SRI: No longer a niche investment strategy
By Jerry Moskowitz

SHAREHOLDER VALUE SRI: No longer a niche investment strategy Being included in socially responsible investment indexes has its rewards. Does your company qualify? BY JERRY MOSKOWITZ I N RECENT YEARS, the notion of a corpora- tion taking the voluntary initiative to up- hold standards and practices that contribute to the greater good of society, its employees, and the environment has taken hold across the globe. Corporate social responsibility — CSR for short — has blossomed from the grassroots ef- forts of a few firms to a worldwide initiative prac- ticed by most, if not all. Fortune 500 companies. The International Finance Corp., a member of the World Bank Group, defines corporate social responsibility as "the commitment of businesses to contribute to sustainable economic development by working with employees, their families, the local community, and society at large to improve their lives in ways that are good for business and for de- velopment." With heightened concerns and media attention being given over to global warming, carbon emis- sions, and other pollutants, as well as general health of the population, corporations are becoming more aware of the impact of their actions. From hiring practices and fair trade to tighter emissions stan- dards and energy conservation, companies are re- examining the way they do business. A need for tools FTSE, which creates and manages more than 100,000 equity, bond, and alterna- tively weighted investment strategy in- dices, first became involved in socially responsible investing (SRI) in response to growing demand from investors for Jerry Moskowitz, president of FTSE Americas, is leading the expansion into the U.S. marketplace for the FTSE Group, which creates and manages financial indices world- wide He has worked in the financial sector for more than 30 years. tools to measure the numerous and varied global CSR standards. FTSE launched the FTSE4Good Index Series in 2001, offering a series of transpar- ent, rules-based, and pre-screened benchmark and tradable indexes. Many companies use the globally reputable FTSE4Good standards in developing CSR strategy and initiatives as well as a measure for their success in meeting CSR goals. One of tbe tenets of the FTSE4Good Index is to challenge companies to improve their CSR prac- tices for the good of the environment and human rights. FTSE4Good criteria are regularly revised to ensure that they reflect developments in corporate responsibility and trends in socially responsible investment. Most recently, in an effort to offset global climate change, FTSE introduced new cli- mate change criteria that companies will need to meet in order to be eligible for inclusion in the FTSE4Good Index Series. These criteria aim to en- courage companies to support and contribute to scientific understanding and consensus on climate change, and to participate in strengthening public policy frameworks to address climate risk and re- duce greenhouse gas emissions. A booming SRI market In response to companies operating with both so- cial and economic concerns in mind, inclusion in socially responsible investment indexes has its re- wards. SRI has been steadily moving from a niche investment strategy to an important part of the investment landscape. Indexes such as the FTSE- 4Good Series are designed for fund managers to cre- ate investable products — mutual funds, exchange traded funds (ETFs), and other vehicles — for the genera! public or institutions. In the U.S. market alone, SRI accounts for an estimated $2.3 trillion in assets under management, and research estimates by financial consultancy Celent predict that the SRI market in the U.S. will reach $3 trillion by 2011. 46 DIRECTORS a BOARDS SHAREHOLDER VALUE Companies that uphold stringent CSR standards appeal to the broad and growing range of institu- tional and retail investors seeking to: invest in com- panies that demonstrate good standards in corpo- rate responsibility; minimize social, ethical, and environmental risks within their portfolio; capital- ize on the benefits of good corporate responsibility (for example, eco-efficiencies and improved brand image); avoid investing in traditionally excluded SRI sectors such as tobacco, defense, and nuclear power; and actively encourage companies to be more responsible. While it appeals to both retail and institutional investors, SRI is seeing the most rapid growth from institutions. Among these are public and private pension funds, foundations, nonprofit organiza- tions, insurance companies, universities, hospitals, and religious institutions. Many pension plans, particularly those in the public sector, have official policies for taking account of corporate respon- sibility in managing their funds. According to a study conducted by Mercer Investment Consulting, representing the views of 183 U.S. institutional in- vestors responsible for more than $500 billion in assets under management, 75 percent of ijivestors believe that environmental, social, and corporate governance factors can be material to investment performance. In fact, more half of those surveyed believe that pursuing an SRI approach will reduce risk or improve returns. As investors become in- creasingly conscious of corporate responsibility and a greater portion of assets are being allocated toward SRI, it is essential that corporate boards review their social responsibility policies and take steps to meet responsible investment standards and to communicate these measures to the public. Manifold benefits Companies with high CSR standards, such as those included in FTSE4Good, also reap the benefits of: • Risk Management— Companies with environ- mental and social policies firmly in place are able to clearly demonstrate responsibility to investors, legislators, shareholders, employees, customers, and the public. • Reputation — Meeting FTSE4Cood Index standards demonstrates companies' dedication to corporate social and environmental responsibility. Many FTSE4Good constituent companies highlight the index inclusion in their corporate reports and investor communications. • "license to Operate"—-A company must ob- tain planning permission before it may operate in any given location. The company's reputation can influence government's decision to grant or reject planning. Having a strong corporate responsibil- ity system demonstrates positive and responsible corporate behavior. • Cc>5f Savings— By focusing on and reducing their environmental impacts, many FTSE4Good constituents report that they have been able to save money on electricity bills, resource use, and waste removal. In many cases, companies with rigorous corporate responsibility standards are best able to attract and retain high-quality staff, reducing em- ployee turnover rates and recruitment costs. An example of cost savings as a result of CSR is offered by DuPont, a muhinational chemical and health care company that claims to have saved $2 billion since 1990 on energy efficiency measures. IBM says that it too has saved $791 million, and BP claims to have increased its valuation by $650 mil- lion through improvements in operating efficiency and energy management. Required criteria The FTSE4Good series is a derived from the glob- ally recognized FTSE Global Equity Index Series, which covers 98 percent of the world's investable market capitalization. All companies listed in the FTSE Developed Index, which covers 23 markets and over 2,030 companies, are eligible for inclusion in FTSE4Good. In the U.S., 697 large and midcap Benefits of FTSE4G00D Index Series Investors •A benchmark for responsible investment funds • A basis for tracker funds • A starting universe for actively managed funds • A basis for a range of structured products • For engagement strategies Companies • A framework for 'responsible