funds review whether companies have changed their behaviour after engagement on
environmental issues over time. Other methods of measuring environmental impacts
include an independent forestry audit, review of the voting record and review of fund
management practices. The Environment Agency Pension Fund sets a quantitative target
that the environmental footprint of its combined actively managed equity portfolios is less
than the environmental footprint of the MSCI All World Index.
It is important to note that while these institutions do measure environmental performance
in some manner, none would claim that positive environmental outcomes are achieved
solely as a result of these institutions engaging with or investing in companies. In fact, all of
these institutions acknowledge that positive change with regard to environmental
performance takes time and their investment strategies are only one element in driving
change. Even so, these case studies provide good examples of innovative ways to
measure environmental impact of funds that could potentially be replicated by other funds.
Other drivers impacting investor and company behaviour
In the past decade, many global initiatives have been launched which have influenced
major financial institutions to become more socially and environmentally responsible in their
investment strategies and processes. These initiatives are currently influencing investor
thinking, policies and decision-making and will continue to do so in the future. In fact
10
several large institutional investors around the world are already referring to many of these
initiatives in their annual reports and policy documents.
These global initiatives can be divided into three categories: Investor initiatives,
Intergovernmental & civil initiatives and industry initiatives. All of these initiatives have
undoubtedly raised awareness about environmentally responsible behaviour, among both
companies and investors. However, it would be difficult to assess how much improvement
in environmental performance in companies can be attributed to these initiatives.
In addition, RI indices are also included as one of the drivers on responsible investment and
improved environmental performance of investee companies.
Collective impact of RI initiatives and investment techniques
To determine whether the growing number of RI initiatives and investment techniques
appears to be contributing to improved company environmental performance over time,
RiskMetrics analysed environmental performance at the company level. Using data from
RiskMetrics’s EcoValue 21 company ratings as a proxy for environmental performance for
the FTSE Eurotop 300 companies, we analysed changes in rating scores over a five-year
period from 2003 – 2008. The results show an improvement. This means that more
companies today have better environmental performance than five years ago.
These results, while generally positive, are inconclusive in terms of understanding the
impact either of environmental investing strategies or of the various initiatives referred to in
this report. It is difficult to say with certainty that companies that are gradually improving
their environmental ratings over time are the ones that are targeted in the environmental
investment strategies or by the initiatives.
Conclusions
The evidence from the literature review and fund manager survey reveals that very little
research has been conducted on this subject, and only a handful of institutions are actually
measuring the environmental efficacy of their funds. The majority of funds are focusing on
11
incorporating environmental targets into the portfolio selection process rather than focusing
on the environmental outcome of the investment strategy.
For those institutions measuring some aspect of environmental outcomes, conducting a
carbon audit of the portfolio at fund level or tracking engagement activities is the most
common practice. The majority of the environmental targets are thus based on improving
company behaviour in terms of environmental policies, disclosure and management
systems. Very few funds and institutions have a target to actually reduce their impact on the
physical environment.
In addition, reporting on environmental performance is typically qualitative in nature.
Consequently, coherent quantitative time series of RI data are still scarce, and it is
therefore very difficult to establish an accurate and verifiable measure of a company’s
progress over time
The metrics used by institutions also varied widely. This ranges from portfolio company
adoption of environmental management systems, to reduction and prevention of
environmental damage and increases in environmentally-focused business activities.
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1. Introduction
Responsible Investing or Investment (RI) has evolved from the traditional socially
responsible investing (SRI) that consists of ethical exclusions as well as different types of
positive screens, to more broad integration of ESG issues to enhance investment
assessment.
In the past decade, RI has seen tremendous growth in the UK. There are now more than 80
RI funds available with an estimated total fund value of GBP 8.9 billion; a decade ago there
were just a dozen with a value of GBP 2.2 billion1. And according to a recent Mori poll, more
than two-thirds of investors say they would be interested in putting their money into
sustainable and responsible investment.
‘Green funds’, or RI funds with an environmental focus, in particular have gained greater
attention recently. In 2007 alone, at least 10 funds have been launched in the UK focusing
on an environmental issue such as climate change or clean technology. This trend is likely
to grow as consumer demands, tightening government policies and rising energy prices
drive companies to consider more environmentally friendly options. The trend for green
investments is also spreading to emerging markets.
Most of the focus of RI and environmental investing has been on enhancing returns or
developing new investment ideas and products. However, very little attention has been
given to the end goal of having a positive impact on the physical environment. As one fund
manager in Europe has noted2,
In order to fill this gap, Defra set out to analyse the potential for investment strategies to
deliver enhanced environmental outcomes and of the effectiveness of different
environmental investing strategies in delivering such outcomes. Defra has commissioned
RiskMetrics Group (RiskMetrics) to evaluate to what extent an environmental objective is
part of an environmental investing strategy, and if it is part of an environmental investing
strategy, how are these environmental goals measured, if at all?
1 EIRIS website, http://www.eiris.org/2 Butz and Pictet 2008
13
1.1 CONCEPTUAL FRAMEWORK
An attempt to understand the extent to which investor strategies have an impact on the
environment is a complex undertaking. There are many different kinds of investors, each
with different approaches. There are also many other stakeholders whose activities will
influence company behaviour, from consumers and employees to government and
regulators. Furthermore, environmental impacts themselves may be hard to define and
measure and attributing a particular type of investment strategy to a change in one
company management practice may be challenging. Below we discuss the context in which
this report needs to be read.
Process versus outcome approach
This survey seeks to ask whether environmental impacts can be evaluated or indeed simply
inferred, purely in terms of stock selection criteria and activist programmes by investors, or
whether investors are going beyond this and attempting to measure the physical
environmental outcomes of their stock selection policies and activities.
By stock selection criteria we are referring to investors choosing to allocate funds to those
companies deemed to be pursuing more environmentally friendly policies and implementing
environmental initiatives and operational performance improvements, in terms of new
environmental products, services and solutions, or eco-efficiencies. By activist programmes
we are referring primarily to engagement activities or voting policies, designed to produce
environmentally favourable results by way of changes in corporate behaviour. A number of
UK investors have adopted an engagement approach and we discuss engagement later on
in this report.
Investors may believe that their stock selection policies and engagement or voting activities
will in themselves be likely to influence corporate behaviour and thus yield environmental
benefits. But we are also putting forward the idea that investors could, in addition, develop
mechanisms that would go beyond stock selection criteria and engagement / voting
activities, in order to ascertain whether or not such approaches deliver tangible
14
environmental impacts, for example by way of reduced resource use by the companies in
which they have invested.
In short, the report will therefore need to examine whether the investor focus is currently on
looking at the processes or the outcomes of their environmental investment strategies, or
both.
A process-oriented approach can look at the research methodology and selection rules for
building a fund portfolio as well as efforts to influence corporate management. Some
questions to be considered in this report are:
How might the allocation of capital influence company behaviour?
What role can engagement play in changing company behaviour?
Do voting and the lodging of specific shareholder resolutions lead to improved
environmental performance? What is the relative importance of a fund or fund
manager and how might the power of the investor determine the extent to
which companies respond to investor action?
Our working hypothesis is that in most cases, institutional investors have focused on
relating their environmental performance in terms of processes in their portfolio selection or
on dialogue with corporate management. The survey results in Chapter 4 indicate that this
is the case, and the reasons for a focus on process impacts rather than outcomes may be
the result of a number of potentially constraining factors, discussed in more detail below.
An outcome-oriented approach looks at the impact that the companies in the fund portfolio
have on the environment and attempts to attribute that impact to the activities of the fund
itself – a difficult task in itself. There are many influences on corporate behaviour, for
example, customer or consumer buying trends or government policies on the environment.
Therefore the impact of investor actions on corporate behaviour and subsequent
environmental impacts should be viewed within the context of a whole range of drivers of
change.
15
It should also be borne in mind that the RI market represents a relatively small part of the
overall investment arena when viewed in terms of assets under management. So
responsible investors may be limited when it comes to changing corporate behaviour and
helping to create new paradigm shifts, whereby companies pay heed to more sustainable
business models and take a longer term view of their markets than the current short term
focus advocated historically by many ‘mainstream’ investors.
There is a further difficulty in assessing environmental outcomes. It is hard to point to
particular steps companies may have undertaken to improve environmental performance,
and their corresponding environmental outcomes. A fundamental question that can be
asked is what is the relationship between corporate management practices (e.g. ISO14001
certification, corporate environmental reporting) and environmental performance (as
measured in terms of emissions, resource consumption, etc), i.e. does one particular
process improvement lead to a known and measurable environmental performance
outcome?
Given the range of actors that may influence company behaviour, and the imprecise
linkages between one type of company management practice and a corresponding
environmental outcome, it may only be possible for investors to make some very general
assumptions about the effectiveness of their actions.
Demonstrating causality
Accepting, then, that there are real challenges in demonstrating causality, it would be useful
to systematically distinguish between those investor activities where such a link is made
with relative confidence (e.g. pure-play investments, offsetting activities) and those with
more uncertainty to them (e.g. stakeholder activism, engagement). This might be a
sensitive issue for some in the industry, but equally it may help to explain why many
investors may not yet have developed fully fledged measurement systems.
It does seem to be true that the subject of environmental performance of RI and
environmental investment strategies have received much less attention. Looking at publicly
available information from fund managers, there is very little reported on what impact their
16
funds have on the environment. In their report ‘Responsible Investment 2008’, RImetrics
evaluated fund managers from around the world managers with over USD 12 trillion (GBP
6.1 trillion) of assets under management, comparing each manager to a series of Best
Practice Principles that measured 22 aspects of RI competency. They found that even for
the managers who engage with companies, a "large proportion" of them do so to get ESG
information, with many less engaging to change companies' behaviours. Importantly, a
majority of managers do not monitor or track the costs of engagements with companies,
with 30% not keeping any record of engagement activities at all.
One reason for this lack of data on environmental performance is the ambiguity in the
process of measuring environmental performance of funds. At the most basic level, there is
a debate as to whether performance should be measured at the institutional level or the
fund level. Often, institutional investors have environmental policies that span their fund
range and it becomes difficult to attribute institution-wide outcomes to specific funds. On
the other hand, particular funds may use a targeted investment strategy with environmental
objectives which would elicit a potentially different environmental outcome from the rest of
the funds.
The following chapter provides a background on environmental investing strategies.
Chapter 3 presents the results of a literature review on the environmental efficacy of
investment strategies. Chapter 4 presents the results of a survey to fund managers about
their approaches to measuring environmental impacts, and Chapter 5 highlights the best
practices of fund managers in the survey. Chapter 6 evaluates trends impacting
environmental outcomes of investor strategies and Chapter 7 is the conclusion of the
overall report.
1.2 Objectives of study
While the financial performance of socially responsible investing has been discussed
widely, there has been little discussion on the actual social and environmental impact these
investment funds can bring. In other words: Do environmental investment strategies have
positive indirect impacts on the environment?
17
As a first step to answering this question, Defra has commissioned a study to understand
how the environmental performance of environmentally-focused investment strategies is
currently assessed. The results of this study will help inform a broader programme to
determine the role that investors can play in promoting sustainable development.
This study seeks to answer:
How do environmental investment strategies measure environmental efficacy?
In order to answer the research question, this study will include the following:
An analysis of how the environmental performance of investment strategies is
currently assessed
An analysis of the investment techniques available, where and how these are
applied, and what approaches, methodologies and metrics are used to assess these
techniques
An analysis of how the environmental performance of current initiatives set up
by industry or civil society is assessed
A review of existing evidence and any newly available empirical data about
how effective these environmental strategies are in driving social and environmental
improvement
The scope of the analysis includes institutional and retail investments across a wide range
of investment categories.
1.3 Methodology
The research consisted of both primary and secondary research over six months.
Preliminary data collection began with a comprehensive literature review on the link
between RI techniques and environmental performance of investment strategies and
approaches to measuring environmental performance. The research reviewed academic
papers, industry reports and civil society reports.
18
Since an initial literature review yielded limited evidence, a survey of environmental-focused
funds was conducted to gather additional data and information on the current practices of
fund managers. The survey consisted of an online questionnaire carried out over a two
month period in June and July 2008. The survey targeted primarily UK funds that have
stated elements of environmental objectives in their investment policies, but also included
some European and US funds. The sample consisted of 55 funds and a total of 20 funds
participated in the survey (36.4% response rate).
Finally, the research evaluated key initiatives set up by investors, industry and civil society
to gather information about how they assess environmental performance. This consisted of
desk-based research and was supplemented by a company-level analysis of environmental
performance over time. This analysis was based on RiskMetrics’s EcoValue 21 ratings of
companies in the FTSE Eurotop 300 from 2003 to 2008.
19
2. Environmental Investing StrategiesThis section provides a description of socially responsible investing and environmental
investment strategies. It also introduces the key issues around the environmental
performance debate.
2.1 What is responsible investing?
Traditionally, environmental criteria were incorporated into broader RI strategies along with
social, ethical and governance issues. Investment managers with RI funds and mandates
overlay a qualitative, and increasingly a quantitative analysis, of corporate environmental
and social policies, practices, and performance onto traditional financial analysis of profit
potential. It is a process of identifying and investing in companies that meet certain
standards of corporate social responsibility.
During the past decade there has been a significant increase in the number of investors
who have adopted RI strategies and are holding companies more and more accountable for
their social and environmental practices. Investors in mutual funds, pension funds, and
other portfolios are also becoming active in shareholder advocacy and engagement in
record numbers, by filing resolutions or engaging in dialogue to pressure companies to
become more responsible on a particular social, environmental, or corporate governance
issue.
There are now more than 80 RI funds available in the UK with an estimated total fund value
of GBP 8.9 billion representing approximately 2% of all assets under management in the
UK3; a decade ago there were just a dozen with a value of GBP 2.2 billion4.
In recent years, the public's broader awareness of environmental issues such as global
warming and its impacts have supported demand for the creation of new RI investment
products with a specific environmental focus. Such environmental funds differ from RI funds
in that they apply only an environmental screen to the companies in which they invest.
Several mainstream financial institutions - Deutsche Bank, F&C, HSBC, Schroders and 3 As of December 2007; Total UK assets under management = GBP 468 billion (source: UK Investment Management Association)4 UKSIF
20
Virgin Money launched climate funds within the past year. In addition, funds that invest
solely in companies involved in developing environmental solutions such as renewable
energy sources and clean technology are on the rise.
In 2008, the number of funds seeking sustainable energy opportunities has risen to 441,
with an estimated total of USD 67.4 billion (GBP 42.2 billion) under management, with 62%
of these funds aimed at buying shares in publicly listed companies5. This is a four-fold
increase over the same period in the previous year. This rapid capital build up was due to a
record number of new clean energy public equity fund launches in 2007 – 17, compared to
just five in 2006. Several of these were from mainstream fund managers launching ‘climate
change’ funds as mentioned above.
FIGURE 1Sustainable energy funds by type and asset class
Source: New Energy Finance; Values in brackets refer to number of funds; Figures as of March 2008 from UNEP Report: Global Trends In Sustainable Energy Investment
2008; Average exchange rate for March 2008: 1 USD = 0.49992 GBP
Investment capital flowing into renewable energy will only continue to increase as more
investors recognise the scale of the climate change problem and future energy investment
needs. The International Energy Agency estimates that USD 17 trillion (GBP 10.5 trillion) of
investment6 will be required in the energy sector from now until 2030 which should prompt
investors to move more capital into this area.
5 As of March 2008; based on figures from UNEP Report: Global Trends In Sustainable Energy Investment 20086 UNEPFI 2008
21
2.2 RI techniques and their influence on corporate behaviour
These techniques are growing exponentially in terms of the numbers of individual and
institutional investors participating, in the amount of invested money involved, and, most
importantly, in the movement's ability to persuade corporations to develop a sense of
corporate social responsibility in the conduct of their businesses.
RI techniques
In the past, negative screening was the most basic and the most popular strategy of social
investing. Today, values-based avoidance screening continues to play an important role in
RI, but new screening issues have also emerged, and RI strategies continue to evolve.
There is growth in the number of RI funds, as well as in the diversity of screening
techniques. Shareholder advocates are also increasingly entering into direct dialogues with
companies, rather than filing resolutions. The following section describes the main
strategies used in RI today.
Screening
Screening is the practice of evaluating investment portfolios or mutual funds using social
and / or environmental criteria. Negative screening, sometimes called exclusion, consists of
barring investment in certain companies, economic sectors or even countries for ESG-
related reasons. There are limitations to using negative screening as a strategy on its own.
Negative screening, especially extensive screening, can potentially increase risk by altering
sector and geographic allocations within an investment universe. This could in turn affect a
portfolio's performance relative to its benchmark index. Nevertheless, negative screening
remains the most common initial strategy employed by investors entering into RI. Following
the definition, environmental funds that utilise negative screening techniques are
sometimes referred to as “Dark Green” funds and have strict ethical criteria to exclude
companies that challenge the environment, such as oil and gas companies. For example,
Friends Provident's Stewardship Fund, managed by F&C, does not invest in airlines
because it believes that the industry as a whole is not doing enough to tackle carbon
22
emissions. Many dark green funds also automatically exclude all companies involved in
tobacco, armaments, gambling, the fur trade and pornography.
RI investors also employ positive screening to select companies with positive attributes for
investment. The most popular form of positive screening is called ‘best-in-class’, where
stocks are selected within each sector of a given index, thereby retaining sector balance
within the investment universe. A less often used, but equally interesting form is pioneer
screening, where funds specialise in the best-performing companies against a specific
criterion, such as management of natural resources. Motivated by a desire to set standards
for, and improve, corporate social and environmental performance, social investors use
such positive screening techniques to identify companies with competitive advantages over
their peers, many of which may be intangible in nature. In contrast to “Dark Green” funds,
“Light Green” funds concentrate on selecting companies with positive environmental
attributes. These funds may invest in industries such as aviation and oil that would be
shunned by many of the stricter dark green funds. Within this category, funds can be
classified as an eco-efficiency or eco-pioneer fund7. An eco-efficiency fund utilises a ‘best-
in-class’ approach to invest in the companies within each sector that score highest when
rated on various environmental criteria. An eco-pioneer fund invests in innovative
companies that have business activities focused on environmental technologies and
services.
When either screening out heavy polluted companies or selecting environmentally friendly
ones, one should ask the question of how screening can influence corporate behaviour and
thus contribute to the goal of making a difference in terms of environmental improvement.
One of the mechanisms is based on the “Cost of Capital” argument. By channelling capital
away from “bad” companies (negative screening), it is said to lead to a decrease in the
share prices and an increase in the cost of capital; the opposite is true for positive
screening. However, if a fund owns only a small proportion of the shares in a company, a
divestment or investment is unlikely to have a significant price impact on the shares and
thus influence corporate behaviour change on the environment. Currently it is estimated
that responsible investment only represents 2% of global market values, which is
7 Adapted from Koellner 2005
23
considered negligible. Heinkel et al (2001) studied the effect of exclusion on a firm’s cost of
capital. It was concluded that the increase in cost will only be significant enough to force
change when the investor owns more than 20% of the market. Therefore the number of
investors that use screening methodologies would have to increase dramatically in order to
have an overall impact on the cost of capital of these companies and ultimately impose
changes on the way companies tackle environmental issues.
In addition, screening can influence corporate behaviour indirectly by impacting a
company’s reputation, awareness raising and identifying management quality. It is believed
that there are reputational impacts attached to being included or excluded from
sustainability standards, indices and benchmarks. For instance, in September 2008
Norwegian Government Pension Fund Global (NGPFG) whose current market value was
NOK 2,076 billion (approximately GBP 200.5 billion) as of 2009 Q1, sold all its Rio Tinto
stock that was worth more than NOK 4.8 billion (GBP 463.6 million) at the end of 2007. This
high profile divestment and exclusion by one of the largest sovereign wealth funds attracted
media attention and thus reputational damage to the company. In response to the
divestment, Rio Tinto wrote to The Norwegian Ministry of Finance outlining Rio Tinto's
Group wide approach to environmental performance, and providing specifics of the
environmental management processes at the Grasberg mine, which was the main subject
of the Norwegian fund’s decision8. Tesco, initially excluded from the FTSE4Good index in
2001, rectified its environmental policies to gain inclusion in the benchmark that tracks
performance of companies with “globally recognized corporate social responsibility
standards”. In 2004, research conducted by the University of Dundee found the Tesco case
"is not an isolated example" and that FTSE4Good's “Best-in-class” approach has "had a
clear impact on a significant subset of companies and their stakeholders"9.
The existence of screening raises the profile of the environmental agenda and supports
communities and regulators in their effort to foster corporate change to a more sustainable
business model.
8 http://www.riotinto.com/media/news_12469.asp9 http://www.guardian.co.uk/business/2008/feb/21/greenbusiness.ethicalliving
24
Management quality is arguably the most intangible asset to a company’s value10 and
company managers are rewarded if their companies are judged to have high quality
management. Considering sustainability issues within business risk and opportunity
assessment is seen as an indicator of high quality management, which incentivises
company managers to improve their corporate environmental performance.
Integrated Analysis
Integrated analysis is an investment style in which analysis of ESG issues contributes to
traditional financial analysis by identifying additional sources of risk and opportunity,
thereby contributing to better overall investment decision-making. It is based on the premise
that non-financial criteria can have an impact on the financial bottom line in the long-term.
Arguably there is a market failure within the traditional financial analyst community, that the
long-term value drivers of companies and sectors are often overlooked. Fund managers
that take on this approach see ESG issues as drivers of long term value, and therefore as a
way to outperform. This is based on their greater understanding of the long-term strategic
value drivers of firms, sectors and the economy.
Desirable environmental impacts by using ESG Integration can be achieved through
signalling. The signal can be from investors, ESG specialists or mainstream analysts and
fund managers. The key mechanism is that by integrating sustainability issues such as
environment issues across the board, it will send a signal to companies that the markets
take into account the financial and environmental materiality of these “non-traditional”
factors. By collecting, evaluating and monitoring the risks and opportunities of
environmental issues that companies face in conjunction to traditional financial valuation,
investors, ESG specialists, research analysts and fund managers create an effective
dialogue with companies on how companies should go about reducing their environmental
impacts and fostering positive change. In addition, the focus on company’s environmental
performance at mainstream level in turn forces companies to disclose and improve.
10 Pricewaterhouse Coopers (2005) “Reporting the Value of Acquired Intangible Assets.”
25
Fund managers that adopt the integration approach include Generation Investment
Management and Cazenove Capital Management. Colin le Duc, head of Research at
Generation, believes that “full integration of sustainability research into equity analysis
enables firms to consider such issues within the context of a company’s business
fundamentals. This integration increases the flow of material information into the investment
process and ensures that both financial and sustainability research is incorporated to more
accurately analyse the effect of sustainability issues on a company’s ability to generate
shareholder value”11.
Shareholder Advocacy and Engagement
Shareholder advocacy and engagement relate to responsible investors taking an active role
as owners of corporate stock. These efforts include dialoguing with companies on issues of
environmental concern, public campaigns as well as filing, co-filing, voting on shareholder
resolutions, and ultimately divestment. Proxy resolutions on environmental issues are
aimed at improving company policies and practices, addressing perceived shortcomings
and encouraging management to exercise good corporate citizenship towards the
environment while promoting long-term shareholder value and financial performance.
There are a number of rationales why responsible investors seek improvements in the
environmental performance of investee companies. Generally speaking, investors claim to
engage on ESG issues in order to increase the value of the companies with which they
engage, resulting in increased returns to their portfolios over the longer term. This is
because they justify their activities on the basis that these ESG issues are connected with
material risks or opportunities that may affect the portfolio, particularly over the longer term.
Another reason for shareholder engagement is that company managers are simply not fully
aware of all the risks and their incentives often are not in line with shareholders’ value. It is
believed that responsible investors can add value by enhancing ESG information flows to
company managers and raising awareness about issues of importance to a company’s long
term value.
11 http://www.generationim.com/media/pdf-environmental-finance-12-04.pdf
26
The term “Universal Ownership” provides a strong argument for investor involvement in
influencing corporate behaviour. A universal owner is often regarded as a large financial
institution such as a pension fund, which owns securities in a broad cross- section across
the economy. As they become larger and more diversified, a universal owner’s returns are
more closely linked to those of the economy as a whole rather than the returns of the
individual companies in its portfolio. As such, universal investors should adopt measures
that enhance the overall market performance by providing incentives for companies to
internalize all the externalities. Ultimately the universal investors have direct benefits in
improvements in corporate ESG performance.
Engagement with companies must be assertive and persistent to have effective results in
sending the message across to the company’s management and board. In 2008, F&C (full
name needed) raised ESG issues at over 900 companies (2007: 762) in 49 countries in
2008, including over 70 face-to-face meetings with board members. 30% of ESG issues
engaged with companies were environmental related including climate change, ecosystems
services and environmental management, while 40% of these engagements were
conducted in Europe. F&C recorded 429 cases (2007: 224) that a company improves its
policies, procedures or practices following engagement, 45% of which were on
environmental issues. For example, Royal Bank of Scotland established a Group
Environment Board with senior management representation to focus on product and service
innovation, environmental risk, employee engagement and group footprint management.
Following active engagement, Tesco adopted a new strategy to make “low-carbon” product
choices easier and more affordable for customers, including promotions and clear labelling.
Collaborative engagement is often considered an effective way to draw management’s
attention. Established in late 2006, the Principles for Responsible Investment (PRI)
Engagement Clearinghouse has been an important factor in facilitating collaborative
engagement. It is a forum where PRI signatories can post ideas and proposals for
collaboration with peers to seek changes in company behaviour and policies. In 2007
Morley Fund Management (now Aviva Investors) led a PRI collaborative engagement
focused on the reporting requirements of the UN Global Compact. A coalition of 20
investors representing approximately USD 2.13 trillion in assets wrote to the CEOs of 103
27
companies in more than 30 different countries to either congratulate them on their good
practice or ask them to improve their engagement with the Global Compact and their
reporting on progress. In total, 78 companies were identified as ‘laggards’ for not producing
a ‘Communication on Progress’ – an annual report on how the company is implementing
the ten principles of the UN Global Compact, and which is a requirement of participation.
The engagement resulted in over 32% of the companies identified as laggards
subsequently submitting a Communication on Progress and improving their engagement
with the UN Global Compact. Another example is a joint engagement by The Carbon Trust
and Hermes through the Clearinghouse to encourage UK publicly listed companies to
reduce their carbon emissions. The engagement programme began in Q3 of 2007 and is
still ongoing. In total six UK companies including International Power, Associated British
Foods, FKI, WM Morrison Supermarkets, Arriva, and TDG were selected based on specific
criteria by Carbon Trust. PRI claims that the engagement is ongoing and so no formal
results have been processed. However, WM Morrisons supermarket is one organisation
that has shown particular improvements after active engagement. In June 2008 Morrisons
became the first company to win an award from the Carbon Trust, called the ‘Carbon Trust
Standard’ for cutting its carbon footprint. Reportedly Morrisons reduced its carbon
emissions by 12.8% in the past three years.
Filing resolutions is considered a good way to warn management that the investor strongly
disagrees with some of the company’s policies. A downside is that the focus of engagement
is intrinsically limited by human factors such as size of engagement teams and time
allotment, thus potentially covering less ground than positive screening strategies.
RiskMetrics research found that 410 ESG related resolutions were filed and 202 came to
votes in the US in 2008.
In addition to the above RI approaches, there are two types of environmental investing that
are often used.
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Thematic investment funds
These funds focus on a range of themes emerging from the shift to a more sustainable
economy, such as clean technology, energy efficiency, renewable energy, waste
management, and water treatment. The idea is that a portfolio which is over-weight in these
long-term themes will out-perform because the change to a more sustainable economy is
necessary and unavoidable. These funds generally invest exclusively in companies which
provide environmental solutions, often called pure-play environmental companies because
they dedicate a majority of their business activities to environmental issues. Thematic
investment funds provide investors with some of the purest environmental investment
options.
Venture capital and private equity funds
An increasing number of venture capital (VC) and private equity (PE) funds are investing in
private companies that develop new environmental products and services. These funds are
relatively illiquid and represent a higher risk investment than many of the funds above which
invest in public companies. These investments generally go directly to the investee
companies and enable them to expand and develop their businesses. Some of these funds
specialise in specific types of environmental companies whereas others take a more
generalist approach to portfolio selection. For example the Low Carbon Accelerator, an AIM
listed fund, invests in sustainable building, energy efficiency and clean energy. It is
important to note that environmental funds may not fit neatly into each category. For
example, on the surface the Virgin Climate Change Fund could be considered a thematic
investment fund; however, it is not investing only in environmental pure-play companies. It
is using an ‘eco-efficient’ approach to identify those with the best environmental credentials
in each industry and select companies considered to deliver the highest returns. Often,
funds will use a mixture of strategies to achieve their environmental objectives.
We believe that the indirect environmental impacts of pure-play, venture capital and private
equity funds (VC/PE) are similar. By providing funding to these companies that tend to be
29
start ups, these environmental investing strategies help deliver significant and scalable
positive environmental outputs indirectly.
Currently there is a large gap between the capital needed and the capital currently
deployed to create solutions to environmental problems such as climate change, energy
scarcity, water shortage and pollution, and waste disposal. According to New Energy
Finance, new investments by VC/PE players grew significantly by 37% from USD 9.8 billion
(GBP 6.1 billion) to USD 13.5 billion (GBP 8.4 billion) in 2008 globally. During the year,
USD 5.6 billion (GBP 3.5 billion) was invested in Solar equally as in Wind, and USD 2 billion
(GBP 1.2 billion) was deployed into the Biofuels sector. There are a number of VC/PE funds
in the UK such as WHEB Ventures, Impax Group Plc and Low Carbon Accelerator (LCA).
Low Carbon Accelerator (LCA), launched in 2006 by Low Carbon Investors (LCI), is an
investment vehicle that has holdings in a diverse portfolio of unquoted private companies
that provide low carbon products and services. Examples of LCA’s portfolio companies
include: Responsive Load Technology, which has developed technology allowing
household electrical appliances to respond to grid pressure and better match supply and
demand; Helio Dynamics, a solar energy technology company, currently reporting to be
achieving 15 times greater generation capacity in photovoltaic cells whilst reducing the
usage of silicon; and Saddlehorn, an 800 acre sustainable housing development in the
U.S.A. The pure-play nature of these investments means that there will be indirect
environmental benefits from the investments made by LCA, particularly if LCA can aid these
companies to expand their market share more rapidly through their engagement activities.
RI investment products
RI Indices and Funds
Since KLD Research & Analytics introduced the Domini 400 Index back in 1990, social
indices and mutual funds that track them have proliferated. An RI index is a stock index of
publicly traded companies that have met certain standards of social and environmental
excellence. Potential candidates for the index will have positive records on issues such as
employee and human relations, product safety, environmental safety, and corporate
30
governance. Companies engaged in the business of alcohol, tobacco, firearms, gambling,
nuclear power and military weapons are often excluded. An RI index fund is a mutual fund
made up of companies from a particular RI index. For example, the Calvert Social Index
Fund seeks to match the performance of the Calvert Social Index™, a benchmark for
measuring the performance of large- and mid-sized US-based socially responsible
companies.
The future for RI index products is likely to be one where investment universes are
progressively more customised so that the needs of all RI practitioners are met. While
mainstream investors have in excess of 50,000 indices in which to invest and RI investors
have only around 10012, there is enough room within which index creators can provide new
products for the environmentally-conscious investor. In the past three to four years, some
indices have already been developed that focus on a particular environmental theme,
examples include the JPMorgan Environmental Index – Carbon Beta.
Exchange Traded Funds (ETFs)
ETFs are mutual funds that are traded on exchanges just like stocks and have become
popular due to the growth in demand for index linked products, their tax efficiency, low cost,
and ease of trading. Socially responsible investors have a handful of ETF products to
choose from, with a growing number of environmentally focused ones. Both FTSE and Dow
Jones have created RI- focused ETFs to develop a niche in the U.S. and Europe.
The number and the complexity of the strategies used in RI have grown considerably and
often involve a combination of screening and shareholder influencing techniques.
Environmental investing can use any of these strategies as part of an integrated RI fund or
a fund with an environmental focus. The following section provides a general overview of
the different types of environmental investing today.
12 http://www.sriadviser.com/commentary.html?id=1331
2.3 Performance of environmental investing strategies
Financial performance of environmental investing strategies
The biggest debate regarding RI relates to whether considering environmental, social and
governance (ESG) factors can have a material impact on investment performance. As more
academic and practitioner research in this field emerges, there is a solid and growing body
of evidence that good management of ESG factors can potentially increase long-term
performance and reduce certain types of portfolio risks.
For instance, in 2007 RiskMetrics carried out a literature review of the most relevant studies
published from 1996 to 2006 that explore the linkages between ESG factors and financial
performance. A review of 88 studies revealed strong evidence for the existence of a
positive relationship between ESG management and performance and financial
performance. In 90% of the total number of relationships that were assessed, a positive
correlation between ESG factors and financial performance was identified; in only 10% of
cases could a negative relationship be said to exist. The implementation of a
comprehensive environmental management strategy in particular can be linked to good
financial performance, as can development of good governance structures.
In general, RI products have maintained competitive performance in comparison to
mainstream and traditional funds. Established indices around the world also show that
companies that incorporate social and environmental standards historically deliver
competitive returns. For example, the HSBC Global RI Life fund, a globally-diverse pension
fund managed by SINOPIA which combines a best-in-class positive screening approach
and quantitative stock selection process has outperformed mainstream equities since its
launch. Over the three-years to end of August 2007, the HSBC Global RI Life fund has
posted a 52.5% gain, net of fees13. This represents a significant outperformance when
compared to the 44.7% return in the MSCI World Index over the same period. The three-
year net annualised performance of the fund equates to 15.1%, compared to 13.1% from
the MSCI World Index.
13 According to figures from HSBC Investments (UK) Ltd. (Figures are quoted total return, in sterling, cumulative over 36 months to 30 August 2007. Time period for performance calculation is based on first full 36 months of available performance data).
32
Environmental performance
The subject of environmental performance of RI strategies has received much less
attention. Environmental performance of RI strategies can have a range of indirect impacts.
As discussed in previous section, indirect environmental impacts can be achieved through
various environmental investing strategies such as screening, integration and shareholder
engagement. Alternatively, fund managers may simply offset the carbon emissions
associated with their portfolio. Looking at publicly available information from fund
managers, there is very little reported on what impact their funds could have on the
environment. In their report ‘Responsible Investment 2008’, RImetrics evaluated fund
managers from around the world managers with over USD 12 trillion (GBP 7.4 trillion) of
assets under management, comparing each manager to a series of Best Practice Principles
that measured 22 aspects of RI competency. They found that even for the managers who
engage with companies, a "large proportion" of them do so to get ESG information, with
many less engaging to change companies' behaviours. Importantly, a majority of managers
do not monitor or track the costs of engagements with companies, with 30% not keeping
any trail of engagement activities at all.
One reason for this lack of data on environmental performance is the ambiguity in the
process of measuring environmental performance of funds. At the most basic level, there is
a debate as to whether performance should be measured at the institutional level or the
fund level. Often, institutional investors have environmental policies that span their fund
range and it becomes difficult to attribute institution-wide outcomes to specific funds. On the
other hand, particular funds may use a targeted investment strategy with environmental
objectives which would elicit a potentially different environmental outcome from the rest of
the funds.
Another core debate is whether to look at the processes or outcomes of environmental
investment strategies. A process-oriented approach can look at the research methodology
and selection rules for building a fund portfolio as well as corporate management. An
outcome-oriented approach looks at the impact that the companies in the fund’s portfolio
have on the environment and correspondingly that impact to the fund itself. In most cases,
33
institutional investors have focused on relating their environmental performance in terms of
processes in their portfolio selection or corporate management.
Beyond these core issues, there are several additional factors to consider in developing a
methodology to measure the environmental outcomes of different investment strategies14:
Standardisation and functional unit – In order to compare the sustainability
outcomes of different investment funds, it is necessary to standardise the measures
of the assessment based on a common functional unit. At a company level, a
common indicator is CO2 equivalent emissions per sale (i.e. pound, dollar or euro of
revenues), but the functional unit for investment funds is harder to define. A study by
Dr. Thomas Koellner and his colleagues at the Swiss Federal Institute of Technology
recommends using percentage of financial performance per year as a functional unit
to measure sustainability performance.
Aggregation – Another issue to consider is whether all the criteria can be
condensed into a single score result. Some of the criteria may not be quantitative
and difficult to add up to a single score.
Time perspective – The outcomes of an assessment of a fund’s
sustainability performance depend very much on the time perspective chosen. Thus,
a methodology must consider whether to assess the current sustainability
performance or its projected future performance because sustainability funds either
build on a strong potential for improvements in the future (e.g. eco-pioneers funds) or
on a powerful sustainability performance (e.g. pure-play thematic funds).
System border – In order to assess these impacts practically, however, it is
necessary to specify the system borders of the environment and society. It is not
possible to investigate the social and ecological impact without narrowing the system
down.
Peer group and benchmark – It is more relevant to compare the fund’s
performance (both financial and non-financial) with the performance of other funds
and relative to a benchmark. Such a comparison allows the analysis to distinguish
14 Koellner 2005
34
the general trends in performance, which affect most funds similarly, from the
individual performance of a specific fund.
35
3. Literature Review of Environmental Efficacy in Investments
This section is a review of the most recent academic research that examines whether
environmentally-focused investment strategies have positive impacts on the environment.
In order to address this question, we explore literature that addresses the following two
themes:
Relationships between socially responsible investing and their impacts on the
environment
Approaches to measuring environmental performance in investment
strategies
We have carried out a literature review of the most relevant studies published over the past
fifteen years, during the period 1993 to 2008. The literature review was global in scope, and
looked at studies published by academia, think tanks, industries and consultancies.
A full list of all the studies reviewed in this paper can be found in the Annex. This list
contains full details of each study including title, year of publication, author(s) and country of
publication, as well as a brief abstract of each study’s methodology and conclusions.
3.1 Overall findings
We identified only 23 studies that discuss environmental performance of investment
strategies in some manner. Approximately half of these studies discuss RI broadly, and
only 11 studies have an exclusive environmental focus. In addition, studies tended to
examine social or environmental performance of the RI industry as a whole, with only 6
studies looking at the performance of specific funds or investment portfolios.
Over two-thirds of the studies have been published in the past five years, indicating a
growing concern for the efficacy of investment strategies in meeting their stated social or
environmental objectives. However, this type of research remains primarily within the
36
academic sphere, with only seven studies conducted outside of academia. Of the 23
studies included in our analysis, 14 originated in Europe (6 of these from the UK)
suggesting that Europe is leading the field in terms of research into the ESG outcomes of
investments. Figure 2 shows the origin of the different studies.
Figure 2 Origin of studies in literature review
By GeographyBy Publisher
3.2 RI and environmental performance
A total of 18 studies evaluated the link between RI and environmental performance either
directly or indirectly. Nine of these studies focused explicitly on environmental outcomes,
while the remaining studies discussed environmental impacts together with social and
governance issues. The studies were roughly split between quantitative and qualitative
analyses.
Some of the studies examined a specific RI technique such as negative screening or
shareholder engagement, but the majority of the studies had a broad focus and looked at RI
as an overall investment strategy.
37
The overall results showing the link between RI and environmental performance, including
the types of strategies featured in the studies, are shown in the chart below. The linkages
are classified as being:
Positive correlationRI strategies influence corporate behaviour on ESG issues
which leads to positive environmental outcomes
Neutral correlation
RI strategies may influence corporate behaviour on ESG
issues but no conclusion was reached regarding effect on
environmental outcomes
Negative correlationRI strategies do not influence corporate behaviour on ESG
issues and do not lead to positive environmental outcomes
There were 14 positive correlations, 2 neutral relationships and 2 negative correlations.
These 14 studies provide rather weak evidence from the studies to suggest that green
investments can be linked to good environmental performance.
Figure 3 Number of correlations between RI and environmental performance
In terms of environmental impacts, the studies considered the influence of RI on changing
corporate behaviour related to the environment in three main areas:
Adoption of an environmental strategy or management system
Reduction and prevention of environmental damage (primarily through cutting
greenhouse gas emissions and curbing pollution)
Increase in an environmentally-focused business activity
38
The indicators used to measure environmental impacts varied widely from measuring fund-
level performance to company level performance. For example one study measured the
percentage of a portfolio invested in pure play environmental companies while several
others measured the actual carbon footprint of the companies in a portfolio. In addition,
many of the studies focused on qualitative indicators instead of explicit quantitative targets.
Summary of study results
Proponents of the positive RI and ESG performance link contend that investments promote
positive ESG activities in companies or discourage harmful corporate behaviour. The
underlying theory behind this is the ‘cost of capital’ argument. By selecting a company with
high ESG standards, a RI fund provides that company with more capital which lowers its
cost of funds and allows the company to pursue more ESG-friendly projects. Conversely, by
divesting or excluding a company with poor ESG standards, an RI fund limits that
company’s capital supply which increases its cost of funds and lowers profitability. This
creates incentive for companies to meet standards called for on ESG issues by RI
investors.
In the earlier studies, the impact of RI is found to be small, which is attributed to the low
level of assets under management in the 1990s. With the tremendous growth in size and
number of funds since then, researchers have been able to conduct more robust analyses
and examine a variety of different investment techniques. In particular, engagement
activities have been found to be more effective than screening in changing corporate
behaviour15.
The sceptics of an RI and ESG performance link argue that the small size of RI funds in
terms of current assets under management prevents them from having any material impact
on corporate behaviour since there are other sources of funds available16. Furthermore,
targeting individual firms will not make systemic changes in the markets. One study argued
that RI funds often invest in the same companies as other funds, noting that the vast
majority of UK RI fund investments are concentrated in the top 350 FTSE companies, with
15 Mackenzie 1997; Gifford 2005; Brown 200716 Schepers and Sethi 2003; Haigh and Hazelton 2004; Brown 2007
39
large companies such as Vodafone, Pfizer and Microsoft the most frequent stocks in RI
portfolios17. As such, existing RI funds are restricted in their direct social and environmental
impact.
However, all four of studies that found either a neutral or negative correlation between RI
and ESG performance had a positive outlook for the impact of RI in the future. These
studies suggest a variety of solutions to improve the impact of RI including collective action
of large institutional investors and increased use of engagement strategies.
Studies with an environmental focus
All nine of the studies with an environmental focus reported a positive correlation between
RI and environmental performance. Two of the academic studies were based on a model
presented by Heinkel, Kraus and Zechner in their 2001 paper ‘The Effect of Green
Investment on Corporate Behaviour.’ The studies explore the effects of negative screening
on investment decisions for polluting firms, and all concluded that investors induce polluting
firms to reform but at various levels of investment18.
Koellner et al (2007) conducted the most robust analysis on environmental outcomes.
Using environmental ratings for companies as well as an input-output life cycle assessment,
the study compared the portfolios of 13 RI funds with 13 randomly selected conventional
funds in Germany. The results from the study suggest that statistically, on average, the
portfolios of sustainability funds emit significantly less greenhouse gases and use less
energy than conventional funds. Furthermore, the damage to human health, ecosystem
quality and resources is less for sustainability funds. However, the advantages of
sustainability funds are less clear-cut than investors might expect, because the portfolios of
both types of funds investigated have a considerable overlap.
Four reports released in the past year from the financial sector are also of significance. One
research firm published a report19 that calculated the carbon footprint of 185 UK equity
investment funds. The report found that the three funds with the lowest carbon footprint are
17 Brown 200718 Heinkel, Kraus and Zechner 2001; Barnea, Heinkel and Kraus 2004; Von Arx 200519 Trucost 2007
40
RI funds. However, although three quarters of RI funds have a smaller carbon footprint than
the benchmark, one quarter of RI funds are more carbon-intensive than the benchmark.
Holden & Partners, a RI asset management firm, published the ‘Guide to Climate Change
Investment’ which examines the extent to which RI funds are invested in companies
offering climate change or environmental solutions and found that there are surprisingly low
levels of investment in pure-play environmental companies. They found that in contrast to
the RI funds which are heavily invested in stocks such as Vodafone and HSBC,
environmental funds generally invest in companies that the fund manager believes will
contribute directly to a low carbon economy. As a result these funds are often overweight in
companies active in the alternative energy, water and waste sectors.
Pictet, a Swiss asset management firm, also published a report that compares the
environmental performance of a sustainable portfolio versus a broad market benchmark.
The authors calculate that a globally diversified benchmark investor would have 'funded'
CO2 emissions of 892 tonnes (without double counting) per one million USD invested in
2007, whereas a client invested in a sustainably optimised portfolio would have been
responsible for emissions of only 528 tonnes of CO2. This translates into a reduction in
greenhouse gas emissions of 40% against a broad market benchmark. Moreover, this
substantial "environmental return" was achieved not by taking risky bets on a few green
sectors or firms, but solely by applying a rigorous carbon-driven stock-selection process as
part of a broadly diversified portfolio.
Ceres conducts an annual report examining the US mutual fund industry’s proxy voting
practices on climate change shareholder resolutions. In its 2008 report of the voting records
of 1,285 mutual funds from 62 leading mutual fund firms covering 2004–2007, they found
that historic opposition toward such resolutions is softening, with some fund firms, such as
Goldman Sachs, supporting many climate resolutions outright and others, such as Fidelity
and Janus, abstaining on most or all resolutions after opposing them in the past. Still, many
mutual fund firms are acting inconsistently on climate change—offering new climate-related
funds and index products while continuing to oppose virtually all climate-related resolutions.
Ceres reports that this inconsistency is especially apparent at Morgan Stanley and other
41
Wall Street firms which are investing aggressively in new climate-related business activities
yet have opposed virtually all climate-related shareholder resolutions in recent years. RI
fund firms are setting the standard on best practices by supporting all climate change
resolutions in 2007. Firms such as Calvert, Citizens and Domini have consistently
supported all climate change resolutions, and often file or co-file many of the resolutions as
well.
3.3 Approaches to measuring environmental performance
We identified five studies that discussed approaches to measuring environmental
performance of RI funds. Only two of these studies were strictly looking at environmental
criteria. Three studies were academic papers and the remaining two were reports
developed by industry groups.
The studies presented indicators for environmental performance broadly from two angles:
1) the process of managing and operating the funds and 2) the outcome of those
processes. Process indicators describe those activities which are important inputs into the
management and reporting of environmental issues. This includes disclosure, reporting and
existence of environmental policies and systems. Outcome indicators describe the actual
impact on the environment or society through influencing the environmental performance of
investee companies.
42
The table below describes the indicators highlighted by the studies.
Process indicators Outcome indicators Investment policy incorporating
environment
Narrative on process model
Narrative on risk rating scheme and
environmental screening process
Environmentally relevant posts and
environmental departments
Environmental management training
Environmental management audits
Quality of the research method and
diligence in carrying out research activities
Involvement of stakeholder (in
defining criteria)
Dissemination of information
(reporting and transparency)
Level of holding in environmental
funds.
Percentage of assets under green
management (split exclusion and positive
criteria)
Percentage of assets in eco-
pioneers and innovations
Evidence of improvement in
investee company environmental
performance
Number of shareholder resolutions
withdrawn after successful negotiation with
company management
Proxy voting percentages achieved
by environmental resolutions submitted or
supported by the fund
Evidence that the cost of capital has
decreased or increased for an investee
company
The following highlights the two approaches developed by industry groups.
EPI-Finance
In 2000, a group of eleven financial service institutions20 with headquarters in Germany and
Switzerland developed a set of Environmental Performance Indicators for the financial
industry. The indicators are divided into four business sectors: Commercial Banking, 20 Bank Sarasin, Credit Suisse Group, Deutsche Bank, Gerling Konzern, HypoVereinsbank, RheinLand Versicherungen, SAMSustainabilityGroup, Swiss Re, UBS, Victoria Versicherungen, Zürcher Kantonalbank
43
Investment Banking, Asset Management, and Insurance. The project applies the
environmental performance evaluation standard ISO 14031 as a guideline. It proposes a
set of indicators for financial institutions displaying: a) the performance of their
environmental management system, based on three management indicators (describing the
system's "drivers"); and b) the environmental performance of their financial services, based
on two operational performance indicators (describing the "results").
FORGE Group
The FORGE Group, consortium of some of the UK’s leading financial service
organisations21, developed a toolkit in 2000 to help to achieve a higher level of engagement
across the sector and encourage consistency in approaches to environmental management
and reporting. These guidelines highlight some of the main business activities that create
environmental impacts and suggest environmental management and reporting plans for
each. Subsequent revisions of these Guidelines are anticipated which will address more
advanced environmental management and reporting issues and the wider governance
issues created by the global move towards achieving a more sustainable future.
3.4 Conclusions
In sum, very little research has been carried out to examine the link between RI and
environmental performance. This compares to over 100 studies that RiskMetrics has
analysed in previous literature reviews that examine the link between RI and financial
performance. Thus, on the surface it seems that the driver for RI is financial return and not
environmental improvement. One study noted that the RI industry spends a large part of its
promotional efforts to justify the funds’ financial and not social performance measures,
which is understandable since in the end, the goal of these funds is to make money22.
While most of the studies concluded that there was a positive link between RI and
environmental performance of portfolio companies, only three studies provided empirical
evidence that this was the case (Koellner, Holden and TruCost). In addition, the studies
21 The Abbey National Bank, Barclays, CGNU, Lloyds TSB Bank, Prudential, The Royal Bank of Scotland and Royal & Sun Alliance22 Schepers and Sethi 2003
44
differed greatly in how they measured environmental performance. Many studies looked at
the processes of the fund managers with very few reports explicitly citing specific
environmental outcomes. This leaves a lot of room for future studies to fill the gap.
One study noted that the overwhelming majority of RI indicators used today are of a purely
qualitative nature. Even when apparently quantitative data is taken into account (e.g.,
emissions data), this data is often just used to corroborate or check the qualitative
conviction of the RI analyst23. Consequently, coherent quantitative time series of RI data are
still scarce, and it is therefore very difficult to establish an accurate and verifiable measure
of a company’s progress over time.
23 Butz and Pictet 2008
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4. Survey of Funds with Environmental Investment Element
The results of the literature review imply that environmental impacts are not being
measured at the fund level, despite funds having an environmental objective. A review of
existing literature yields only a partial answer to the research question: to what extent are
positive environmental impacts part of an environmental investing strategy, and how are
these impacts measured, if at all? In order to assess actual practices in fund management,
RiskMetrics conducted an on-line survey of RI funds with an environmental component.
This chapter presents the results and analysis of the survey.
4.1 Survey methodology
The survey targeted RI funds with an environmental objective stated in their publicly
available literature. Funds were selected based on profiles provided by several sources
including the EIRIS Green & Ethical Funds Directory, the Holden & Partners ‘Guide to
Climate Change Investment’ report, the online Ethical Fund Directory from Ethical Fund
Managers and the Eurosif RI Funds Service.
The sample universe focused primarily on UK funds, but also included some European and
US funds. The universe also included funds utilising a variety of investment styles (as
described in Section 2.2) to ensure a representative sample. In total 55 funds were
contacted to participate in the survey. A full list of the funds selected and the participants in
the survey are in the Annex.
The aim of the survey was to identify the extent to which environmental investment
practices seek to improve the environmental performance of portfolio companies, and if so,
how those improvements are measured. RiskMetrics, with input from Defra, compiled a
questionnaire to gather information on a) the different investment styles used by fund
managers, b) the environmental objectives of these different investment styles and c) the
extent to which fund managers are analysing the environmental outcomes of these
investment styles (i.e. objectives beyond looking at financial return characteristics). Survey 46
respondents were able to complete the questionnaire on-line or as a Word document. See
the Annex for the full list of questions.
The survey was conducted over a two-month period from June to July 2008. Survey results
were followed up with phone calls when necessary. Overall, 20 funds participated in the
survey, a 36.4% response rate. Although the response rate is relatively low, a total of 20
responses is still significant and sufficient to enable a meaningful analysis of basic trends in
the sector.
4.2 Overall findings
Of the 55 funds contacted, 20 funds (36.4%) participated in the survey and provided full
responses. From the outset, we did not expect a high response rate given the paucity of
data from the literature review.
The majority of the funds are UK-based and ranged in size from GBP 2 million in assets
under management to GBP 1.4 billion. Almost all (19) respondents are equity funds, but
varied in investment style from growth to value to tracker. The charts below show some
basic information about the funds.
47
Figure 4 Basic fund info
Fund origin
Launch date
Size of funds
Geographical focus
Based on 20 survey responses
Eight of the funds were launched before 2000, five were launched between 2000 and 2005,
and seven were launched after 2006. Most of these funds invest in companies globally, with
only four investing in UK companies exclusively.
48
(in millions of GBP)
Environmental aims, objectives and targets
All of the 20 respondents have some environmental objective, with 9 funds incorporating
environmental objectives with broader social and governance considerations and 11 of the
funds focusing primarily on the environment. These 11 environmentally focused funds use
different investment strategies and were categorised as the following:
Dark green: excluding companies based on environmental criteria
Eco-pioneer : investing primarily in public companies with some involvement in
environmental technologies, products or services
Eco-efficiency : utilising a best-in-class approach to select superior public
companies in managing environmental risks within a sector
Pure-play : investing only in public companies whose main business is focused
primarily in environmental technologies, products or services
Private equity : investing in private companies that are involved in
environmental technologies, products or services
Figure 5 Environmental investment strategy of funds
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Dark Green10%
Eco-pioneer5%
Eco-efficiency10%
Pure-play25%
Private equity5%
Integrated SRI 45%
Based on 20 survey responses
It is important to note that some funds may fall under more than one category, particularly if
they use a range of investment strategies. In those cases, the funds were put into the
category which reflected the dominant strategy of the fund.
Most of the respondents selected almost all twelve of the environmental objectives listed in
the questionnaire as part of the objectives of their investment strategies. Promotion of
renewable energy sources and promotion of energy efficiency are the most common
objectives. Other objectives that respondents cited were increasing environmental
awareness, improving environmental reporting and promotion of environmentally-friendly
products.
Figure 6 Environmental objectives of investment strategies
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Based on 20 survey responses
While most respondents have specific environmental objectives, only one fund has set a
quantitative target to meet those objectives and only five funds have qualitative targets to
meet those objectives. These targets can be broadly classified as either improving how
companies manage environmental issues (through policies, disclosure and management
systems) or reducing actual physical impacts on the environment.
Figure 7 Environmental targets
Based on 20 survey response
The Environment Agency Pension Fund sets a quantitative target that the environmental
footprint of its combined actively managed equity portfolios is less than the environmental
51
footprint of the MSCI All World Index.
In terms of qualitative targets, funds mentioned increasing adoption of or improvements to
environmental management strategies, increasing levels of ISO or environmental institution
accreditation, generally improving company behaviour on environmental issues and
investment in companies that provide environmentally-friendly solutions.
Investment strategies to achieve environmental objectives
As mentioned above, the respondents use a variety of investment strategies to achieve
their environmental objectives. Five funds utilise a thematic approach and only invested in
companies that have some or most of their business activities focused on improving the
environment. These funds do not use any other RI techniques. The criteria used to select
these companies vary from climate change factors to deforestation issues. Four funds
invest 100% of their portfolio in pure-play environmental companies (defined as a company
that generates over 50% of its revenue from business activities that support the
environment).
Fifteen respondents indicated that they use traditional RI techniques such as negative
screening and shareholder advocacy to achieve their environmental objectives. Of these
fifteen, almost all (93%) use negative screening techniques and only half (53%) use positive
screening techniques.
Figure 8 RI techniques used in investment strategies
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Based on 20 survey responses
Almost three-quarters (73%) of the respondents using RI techniques directly engage with
companies on environmental issues and two-thirds (67%) partner with other institutions to
engage with companies. The environmental issues on which they engage include carbon
emissions, environmental disclosure, environmental management and pollution, among
others. The respondents engage with companies at varying levels and some respondents
have nuanced strategies depending on the sector or company. In terms of collaboration,
many respondents work together through initiatives such as the Carbon Disclosure Project
or IIGCC, while a few work with specific fund managers or NGOs. Seventy-three percent
also state they plan to collaborate with other investors on engagement issues related to the
environment in the future.
Based on the survey response, nine out 20 respondents using RI techniques exercise their
ownership rights and vote on resolutions, primarily relating to climate change issues or
disclosure. Most of these funds track the number of times they have voted, but only two
trace the outcome of these votes. Many respondents commented that that it was not
possible to quantify how many times their voting had led to an environmental outcome. Only
two institutions from the survey filed a shareholder resolution (in collaboration with other
investors) on climate change at Exxon Mobil.
Other investment strategies used to improve the environmental performance include
purchasing emission credits to offset the carbon footprint of the portfolio, evaluating fund
managers on how well they incorporate environmental criteria into portfolio selection and
correlating environmental factors with long-term financial performance. These will be
discussed in more detail in the next chapter.
Environmental information
Survey participants were asked about the source of their environmental information and the
quality of that information. The majority of respondents do not rely on a single source of
information; they tend to use a combination of sources that included company CSR reports,
third-party company CSR information (e.g. trade journals and NGO reports), third-party
53
carbon data (e.g. Carbon Disclosure Project and NGO reports), direct engagement with
companies and / or investment research firms specialising in environment research. Other
sources of environmental information were media, independent forestry audits, mainstream
financial research and academic research.
In terms of quality of information, respondents were asked to rate each source on a 5-point
scale from poor to excellent. We assigned scores to each rating with 1 corresponding to
poor and 5 corresponding to excellent. On average, the quality of information hovered
around 3, or average. Information from third-party carbon data and direct engagement
received the highest scores (3.56), with specialised research firms following closely behind
(3.44). The figure below shows the frequency of use for each source of information and its
corresponding quality rating.
No source of information received an overall excellent score which could be an explanation
as to why companies utilise several different sources to evaluate companies. One fund
commented that the quality of information cannot easily be rated as it varies by sector and
size of company. Furthermore, direct engagement with a company will often be the most
informative to clarify technical details of production and processes, but responses to critical
questions can be poor.
Figure 9 Sources of environmental information on investee companies
54
Based on 20 survey responses
Several respondents suggest that a sector-based approach to establishing standard
environmental indicators would improve information on company environmental
performance. Some even suggest mandatory disclosure on environmental criteria. In all
cases, an agreed standard on reporting company environmental performance is seen as
lacking, and would be instrumental for making comparisons.
Measuring environmental impacts
Of the 20 respondents in the survey, eight (40%) monitor environmental performance of
their funds in some manner. Four funds have conducted a carbon audit of their portfolio;
three of them conduct an audit annually and one fund does it on an ad-hoc basis. Four
funds review whether companies have changed their behaviour after engagement on
environmental issues over time. Other methods of measuring environmental impacts
include an independent forestry audit, review of the voting record and review of fund
management practices. The table below summarises the number of funds using each
monitoring technique. These will be discussed in more detail in the next chapter.
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Monitoring technique Number of fundsCarbon audit 4
Review engagement outcome 3
Review voting record 2
Review fund management 1
Forestry audit 1
Environmental dividend 1
Four of these funds indicated that they use environment-related metrics to assess long-term
risk and value of their funds. The figure below shows the number of funds measuring
environmental impacts in each investment strategy.
Figure 10 Number of funds measuring environmental impacts
Based on 20 survey responses
For those funds that do not currently measure or monitor any environmental outcome of
their investment strategy, only two state they plan to do so in the future. This implies that
measuring environmental impacts is not a priority for over half of the funds surveyed.
Environmental outcomes of investment strategies
While 8 funds measure their environmental performance, only 3 funds reported on their
progress in meeting environmental targets in the survey. Six funds stated that they have
met their environmental objective through the selection process of their portfolio, rather than
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through a physical environmental outcome of the overall fund strategy. Nine funds reported
that they have no data on environmental performance and two respondents did not answer
the question. Given the scarcity of concrete environmental outcome data, any judgement on
the relative effectiveness of the different investment strategies would be premature.
Twelve funds report some aspect of the environmental impact of their environmental
investment strategies. This is typically reported on a quarterly or annual basis to clients via
newsletters, reports or emails. All of the funds report on environmental impact along with
financial performance in these client communications. One fund noted that they do not
report except to showcase positive examples of environmental performance in newsletters,
quarterly research reports and sustainability studies. None of the funds issue a stand-alone
report on environmental performance, with the exception of carbon audit reports from a few
of the funds. Furthermore, some of the RI integrated funds do not disaggregate
environmental performance from general RI performance.
Figure 11 Progress of respondents in meeting environmental targets
Based on 20 survey responses
In terms of actions based on the environmental performance results, 9 funds reported that
they follow-up by reviewing their holdings or engage with specific companies to improve
poor behaviour. If a specific company continually exhibits poor environmental performance,
some funds stated that they would divest that company.
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4.3 Conclusions
To summarise the results of the survey:
In total, 20 funds responded to the survey. Nine (45%) are RI funds with
integrated environmental objectives and 11 (55%) funds are primarily focused on the
environment.
Most funds have multiple environmental objectives covering a wide range of
issues.
Only 5 funds (25%) have measurable targets for achieving their stated
environmental objectives, and only 1 of these funds has targets that are quantitative.
The funds employ an array of investment strategies to achieve their
environmental objectives. There was little data provided in the survey on the
environmental outcomes of each of these investment strategies.
The funds rely on multiple sources of environmental information and the
overall quality of each source was rated as average. Suggestions to improve quality
of information called for sector-based, standard indicators on environmental issues.
Eight (40%) respondents monitor the environmental impact of their fund in
some manner. Four of these 8 funds have conducted a carbon audit of their portfolio.
Only 3 (15%) funds reported their progress on meeting environmental
objectives in the survey. No fund releases a stand-alone report discussing its
environmental performance; any environmental impact reporting is integrated into
quarterly updates, annual reports or newsletters.
Overall, the survey results indicate that RI and environment-themed funds are not
measuring the environmental impacts of their investment strategies. The environmental
outcomes of the investment strategy do not appear to be considered a priority.
While 40% of respondents in the survey did state that they monitor environmental
performance, it would be difficult to claim that the same percentage of funds in the broader
RI fund universe is actually measuring environmental impact. It could reflect that those
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funds that are already doing something in this area may have a higher propensity to
participate in the survey.
Even so, the survey results do provide some evidence to suggest that financial
performance, not environmental performance, is the key measure against which RI and
environmentally-focused funds benchmark their success. Moreover, while all the funds
have environmental objectives, some funds responded that they are not marketed as
environmental funds, and therefore do not have environmental targets. Some funds also
cited their fiduciary responsibility limiting the ability for them to pursue environmental
targets.
Furthermore, it does not seem that particular types of funds are performing better on the
environment or more likely to measure environmental impacts than others. However, it is
interesting to note that none of the pure-play funds or private equity funds monitor
environmental performance. This may reflect the fact that these thematic funds
automatically assume that their funds will have positive environmental outcomes since they
focus exclusively on companies that contribute to environmental solutions.
The qualitative responses in the survey also highlighted several issues about measuring the
environmental performance of funds. Several respondents mentioned that it is difficult to
pinpoint what to measure and to develop an appropriate measurement methodology. For
example, one fund commented that institutions can use the Global Reporting Initiative (GRI)
indicators to report their environmental performance on a standardised basis, but these are
nevertheless difficult to interpret since impacts are relative to where a company is located.
Some respondents questioned the validity of measuring environmental impact at a fund
level versus an institutional level. Several of the respondents reported having environmental
policies that apply across the fund management institution and are not fund specific so it is
difficult to disaggregate institution-wide activities from fund activities.
Some respondents also have reservations about the correlation between environmental
investment strategies and positive environmental outcomes at companies. While strategies
59
such as engagement and screening may contribute to changes in company behaviour, they
consider it to be one of many factors that influence company behaviour.
Another issue that was raised in survey responses was that measuring environmental
performance was not relevant to some of the funds that are passively managed, particularly
tracker funds, or even thematic funds.
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5. Best Practices in Measuring Environmental Performance
We have identified five institutions from the survey to highlight innovative practices in
measuring environmental performance and improving environmental outcomes. These
institutions utilise a wide range of investment strategies and all engage directly with portfolio
companies to varying degrees on environmental issues. Each of the institutions
incorporates environmental objectives slightly differently in their fund management. The
table below summarises the innovative characteristics of each of these funds.
Figure 12 Summary of best practices of selected funds
Institution Fund Innovative Characteristics Environmental Target
Banco Fonder (Sweden)
Banco Svensk Miljö (Environment Fund)
Conducts carbon audit then purchases emissions credits to offset impact; continuous engagement with companies to improve environmental as well as other broader sustainability performance
Carbon neutral portfolio
Environment Agency (UK)
Environment Agency Pension Fund
Measures ‘environmental footprint’ and ‘environmental dividend’; Votes on all environment-related shareholder resolutions
Environmental footprint of equity portfolios less than the MSCI All World Index
Jupiter(UK)
Jupiter Ecology Fund
Monitors ongoing engagement outcomes and maintains voting records which are regularly reported
Improve portfolio company management of environment
Morley(UK)
Norwich Sustainable Future Fund Range
Measures voting outcomes and ‘success’ rate measured by change in company behaviour over time; Tracks engagement through database; Provides regular reports
Improve portfolio company management of environment
Quadris Environmental Investments (UK)
Quadris Environmental Fund
Measures compliance with environmental standards and accreditation with institutes; Conducts forestry audit of its projects
ISO and Forestry Stewardship Council accreditation
Source: Responses to survey and publicly available literature
It is important to note that while these institutions do measure environmental performance
in some manner, none would claim that positive environment outcomes are achieved solely 61
as a result of these institutions engaging with or investing in companies. In fact, all of these
institutions acknowledge that positive change with regard to environmental performance
takes time and their investment strategies are only one element in driving change. Even so,
the following case studies provide good examples of innovative ways to measure
environmental impact of funds that could potentially be replicated by other funds.
5.1 Selected case studies
Banco Fonder
Banco Fonder is an asset management firm based in Sweden with approximately SEK 18
billion (GBP 1.5 billion) assets under management. Banco’s investment criteria are based
on the principles of the United Nations Global Compact, and it utilises a variety of RI
strategies including negative screening, positive screening and shareholder advocacy. In
order to streamline its work according to the Global Compact Principles, it has over the past
years converted a number of mainstream funds into RI funds, representing 58% of its
assets. In 2007 Banco implemented a new investment tool with focus on upside and
opportunities instead of the traditional risk perspective. This means that Banco favours
companies that integrate sustainability within the core business strategy and products.
Banco’s Svensk Miljö Fund (the Environment Fund) invests in Swedish companies that are
in the frontline of operating in a future environmentally sustainable society. It was launched
in 1994 and has approximately SEK 420 million (GBP 35.1 million) in assets. The fund has
approximately 60 companies in the portfolio, and selection focuses on companies that
demonstrate energy efficiency (both own operations and within the supply chain), or
companies that develop products and services that attempt to solve environmental
problems or improve energy efficiency, and finally those that address environmental
aspects or energy efficiency by developing new business areas. As such, the fund is
classified as an eco-efficiency fund that utilises a ‘best-in-class’ approach to select
companies, but it also employs other RI techniques such as exclusion and shareholder
engagement. If a company does not respond to engagement, the company is excluded
from the fund and also the investment universe. By the end of 2008 approximately 41
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(2007: 40) Nordic companies were excluded from Banco’s investment portfolios due to their
lack of commitment and/or poor practices. An example would be the divestment of
AarhusKarlshamn (AAK), a Swedish/Danish vegetable fat producer in February 2009.
During the last year Banco has engaged with AAK to understand what criteria the company
applies when purchasing non-certified palm oil. Due to a lack of information about the
purchasing practices regarding non-certified palm oil, Banco withdrew all investments in the
company. Despite exclusion, Banco continues to engage with AAK with to set a target for
the purchase of sustainable palm oil and to increase transparency of its palm oil supply
chain and the company’s sustainability management of their supply chain. According to
Banco, AAK has now showed progress within this area.
Banco engages with companies to encourage focus on sustainable products and services
as well as integration of sustainability into research and development. Their environmental
focus is primarily on climate change, biodiversity and water issues. Banco meets with larger
companies on an annual basis and has recently visited companies in emerging markets to
provide them with suggestions for improvement. During 2008, Banco conducted around 40
dialogues with Swedish and international companies. Banco recorded that desirable
environmental outcomes had been achieved, such as improved environment management
systems at oil rigs in the Mediterranean, improved water management at suppliers in
Bangladesh and better information addressing water aspects in the washing instructions for
clothes. These aspects had been raised during fieldtrips at company sites and also in
dialogues with the companies.
For example, Banco went to Tunisia to visit an oil platform owned by a Swedish company to
evaluate their environmental practices. After the meeting the company was urged to
develop an environmental plan for decommissioning the site in order to minimise impact on
the marine environment.
At fund level, Banco has conducted a carbon audit to evaluate the total emissions of the
companies in the Environmental Fund at the end of each year. Based on the fund’s
percentage of holdings in those stocks, Banco purchased carbon credits to offset those
emissions.
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Environment Agency Pension Fund
The Environment Agency’s Active Pension Fund for England and Wales (EAPF), with a
market value of GBP 1.4 billion, is the twentieth largest fund in the Local Government
Pension Scheme.
EAPF commenced a new investment strategy in May 2005 which entailed a move from
three 'balanced' managers to eight specialist fund managers following a period of
disappointing investment returns and considering new evidence that supported a positive
link between environmental performance and financial performance. As part of this strategy,
the Environment Agency has adopted an Environmental Overlay Strategy which requires
each of the EAPF’s investment managers to assess and evaluate environmental risks and
opportunities when meeting the senior management of investee companies and before
selecting investments for the fund. EAPF favours investing on a best-in-class selection
basis, takes an active approach to the exercise of its shareholder rights and encourages the
use of engagement rather than negative screening.
In terms of measuring environmental outcomes, EAPF has the most robust approach of all
the funds participating in the survey and is the only fund that sets a quantitative target for
achieving its objectives. EAPF has set a target to maintain an environmental footprint of its
combined actively managed equity portfolios that is less than the environmental footprint of
the MSCI All World Index.
To measure its progress, EAPF evaluates each of its managers not only on financial
targets, but also their delivery of the EAPF Environmental Overlay Strategy. This includes
their integration of environmental considerations into risk management, stock selection,
company engagement, and proxy voting, and referral of any environmental resolutions to
the Agency. Their relative performance is also benchmarked using corporate governance
and RI indices and environmental reporting tools. Each equity manager is also required to
assist the Agency in assessing the environmental footprint of the fund.
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The EAPF has undertaken Environmental Footprint analysis24 for each of its active equity
funds against their respective benchmarks for the last three years. The Footprint
methodology evaluates over 700 factors in assessing a company’s environmental impact,
such as the amount of raw materials, water and energy used and the waste and carbon
emitted. The Footprint for each equity manager, in relation to the EAPF, is compiled by
allocating a proportion of the environmental impact of each company relative to the amount
of stock that is held. EAPF publishes performance results in its annual report and accounts.
In 2008 the environmental footprint was 10% less than the MSCI index.
EAPF has also recently undertaken an analysis of one of its funds to identify the
environmental impact of using an ‘Environmental Dividend’ methodology25. This
methodology uses a life-cycle analysis and economic input/output model to estimate the
environmental burden reduction of the fund relative to the FTSE 350 index per GBP 10
million of assets under management. They estimate that compared to the FTSE 350, the
fund reduced the environmental burden by 140 disability adjusted human life years, 224
potentially disappeared fraction of species per km2 per year, almost 60 tonnes of CO 2 and
91 TJ of primary energetic resources.
EAPF believes the results of its investment strategy have been positive so far, in particular
for specialist sustainability mandates and alternative energy related investments.
Jupiter
Jupiter is a subsidiary of Commerzbank. The Jupiter Ecology Fund, launched in 1988, was
one of the world’s first investment funds with an explicit focus on sustainable development.
The Ecology Fund has grown to GBP 322 million in size and aims to achieve long-term
capital appreciation together with a growing income consistent with a policy of protecting
the environment. It invests in companies on a global basis that are responding positively to
the challenges of environmental sustainability and are making a positive commitment to
social wellbeing. Companies’ environmental and social performances and financial
prospects are assessed separately by Jupiter’s RI team.
24 Based on TruCost methodology25 Based on RiskMetrics methodology
65
The Ecology Fund is considered ‘dark green’, in that there are rigorous ethical exclusion
criteria for the companies it can invest in. The fund actively focuses on six green investment
themes: clean energy; water management; green transport; waste management;
sustainable living; and the beneficiaries of regulation. The Ecology Fund also employs other
RI techniques such as ‘best-in-class’ stock selection, engagement and voting on
shareholder resolutions.
At the institutional level, Jupiter has a Corporate Governance and Voting Policy that spans
across all of its funds. In terms of environmental performance, Jupiter sets qualitative
targets to monitor engagement which focuses on encouraging companies to develop their
environmental management systems and sustainability and corporate responsibility
programmes. To achieve this, Jupiter aims to establish a positive, constructive and ongoing
dialogue with the senior management of investee companies. If one engagement strategy
appears to be unsuccessful, Jupiter would review that strategy and adopt an alternative
strategy. For example, it may seek to engage with another member of the company
management team, or possibly collaborate with other investors, support a shareholder
resolution or, as a last resort, divest.
Ongoing engagement with companies allows Jupiter to assess progress of and changes
being made in companies. For instance, a request during engagement discussions for
greater transparency and disclosure in terms of climate change impacts resulted in specific
details being included in a company’s Corporate Responsibility report. Another company
received ISO 14001 accreditation after Jupiter’s discussions with them around
environmental processes.
All engagement by Jupiter is entered into a database and when engagement with a
company is undertaken previous engagement records are reviewed and taken into
consideration. Also details of engagement are circulated to portfolio managers regularly.
The database is used to produce bespoke biannual engagement reports to clients and the
published Jupiter’s Voting & Engagement Report to coincide with client reporting on
engagement. There are regular checks to ensure engagement matches core holdings.
66
Morley
Morley is one of the UK’s largest active fund managers wholly owned by Aviva plc. Morley
manages the Norwich Union Sustainable Futures Fund range which was launched in 2001.
The funds seek out investment in companies whose core business and operational
processes address environmental and social problems (e.g. resource shortage, climate
change, world health and human rights abuses). The funds will also seek to invest in
sectors such as renewable or low-emission energies, healthcare, education and waste
recycling.
The Sustainable Futures Fund range is categorised as an RI fund with environmental
objectives integrated with other social and governance objectives. Companies are
assessed against four main themes: climate change and energy, quality of life, sustainable
consumption and governance and risk management. The funds utilise a variety of RI
techniques including negative screening, positive screening, engagement, proxy voting and
filing shareholder resolutions.
At an institutional level, Morley has adopted an innovative Corporate Governance and
Voting Policy. This policy covers a range of corporate governance and corporate
responsibility issues. Significantly, as part of its voting policy Morley expects all FTSE 350
and FTSE EuroFirst 300 Index companies to disclose information on their exposure to and
management of key environmental and social risks. In the case a company publishes
insufficient information or does not publish corporate responsibility information at all, Morley
may abstain or vote against the resolution to adopt the company annual report and
accounts.
To measure the effectiveness of this policy, in 2007 Morley conducted a five year review of
its RI voting policy. Between January 2002, and December 2006, Morley voted against or
abstained on a company’s Reports and Accounts for ESG reasons at 121 different
companies. It found that the average 12-month success rate over the data period was
58.7% (see table below). The changing total number of companies relates principally to the
expanding geographical scope of its policy, as well as the increasingly stringent
67
requirements that it sets out. “Repeat offenders” are companies that Morley had previously
withheld support from. “Success” is defined as being able to vote in favour of Reports and
Accounts in that year, having withheld support in previous years.
Figure 13 Analysis of Effectiveness of RI Voting Policy at Morley
Year 2002 2003 2004 2005 2006Total 31 16 6 43 59
New companies 31 4 0 38 33
Repeat offenders N/A 12 6 5 26
Repeat offenders from previous year
N/A 12 6 2 24
Success rate 61% 63% 67% 44%
Source: Morley survey response
Looking at just one year’s withholds - and measuring how quickly the company responded -
in 2002 Morley withheld support from 31 companies. Three years later, Morley was able to
support 97% of these companies’ report and accounts. An example of an environmental
issue that it voted on was improved disclosure of greenhouse gas emissions.
In terms of engagement, Morley measures how effectively it has improved corporate
performance on a range of issues by analysing whether and how companies have
responded to any requests for change that it raises directly with the company. Morley uses
a contact management system to keep a record of these requests and share key concerns
and engagement plans with its institutional clients.
For instance, Morley engaged with 29 persistently non-responding companies to request
CDP adherence. It targeted companies based on the potential impact of climate change on
their business, as well as the potential for their business to impact on climate change.
Morley threatened to withhold support for the report and accounts at future AGMs if the
company did not respond to the CDP. Over half of the companies that Morley engaged with
provided a full answer to the CDP for the first time: of the 29 companies that it engaged
68
with, 15 provided a full answer, 3 provided some information, and 1 committed to respond
but was outstanding. Morley uses this information in its investment analysis – as well as in
deciding how to vote at future AGMs. The CDP has said that it believes Morley’s input
definitely did have an impact on the response rate.
Morley's engagement with companies on corporate responsibility and corporate
governance issues is detailed in a variety of client reports on a regular basis. These reports
include:
A record of all relevant meetings where corporate responsibility and corporate
governance issues were raised.
Details of focused engagement meetings or ongoing dialogue with companies
including information on recommendations it has made to companies and how
companies are performing against those recommendations.
A regular update of its voting activities including reasons for abstentions
and/or votes cast against management.
Case studies of its effectiveness and progress reports in relation to the
collaborative external engagement initiatives that it works on.
Quadris Environmental Investments Limited
Quadris Environmental Investments, established in 1999, is part of a group of companies,
inaugurated in the Netherlands with assets under management currently in excess of USD
300 million (GBP 152.5 million). Quadris is a niche market player in the development of
positive RI criteria in the UK. In 2001, Quadris launched its Environmental Fund which
invests directly in the plantations managed by Floresteca Agroflorestal Ltda., or corporate
bonds issued to finance their operations. Floresteca is a large scale sustainable teak
forestry business, operating in accordance with leading international guidelines for
sustainability.
The fund is categorised as dark green since it invests exclusively in the projects of one
forestry business. Its environmental objectives are preservation and reforestation of natural
forest areas, maintenance and improvement of soil condition, and minimisation of impact on 69
water tables and local water courses. Quadris has set a qualitative target for Floresteca
operations to meet ISO 14001 criteria as well as accreditation by the Forest Stewardship
Council and compliance with their policies and guidelines. Quadris monitors environmental
performance of the fund through an independent forestry audit of projects invested in, which
includes quantitative measurement of environmental impact such as projections of growth
of Teak trees and size of effectively planted areas.
70
6. Trends Impacting Investor Strategies
In this section, we review the current initiatives set up by investors, industry and civil society
to encourage uptake of responsible investment among investors, with a focus on
environmentally-related initiatives. The original objective was to analyse if the
environmental impacts of these initiatives are currently assessed and how effective these
initiatives are in driving social and environmental improvement. However, these are difficult
questions to answer since the primary goal of most of these initiatives is to provide a forum
for investors to discuss environmental impact issues or to raise awareness on particular
issues, rather than directly impacting environmental outcomes.
Given that there is also very little empirical evidence on the effectiveness of these
initiatives, this section concentrates on describing their influence on investors and their
views on investors’ environmental performance. In addition, it provides an analysis of
environmental performance at the company level to determine whether the growing number
of initiatives and investment techniques appears to be contributing to improved company
environmental performance over time.
6.1 Global initiatives
In the past decade, many global initiatives have been launched which have influenced
major financial institutions to become more socially and environmentally responsible in their
investment strategies and processes. These initiatives are currently and will in the future
influence investor thinking, policies and decision-making. In fact several large institutional
investors around the world are already referring to many of these initiatives in their annual
reports and policy documents.
The global initiatives can be divided into three categories: investor initiatives, civil society
initiatives and industry initiatives. The following are key international initiatives in each of
these categories that are helping to shape the future policy decisions of investors.
71
Investor initiatives
All of the initiatives described below have been launched by groups of investors to address
broad sustainability issues or specific environmental challenges such as climate change.
These initiatives are very high profile and are leading the trends in addressing the
measurement of environmental performance of investors.
Principles for Responsible Investment
In 2005, the United Nations Secretary-General invited a group of the world’s largest
institutional investors to join a process to develop the Principles for Responsible Investment
(PRI). They developed six principles which provide a menu of possible actions for
incorporating ESG issues into mainstream investment decision-making and ownership
practices.
Signing is voluntary and represents a commitment to the Principles, demonstrating support
from the top-level leadership of the whole investment business. In its short existence, the
PRI has grown very rapidly to over 500 signatories representing asset owners, investment
managers, and professional service partners that have over USD 15 trillion (approximately
GBP 10 trillion) in assets under management. In fact many major institutional investors cite
PRI in their investment policy documents.
In the 2008 PRI Report on Progress, a large number of signatories stated that the PRI has
been successful in raising awareness and many are confident that significant change will
eventually follow. The main benefits noted generally have been in building networks among
like-minded investors, facilitating information-sharing and enhancing the profile and
credibility of RI/ESG issues and investment approaches. On the other hand, a small
number of signatories stated that they had not yet derived any tangible benefit from their
participation in the PRI Initiative.
As of October 2008, the Enhanced Analytics Initiative (EAI) and PRI have joined forces
under the PRI name to internationalise the call for better investment research. Launched in
72
2004, EAI seeks to address the absence of quality, long-term research which considers
material extra-financial issues.
Global Reporting Initiative
A network of investors started the Global Reporting Initiative (GRI) in 1998 and created a
sustainability reporting framework that sets out the principles and indicators that
organisations can use to measure and report their economic, environmental, and social
performance. In terms of measuring environmental performance of companies, the GRI
uses 30 indicators which are structured to reflect the inputs, outputs, and modes of impact
an organisation has on the environment. Within those parameters, the indicators are
divided into the following categories: energy, water, materials, emissions, effluents, waste
and biodiversity.
Because the indirect environmental impacts associated with financial products and services
can be significantly greater in scale than the direct impacts of financial institutions’
operations, GRI created a special set of performance indicators for the financial institution
sector. The 13 performance indicators (see table below) relate primarily to the policies,
procedures and practices used by institutions to incorporate environmental considerations
into their business activities.
73
Figure 14 Global Reporting Initiative - Environmental Performance Indicators for the Financial Services Sector
Ref Agreed indicatorPolicy F1 Description of environmental policies applied to core business lines.
Proc
edur
e
F2 Description of process(es) for assessing and screening environmental risks in core business lines.
F3 State the threshold(s) at which environmental risk assessment procedures are applied to each core business line.
F4Description of processes for monitoring clients’ implementation of and compliance with environmental aspects raised in risk assessment process(es).
F5 Description of process(es) for improving staff competency in addressing environmental risks and opportunities.
F6 Number and frequency of audits that include the examination of environmental risk systems and procedures related to core business lines.
Prac
tice
F7 Description of interactions with clients/investee companies/business partners regarding environmental risks and opportunities.
F8 Percentage and number of companies held in the institution’s portfolio with which the reporting organisation has engaged on environmental issues.
F9 Percentage of assets subjected to positive, negative and best-in-class environmental screening.
F10 Description of voting policy on environmental issues for shares over which the reporting organisation holds the right to vote shares or advise on voting.
F11 Percentage of assets under management where the reporting organisation holds the right to vote shares or advise on voting.
F12 Total monetary value of specific environmental products and services broken down according to the core business lines.
F13 Value of portfolio for each core business line broken down by specific region and by sector.
GRI is fast becoming the global de-facto standard in sustainability reporting. Since its
inception in 1997, nearly 1,000 organisations in 60 countries have referenced the
Guidelines in their sustainability reports. These include organisations from many sectors,
and from every corner of the globe. Several governments and high-profile multi-nationals,
as well as the EU, OECD, UN, World Economic Forum, have referenced the GRI
Guidelines in communications to their constituents. While GRI Guidelines can provide
companies with standard indicators, there is very little in the guidelines to promote
assessment of environmental impacts.
74
Carbon Disclosure Project
The Carbon Disclosure Project (CDP) provides a secretariat for the world's largest
institutional investor collaboration on the business implications of climate change. It allows
investors to obtain information on the business risks and opportunities presented by climate
change and greenhouse gas emissions data from the world's largest companies. Launched
in 2000, currently CDP represents institutional investors with combined assets of over USD
57 trillion (GBP 29 trillion) under management. CDP has a repository of greenhouse gas
emissions data for 3,000 companies around the world.
This international coalition of institutional investors represents a powerful concentration of
ownership in the world’s largest 500 quoted companies, and therefore a potentially powerful
influence over their disclosure of high-quality information on greenhouse gas emissions.
This coalition is not engaging directly with companies to improve their environmental
performance and so there will be little benefit in the short-term to sustainable development.
However, if successful in forcing disclosure of high-quality, consistent and comparable data,
this may have substantial long-term benefits to reducing corporate climate change impacts,
as investors will better be able to scrutinise company progress on tackling climate change.
Institutional Investors Group on Climate Change
The Institutional Investors Group on Climate Change (IIGCC) was established in 2001 as a
forum for collaboration between pension funds and other institutional investors to address
the investment risks and opportunities associated with climate change. The group currently
has 39 members, with assets of over EUR 3.5 trillion (GBP 2.8 trillion). IIGCC seeks to
promote better understanding of the implications of climate change amongst institutional
investors and encourage companies and markets to address any material risks and
opportunities to their businesses associated with climate change and a shift to a lower
carbon economy.
For instance, IIGCC has produced reports on aviation and power generation, analysing the
investment issues from a move to a low-carbon economy. In both cases the analysis
concluded that the sectors would be significantly affected, and that the impacts would vary 75
significantly from company to company, with obvious implications for sector weightings and
stock selection. In aviation, the low-cost airlines would be hardest-hit, potentially losing 80%
of current profits. In the power sector, Scottish and Southern and E.ON were seen as
winners because of their relatively low carbon intensity.
It remains to be seen how effective the influence IIGCC has over the policy-making
process, and whether the coalition concludes that active stock selection on the basis of
climate change performance will have sufficient impact to justify this approach over direct
engagement with companies. There is certainly significant potential impact on sustainable
development through engagement with investee companies and property assets. IIGCC
reports that it is already affecting government and fiscal policy and consumer behaviour in
some countries in Europe. Currently, it does not systematically measure the environmental
performance of institutional investors or their portfolio companies. IIGCC does report on
members’ progress on actions taken to increasing their focus on climate change in their
own processes and in their engagement with companies and governments.
Intergovernmental and Civil Society initiatives
The following initiatives have been launched by intergovernmental and civil society
organisations to encourage companies to incorporate ESG issues into their operations,
which have allowed investors to get better data on company performance on ESG issues.
For example, the UN Global Compact, the UN Environment Programme Finance Initiative,
Business in the Community’s Corporate Responsibility Index, and the WWF’s Climate
Savers initiative.
Industry initiatives
The aim of the following industry initiatives is to contribute to better company disclosure on
environmental issues in specific sectors. They provide investors with information on
sustainable issues in each sector as well as a platform for investors to engage
collaboratively with companies. For example, these include the Cement Sustainability
Initiative and the Natural Value Initiative.
76
Evaluation of initiatives
All of these initiatives have undoubtedly raised awareness about environmentally
responsible behaviour, among both companies and investors. The rapid growth in their
membership as well as the proliferation of the initiatives themselves are indicators that they
are effective in meeting their objectives of fostering dialogue and increasing knowledge on
social and environmental issues. However, it would be difficult to assess how much
improvement in environmental performance in companies can be attributed to these
initiatives.
Moreover, the initiatives have received two main criticisms26 from academics and
practitioners. First, some critics argue that their vague language and lack of enforcement
mechanisms prevent them from providing clear guidance to institutional investors. For
example, the PRI states that they provide “possible actions” to accompany each principle,
but the actions themselves can be somewhat ambiguous.
Also the international initiatives do not provide effective incentive structures to encourage
more responsible investment or punish bad practices. In the CDP for instance, companies
can only expect penalties for truthful disclosure of bad practice.
Still, some initiatives have begun to make changes to address these criticisms. UN PRI
recently announced that it is considering more comprehensive analysis of the funds that
join with the Principles and a stricter certification process. Firms and fund managers who
have signed onto the UN PRI could be expelled if they do not follow through with its
disclosure provisions.
6.2 RI Indices
RI indices provide a benchmark for developing and managing RI products and services.
Also, these indices make it easier to quantify sustainability at a larger scale than individual
RI funds. RI indices also act as one of the driving forces pushing the environmental agenda
26 Oxford Business Knowledge 2007
77
of companies to the forefront. For example, Dow Jones Sustainability Index, FTSE4Good
Index Series, and Kempen / SNS Smaller Europe and UK SRI Index.
6.3 Company level trends
As an additional layer of evaluation, we conducted an analysis of company environmental
performance over time to determine if these environmental initiatives and investment
strategies are indeed influencing company behaviour to lead to positive environmental
impacts.
Using data from RiskMetrics’s EcoValue 21 company ratings as a proxy for environmental
performance for the FTSE Eurotop 300 companies, we analysed changes in rating scores
over a five-year period from 2003 – 2008. EcoValue 21 ratings measure a company’s
environmental performance on 3 major aspects: a) environmental strategy and
management; b) environmental risks and c) environmental strategic profit opportunities.
Based on these factors, companies were given a cumulative score on a 7-point scale from
CCC (lowest score) to AAA (highest score). The EcoValue 21 model is explained in more
detail in Annex D.
Our analysis tracked whether the EcoValue 21 ratings improved over time with results
shown in the figure below.
Analysing the percentage of companies in the FTSE Eurotop 300 that received above
average EcoValue 21 ratings (‘A’ or above), the data results paint an encouraging picture
(see Figure 15 below). The results find that the number of companies with above average
ratings grew from 50.2% in 2003 to 63.6% in 2008. This means that more companies today
have better environmental performance than five years ago.
These results, while generally positive, are inconclusive in terms of understanding the
impact either of environmental investing strategies or of the various initiatives referred to
earlier in this report. It is difficult to say with certainty that companies that are gradually
improving their environmental ratings over time are the ones that are targeted in the
environmental investment strategies or by the initiatives.
78
Figure 15 Percentage of companies in FTSE Eurotop 300 with above average EcoValue 21 ratings
Source: RiskMetrics
Nevertheless, the overall trend is that more companies are looking at their environmental
performance and considering their environmental impacts, potentially as a result of the
pressure being brought on them by these RI / environmental initiatives and investment
strategies.
79
7. Conclusions
This study has attempted to determine if and how environmental performance is currently
being measured by fund managers for different responsible investment strategies
encompassing a range of environmental objectives.
The evidence from the literature review and fund manager survey reveals that very little
research has been conducted on this subject, and only a handful of institutions are actually
measuring the environmental efficacy of their funds at all. The majority of funds are
focusing on incorporating environmental targets into the portfolio selection process rather
than into the end outcome of the investment strategy.
For those institutions measuring some aspect of environmental impacts, conducting a
carbon audit of the portfolio or tracking engagement activities are the most common. The
majority of the environmental targets are thus on improving company behaviour in terms of
environmental policies, disclosure and systems. Very few have a target to actually reduce
impact on the physical environment.
In addition, reporting on environmental performance is often not disaggregated from other
CSR reporting and most of the information provided is typically qualitative in nature. The
metrics used by institutions also varied widely ranging from portfolio company adoption of
an environmental management system to reduction and prevention of environmental
damage to increases in environmentally-focused business activities.
Institutions that do not measure environmental performance may argue that environmental
outcomes are not the primary objective of investment strategies so do not justify
measurement and that they face difficulties in identifying what to measure and developing
an appropriate measurement methodology.
While financial performance may be the ultimate objective of funds and environmental
impact measurement challenging, it makes sense to understand the role they are playing in
helping to achieve environmental goals. Because of their large size, institutional investors
80
(representing approximately USD 48.1 trillion or GBP 29.8 trillion in 2006) 27 wield significant
influence over future economic development and industrial management pathways and,
therefore, the pattern of future environmental impacts of companies.
Furthermore, the number of funds with an environmental focus is continuing to grow at a
rapid pace, and the types of investment strategies used in these funds are becoming more
sophisticated. This trend will persist as the international initiatives such as CDP and PRI
increase pressure on investors to integrate environmental issues into investment process
and utilise their influence to encourage environmentally-friendly company behaviour. If
investors do include environmental objectives into their investment strategies, clients of
these funds may in future wish to know how they are meeting those objectives.
This study has highlighted many issues in developing a methodology to measure the
environmental impact of environmental investment strategies. In addition, measurement
strategies identified to date appear limited and not highly developed.
Finally, one of the oddest characteristics of RI is that sustainability-oriented investors
expend considerable efforts to identify their investment candidates according to their vision
of sustainability but at the end of the day content themselves with measuring the financial
performance of their holdings. One cannot but notice the blatant contradiction of expending
both money and effort to identify the ‘good’ companies when all that counts in the end is
how these companies have fared financially.
27 Butt et al 2007
81
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85
9. Annex
A. Summary of literature review
B. List of funds contacted in survey
C. Survey questionnaire
D. EcoValue 21™ Rating Methodology
86
A. Summary of literature review
Studies examining link between RI and environmental impacts
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
1 Barnea, Amir; Heinkel, Robert; Kraus, Alan
Green Investors and Corporate Investment
2004 Study uses modeling to explore the effects of ethical screening on investment decisions for polluting firms that fail the screen and on their decisions to reform. Looks at the relationship between critical mass of green investors, costs of reforming, and rate of reformation for polluting firms. Green investors are found to induce polluting firms to reform, but existing levels of RI are believed to lead to under-investment by polluting firms.
Positive
2 Baue; Bill and Cook, Jackie
Mutual Funds and Climate Change: Opposition to Climate Change Resolutions Begins to Thaw
2008 Fifty-five large mainstream and seven prominent socially responsible investing (RI) mutual fund firms’ votes on climate change shareholder resolutions were analyzed for the period of 2004 through 2007. The analysis covered 1,285 individual funds from 244 N-PX filings. This review shows that historic opposition toward such resolutions is softening, with some fund firms, such as Goldman Sachs, supporting many climate resolutions outright and others, such as Fidelity and Janus, abstaining on most or all resolutions after opposing them in the past.
Positive
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
3 Brown, Jessica
Going Green? How financial services are failing ethical consumers
2007 Discusses broadly the current state of the ethical finance sector. Regarding RI funds, provides analysis based on interviews with 26 industry representatives from high street banks, ethical finance networks, RI funds, ethical consumer organisations, ethical independent FAs and ethical finance initiatives. Does not provide environmental indicators, but discusses broad recommendations for progressing the field.
Neutral
4 Butz, Christoph; Pictet, Olivier
The RI Performance Paradox
2008 This paper argues that the fixation on the financial return of RI is a paradox. Social investors’ objectives are not one-dimensional but multi-dimensional. Hence the need for a credible and transparent extra-financial reporting. Current RI ratings are too qualitative and subjective and do not allow for tracking the extra-financial performance of portfolios. By using straightforward proxies for sustainability - CO2 emissions for the environmental and job creation for the social responsibility of companies – this paper shows that the companies in the sustainable portfolio emit less CO2 and create more jobs than their peers and thus provide the sustainable investor with a measurable social and environmental added value.
Positive
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
5 Gifford, James The effectiveness of shareholder engagement in improving corporate social and environmental performance
2005 This paper summarises the preliminary results of a case study of an engagement conducted by a UK fund manager (Insight Investment), focusing on one of their sector benchmarking exercises conducted on the UK listed house building sector. It looks at how they measure their effectiveness and discusses the factors that may have contributed to successful investor interactions with companies. Conclude that this engagement was responsible for a large proportion of improvements in sustainability performance and public reporting of that performance in all companies.
Positive
6 Graves, Samuel B.; Waddock, Sandra A.
Institutional Owners and Corporate Social Performance
1994 Using data from 430 of the S&P 500 firms, the study looked at correlations between the number and percentage of institutional owners and corporate social performance. KLD corporate social performance data is used but is not disaggregated. The impact of RI firms is found to be small; this is attributed to the level of assets under management in the early 1990's.
Positive
7 Haigh, Matthew; Hazelton, James
Financial Markets: A Tool for Social Responsibility?
2004 Argues that the claim that investing in RI funds promotes socially and environmentally desirable activities, and discourages detrimental activities, appears unfounded on several counts. RI funds cannot guarantee that they can alter the cost of capital for their investments. Fundamentally, addressing social problems by targeting individual firms, either by way of shareholder activism or RI fund investment, is not likely to result in systemic changes. RI fund managers who truly desire corporate change need to do two things: increase their funds under management and agree to act in concert to achieve common objectives
Negative
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
8 Heinkel, Robert; Kraus, Alan ; Zechner, Josef
The Effect of Green Investment on Corporate Behavior
2001 Using modeling, study assesses at what point RI investors will have an impact on the cost of capital for polluting firms. Finding is that 20 percent of all funds invested will need to use environmental screening before polluting firms will have financial incentives to reform.
Positive
9 Holden & Partners
Guide To Climate Change Investment
2008 Discusses the main RI and environmental funds available to UK investors and provides details of their ten largest investments by percentage of the portfolio and the percentage of the fund invested in environmental pure-play companies (as defined by the fund managers asked).
Positive
10 Koellner, Thomas ; Suh, Sangwon ; Weber, Olaf ; Moser, Corinne
Environmental Impacts of Conventional and Sustainable Investment Funds Compared Using Input-Output Life-Cycle Assessment
2007 Compared 13 sustainable investment funds managed in German-speaking countries with 13 randomly selected conventional funds. Fund companies provided every stock held in each portfolio, and the proportion of each stock. Used environmental ratings for the 1,131 companies held in the 26 portfolios as well as input-output life-cycle assessment. Found considerable overlap in portfolios. Environmental impact damage of sustainable portfolios was lower than for conventional portfolios, but difference was smaller than expected.
Positive
11 Mackenzie, Craig
Ethical Investment and the Challenge of Corporate Reform
1997 Includes an analysis of RI's effectiveness in combating "corporate harm." Finds that engagement is more effective than screening. Does not disaggregate environmental concerns. Looks at Friends Provident Stewardship Fund as case study
Positive
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
12 Mackey, Allison; Mackey, Tyson B.; Barney, Jay B.
Corporate Social Responsibility and Firm Performance: Investor Preferences and Corporate Strategies
2007 Econometric model of supply and demand for opportunities to invest in socially responsible firms. Efforts to increase RI are found to make it in the value-maximizing interests of more firms to take voluntary action to improve social or environmental conditions.
Positive
13 Michelson, Grant; Wailes, Nick ; van der Laan, Sandra
Ethical Investment and Process Outcomes
2004 Looks at ethical investing as a complex process, beyond specific aims. Because ethical investors are still dependent on managers to act as their agents, the impact of ethical investment on firm behavior is indeterminate.
Neutral
14 Schepers, Donald; Sethi, S. Prakash
Do Socially Responsible Funds Actually Deliver What They Promise?
2003 Theoretical discussion of how to look at social performance of funds. Proposes examining 1) the clarity and precision with which individual funds define their mission and investment policies; and 2) the robustness and rigour of various research methodologies to select investment vehicles.
Negative
15 Scholtens, Bert
Financial and Social Performance of Socially Responsible Investments in the Netherlands
2007 This paper analyses the performance of RI in the Netherlands and tries to establish a link between financial and social performance. It constructs a proxy to measure the CSR performance of RI funds by evaluating the screens they utilize. It assigns a score to each screening criteria of the fund and calculates a overall score for each fund. Does not provide information specifically on environmental performance of each fund, only an aggregate score. It finds different financial and social efficiency with respect to the transmission channels by which financial institutions impact on the social performance of their funds. In this respect, the stock market channel appears to be less successful than the credit channel.
Positive
Author(s) Title Year of Publication
Methodology and Findings Env. perf and RI link
16 Trucost Carbon Counts 2007: The Carbon Footprint Ranking of UK Investment Funds
2007 Analysis of 185 UK funds. CO2 equivalent emissions of each fund are divided by the total value of the portfolio for CO2 intensity per million pounds invested. While not all RI funds considered have environmental mandates, the average carbon footprint for RI funds was found to be lower than the average for other fund categories.
Positive
17 Von Arx, Urs Environmentally friendly investing: The use of negative screens and their effects on pollution and investment performance and investor's wealth
2005 This paper aims to clarify how RI funds could, through the use of exclusionary screens, indirectly induce polluting firms to switch to a clean technology. Concludes that if the population of green investors overcomes a certain threshold level, it is possible, that some firms with polluting technology will upgrade their production process to a cleaner one, in order to raise firm value. But even assuming low upgrading costs, the population of green investors has to be sizeable, for this event to occur.
Positive
18 Weber, Olaf Investment and Environmental Management: the Interaction between Environmentally Responsible Investment and Environmental Management Practices
2006 Questionnaire sent to 160 companies in German-speaking countries asked about environmental management practices and whether or not the company was owned by an environmentally responsible fund. Found a correlation between RI and company environmental management systems but concluded RI is not the driver. Found that firms with RI investors did a better job of implementing environmental management practices.
Positive
Studies discussing measurement of environmental performance
Author(s) Title Year of Publica
Methodology and Findings
tion1 FORGE
GroupGuidelines on Environmental Management and Reporting for the Financial Services Sector
2000 Report provides an implementation toolkit for UK financial sector to enable wider and more consistent engagement in environmental management and reporting across the sector. Highlight some of the main business activities that create environmental impacts
2 Gifford, James Measuring the social, environmental and ethical performance of pension funds
2004 This article discusses the reporting and rating of the SEE performance of pension funds and proposes a number of ways to address the problems associated with the current reporting frameworks. Provides qualitative and quantitative indicators for measuring
3 Jayne, Michael Ross ; Skerratt, Glynn
Socially Responsible Investment in the UK – Criteria That Are Used To Evaluate Suitability
2003 Questionnaire sent to 83 (22 responded) ethical fund managers in order to determine the nature of the environmental and sustainability criteria that are used as a basis for directing investments, and the ways in which these factors are compared and balanc
4 Koellner, Thomas; Weber, Olaf ; Fenchel, Marcus and Scholz, Roland
Principles for Sustainability Rating of Investment Funds
2005 This paper outlines the basic principles and methods on a comparative sustainability rating for RI funds. The sustainability rating is based on assessment of the research processes in the fund management as well as investigation of the fund portfolio in
5 Schmid-Schönbein, Oliver; Braunschweig, Arthur
EPI-Finance 2000: Environmental Performance Indicators for the Financial Industry
2000 This report is a workbook for the financial industry to better communicate and benchmark its environmental performance using a common set of management and operational performance indicators that are relevant for the sector.
B. List of funds contacted in survey
Funds listed in bold and italics responded to the survey
Fund Manager Fund Name Region
Aberdeen Asset Managers Aberdeen Ethical World Fund UK
Aegon Asset Management Aegon Ethical Equity Fund UK
Allianz Global Investors Global EcoTrends Fund EU
AXA Investment Managers Paris AXA WF Clean Tech EU
Banco Fonder AB Banco Svensk Miljö EU
Barchester Barchester Best of Green Life Fund UK
Barclays Global Investors iShares KLD Select Social Index Fund US
Black Rock Investment
Management
BGF New Energy Fund UK
Co-operative Insurance Society CIS Sustainable Leaders Trust UK
Cowen Asset Management Cowen Climate Change Fund UK
Credit Agricole Asset
Management
CAAM Funds Green Planet Fund EU
Credit Suisse Credit Suisse Fellowship Fund UK
DWS Investment GmbH DWS Klimawandel (Climate Change Fund) EU
Ecclesiastical Investment
Management
Amity Fund UK
Environmental Agency Environment Agency Active Pension Fund UK
F&C Asset Management F&C Global Climate Change Opportunities
Fund
UK
F&C Asset Management F&C Stewardship Growth Fund UK
First State First State Asia Pacific Sustainability UK
Forward Funds Sierra Club Stock Fund US
GLG Partners GLG Environment Fund UK
Henderson Global Investors Industries of the Future UK
Fund Manager Fund Name Region
HSBC/ Sinopia HSBC GIF Climate Change Fund EU
Impax Asset Management Ltd IMPAX - Environmental Markets Fund OEIC UK
Insight Insight Investments Evergreen Retail UK
Invesco Powershares WilderHill Clean Energy Portfolio US
Jupiter Jupiter Ecology Fund UK
KBC Asset Management KBC Eco Fund World EU
King & Shaxson Asset
Management
K&S Ethical Green Solutions UK
London Asia Capital London Asia Chinese Private Equity Fund
Limited
UK
Low Carbon Investors UK Low Carbon Accelerator UK
Ludgate Investments Ludgate Environmental Fund Limited UK
Lyxor Asset Management New Energy Protected Fund EU
M&G Investment Management Prudential Ethical Trust UK
Marlborough Fund Managers Marlborough Ethical Fund UK
Morley Norwich Sustainable Future Global Growth
Fund
UK
Neptune The Neptune Green Planet Fund UK
Nviro Nviro Cleantech UK
Old Mutual Old Mutual Ethical Fund UK
Pictet Pictet Clean Energy Fund EU
Quadris Quadris Environmental Fund UK
Rathbone Rathbone Ethical Bond Fund UK
SAM Sustainable Management SAM Sustainable Water B Acc EU
Sarasin Sarasin Sustainable Equity - Global EU
Schroders Schroders Global Climate Change UK
Scottish Widows Scottish Widows Environmental Investor
Fund
UK
Skandia Skandia Ethical Fund UK
Fund Manager Fund Name Region
Standard Life Standard Life UK Ethical Inst UK
SVM SVM All Europ RI Fund UK
Swisscanto Swisscanto Portfolio Fund Green Invest
Equity
EU
Trillium Asset Management Green Century Balanced Fund US
Triodos Triodos Renewable Energy Funds plc UK
UBS UBS(Lux) Equity Fund - Future Energy EU
Virgin Money Virgin Climate Change Fund UK
Winslow Winslow Green Growth fund US
Zegora Zegora Environmental Fund EU
C. Survey questionnaire
Dear Fund Manager:
Thank your for participating in this study on behalf of the UK Department for Environment, Food and Rural Affairs (DEFRA) regarding sustainable finance. The objective of this survey is to understand how different investment funds measure the environmental outcome of their investment strategies in relation to their environmental objectives.
It will take approximately 30 minutes to complete the questionnaire.
If you have questions at any time about the survey or the procedures, you may contact Karina Wong at +44 (0)20 7073 0475 or at the email address specified below.
Please note that survey responses will be strictly confidential and be used for DEFRA purposes only. The final published report will not reveal any individual fund responses, except to highlight any examples of positive environmental impact performance and measurement practices.
Please complete the survey by 11th July 2008.
(Questions marked with a * are required)
Section 1: Basic fund info
1. Fund manager: _______________________________
2. Fund name: _______________________________
3. Fund contact person:
a. Name *_______________________________
b. Title_______________________________
c. Phone Number *_______________________________
d. Fax Number _______________________________
e. Email *_______________________________
4. Fund currencyo GBPo USDo EURo Other________________________________
5. Fund size (in millions of currency selected above) _____________________
6. Launch date (month/year) _______________________________
7. Geographical focuso Asiao Europeo UK
o USAo Globalo Other________________________________
8. Fund type / Investment style (growth, tracker, etc.) _______________________
9. Asset allocation/targets _______________________________
10. Fund performance. (Please upload any financial performance reports on the following page.) _______________________________
Section 2: Mission and objectives
11. What is your fund objective? (i.e. type of companies/sectors in which fund seeks to invest) _______________________________
12. What is your investment philosophy? (i.e. broad sustainability/ environmental aims of the investment strategy) _______________________________
Section 3: Environmental aims, objectives and targets
13. Please select the specific environmental objective(s) of the fund's investment strategy from the list below (select all that apply) *
Reduction of CO2 or other greenhouse gas emissions Promote use or development of renewable energy sources Promote clean technology Promote energy efficiency Promote waste reduction and improved waste management Control pollution Promote water management and conservation Promote adoption of environmental policies Promote green transport Promote more efficient use of raw materials Prevent deforestation (i.e. avoiding companies that sell tropical hardwoods, clear forests or damage
forests) Other ______________________________________________
For the following questions, ‘targets’ refer to the measurable environmental outcomes of the overall fund; NOT the criteria for selecting portfolio companies
14. Does the fund have quantitative targets for meeting the environmental objectives you selected above (eg. % reduction in carbon footprint of the fund, reduction in number of pollution incidents by companies in the fund, etc.)?
o Yeso No
If yes, please list any quantitative targets for meeting each of the environmental objectives selected above ______________________
15. Does the fund have qualitative targets for meeting the environmental objectives you selected above (eg. increasing adoption of or improvements to environmental management strategies of fund companies, growing level of ISO accreditation across fund holdings, improved environmental ratings of companies in the fund, etc.)?
o Yeso No
If yes, please list any qualitative targets for meeting each of the environmental objectives selected above ______________________
Section 4: Environmental strategies to achieve objectives
16. Does the fund invest predominantly in companies that have some business activities focused on improving the environment (i.e. through technology, products or services that have positive impact on the environment)?
o Yeso No
If yes, please describe the fund’s strategy for selecting companies. ______________________
17. Does the fund invest in pure-play environmental companies? In this case, pure-play is defined as a company that generates over 50% of its revenue from business activities that support the environment (i.e. clean technology, alternative energy, etc.)
o Yeso No
If yes What percentage of the fund's portfolio is invested in pure-play environmental companies? ______________________
18. Please describe the environmental criteria, if any, used to select companies with environmentally-focused business activities.
19. Does the fund use any traditional RI techniques such as negative screening, engagement or proxy voting to achieve environmental objectives?
o Yes o No
IF YES, CONTINUE TO NEXT QUESTION. OTHERWISE SKIP TO QUESTION 27
20. Does the fund disinvest from or exclude companies that are considered not to meet the environmental criteria of the fund?
o Yeso No
If yes, please describe the fund’s strategy for disinvesting or excluding companies. ______________________
21. Does the fund invest more heavily in those companies that may not be involved in environmentally-focused business activities, but are responding positively to the challenge of environmental sustainability?
o Yeso No
If yes, please describe the fund’s strategy for selecting these companies. ______________________
22. Is the fund involved in engagement directly with companies on environmental issues?o Yeso No
If yes, on what environmental issues? ______________________
Please describe the fund’s strategy for engagement. __________________
23. Have you collaborated with other investors on engagement issues related to the environment in the past?o Yeso No
If yes, on what environmental issues? ______________________
If yes, with whom? ______________________
24. Do you plan to collaborate with other investors on engagement issues related to the environment in the future?o Yeso No
If yes, on what environmental issues? ______________________
If yes, with whom? ______________________
25. Has the fund exercised voting rights associated with environmental issues?o Yeso No
If yes, on what environmental issues? ______________________
If yes, how many times? ______________________
If yes, how many times did voting lead to a favourable environmental outcome? ______________________
26. Has the fund filed shareholder resolutions on environmental issues?o Yeso No
If yes, on what environmental issues? ______________________
If yes, how many times? ______________________
If yes, how many times did filing a shareholder resolution lead to a favourable environmental outcome? ______________________
27. Does the fund use any other investment strategies to improve the environmental performance of the fund?o Yes
o No
If yes, please explain. ______________________
Section 5: Measuring environmental impacts
In this section, please tell us how the fund measures or monitors the environmental performance of its investment strategy.
28. Has the fund undertaken a carbon audit to measure the climate change impacts of its portfolio companies?o Yeso No
If yes, how often do you conduct a carbon audit?
Annually Bi-annually Ad-hoc Other __________________________________________________
If yes, when was the last carbon audit conducted? ____________________
29. For the other environmental objectives selected earlier, does the fund measure or monitor its environmental performance in any other way?
o Yeso No
30. If yes, what criteria or monitoring systems are used to measure the environmental outcome of the fund (eg. recording whether an engagement strategy with XX number of companies led to implementation of an environmental policy at XX number of companies)?
31. If you do not currently measure or monitor any environmental outcome of your investment strategies, do you plan to do so in the future?
o Yeso No
If yes, please explain. ______________________
32. Do you use any environment-related metrics to assess long-term risk and value of the fund?o Yeso No
If yes, please explain. ______________________
Section 6: Environmental Information
33. Where do you get your information on company environmental performance? (Select all that apply)o Company CSR reportso Third-party company CSR information (eg. Trade journals, NGOs)
o Third-party company carbon information (eg. Carbon Disclosure Project, NGOs)o Direct engagement with companieso Investment research firms specializing in environmental researcho Other __________________________________________________
If you use investment research firm(s) for your environmental information, please list which ones you use. [Optional] ______________________
34. Please rate the quality of information available on company environmental performance from each of the sources below.
Poor Below Average
Average Good Excellent
Company CSR reports ❏ ❏ ❏ ❏ ❏Third-party company CSR information (eg. Trade journals, NGOs)
❏ ❏ ❏ ❏ ❏
Third-party company carbon information (eg. Carbon Disclosure Project)
❏ ❏ ❏ ❏ ❏
Direct engagement with companies
❏ ❏ ❏ ❏ ❏
Investment research firms specializing in environmental research
❏ ❏ ❏ ❏ ❏
35. Do you have suggestions on how information on company environmental performance can be improved? ______________________
Section 7: Environmental outcomes
36. How do you report on the results of any environmental investment strategies in terms of environmental impacts (eg. quarterly report to clients, email updates, etc.)? ______________________
37. What is the fund’s progress to date in meeting any environmental targets referred to previously? ______________________
38. Please provide examples, if any, of how engagement strategies by the fund have led to improved environmental performance of a portfolio company. [ANSWER ONLY IF YOU HAVE COMPLETED QUESTION 22] ______________________
39. What kind of follow up steps do you take, based on the results of any environmental impact measurement and environmental impact performance results? ______________________
40. Please add any additional comments here. ______________________
Please email any environmental policies or results of environmental performance to Karina Wong at [email protected].
D. EcoValue 21™ Rating Methodology
The EcoValue 21™ analytical model has been developed to enable
investors and industry analysts to assess companies’ relative
environmental performance, risk, and strategic positioning as well as
the financial consequences of these factors. The following section
describes the model.
Methodology - The EcoValue 21™ Rating Model
At the heart of EcoValue 21™ analytical model and risk algorithms is
the attempt to balance the level of environmental risk with the
companies' capacity to manage that risk strategically and profitably
into the future. It is the product of these two variables, not the absolute
level of risk alone, which determines the ultimate financial
consequences of environmental risk for industrial companies and their
investors.
EcoValue’21 ratings measure a company’s environmental
performance on 3 major aspects: a) environmental strategy and
management; b) environmental risks and c) environmental strategic
profit opportunities.
While companies’ current performance levels are obviously important
to the analysis, the EcoValue 21™ models are designed to move
beyond simply providing a static snapshot of the present situation.
Instead, they attempt to provide dynamic, predictive indication of
companies’ relative ability to manage environmental issues profitably
into the future. Accordingly, the models place considerable emphasis
on the trajectory and rate of performance improvement (if any), and on
the robustness of the company’s strategic management capability.
Rating a company means
examining both
environmental risk and a
company’s ability to manage
that risk.
The EcoValue 21™ rating model can be expressed schematically as
shown below.
Data Sources
Information needed to complete EcoValue’21 ratings is gathered from
several sources, including company literature (environmental reports,
annual reports, 10Ks, 10Qs, websites, etc.), environmental groups
and other NGOs, trade groups and other industry associations,
government data bases, periodical searches, and financial analysts’
reports. Following a review of the literature, RiskMetrics analysts
usually interview senior executives at the companies, most often in
the environmental area. When comparing companies, data is
normalized by the most relevant, available factor, such as domestic
sales or production levels.
Figure 16 Schematic of Major EcoValue 21TM Analysis Factors.
EcoVALUE '21 analyzes over 60 key variables using over 20 data sources:
Historical Contingent Liabilities:- Superfund- State and hazardous waste sites- RCRA- Toxic torts
Historical Contingent Liabilities:- Superfund- State and hazardous waste sites- RCRA- Toxic torts
Operating Risk Exposure:- Toxic emissions- Product risk liabilities- Hazardous waste disposal- Waste discharges- Supply chain management risk
Operating Risk Exposure:- Toxic emissions- Product risk liabilities- Hazardous waste disposal- Waste discharges- Supply chain management risk
Eco-Efficiency and Sustainability Risk:- Energy intensity and efficiency- Raw materials & natural efficiency and intensity- Product life-cycle durability and recyclability- Exposure to shifts in consumer values
Eco-Efficiency and Sustainability Risk:- Energy intensity and efficiency- Raw materials & natural efficiency and intensity- Product life-cycle durability and recyclability- Exposure to shifts in consumer values
EcoVALUE '21RATING
Managerial Risk EfficiencyCapacity- Strategic corporate governance capability- Environmental management systems strength- Environmentalaudit/accounting capacity- Supply chain management- Training capacity and intensity- Generic environmentalmanagement protocols- Industry-specific protocols
Managerial Risk EfficiencyCapacity- Strategic corporate governance capability- Environmental management systems strength- Environmentalaudit/accounting capacity- Supply chain management- Training capacity and intensity- Generic environmentalmanagement protocols- Industry-specific protocols
Strategic Profit Opportunities- ability to profit from environmentally-driven industry and market trends
Strategic Profit Opportunities- ability to profit from environmentally-driven industry and market trends
Source: RiskMetrics
Eco-efficiency analysis
demands thorough data
acquisition and disciplined
examination.
The Scoring System
For most categories, the data is then converted to a relative score, by
allocating the company with the best performance within its industry
sector in a given category a ten, the top score, giving the company
with the worst performance a zero, the lowest, and scoring the
remainder pro-rata between ten and zero. This system is designed to
clarify and highlight performance differentials that would otherwise be
more difficult to discern.
All of this data is then input into the scoring matrix, where it is
adjusted by weightings for each category. We have developed these
weightings through extensive back-testing with over 350 Fortune 500
companies. The weightings were then further refined through beta-
testing with our strategic partners such as PriceWaterhouseCoopers,
with financial institutions such as Union Bank of Switzerland and the
Zurich Insurance Group, and with specialist environmental engineers
and other colleagues. They reflect our view of the relative importance
of each category in determining companies’ medium-term profitability
and share price performance.
The final EcoValue 21™ relative score is intended for comparison
within industry sectors. The scores have been converted into the
familiar letter categories used by bond rating agencies.
The end result is the
translation of complex
environmental issues into
financially relevant measures.
Figure 17 RiskMetrics’s Rating Scale
AAA: A company with minimal, well-identified environmental/social risks and liabilities, and with a strong ability to meet any losses which might materialize. Extremely well-positioned to handle any foreseeable tightening of regulatory requirements, and strongly positioned strategically to capitalize on environmentally/socially-driven profit opportunities.
AA: A company with environmental/social risks and liabilities which have been well-identified and provided for. This position is unlikely to be impaired by any foreseeable tightening of regulatory requirements. The company is well-positioned strategically to capitalize on environmentally/socially-driven profit opportunities.
A: A company with large but well-identified environmental/social risks and liabilities, and sufficient financial and managerial strength to absorb all but exceptional risks. Able, also, to finance any currently proposed regulatory requirements. Above-average positioning with respect to profit opportunities.
BBB: A company with strong managerial capability, but one where environmental/social risks and liabilities are a potential source of loss, though not on any material scale. Average level of positioning vis a vis profit opportunities.
BB: A company with good managerial capability, but one where environmental/social risks and liabilities are a potential source of material loss. Below-average level of strategic positioning.
B: A company whose environmental/social risks and liabilities create a strong likelihood of material losses in both profitability and competitive position. Significantly below-average strategic positioning.
CCC: A company where there are significant doubts about management's ability to handle its environmental/social risks and liabilities, and where these are likely to create a serious loss. Well below-average ability to capitalize on environmentally/socially-driven profit opportunities.
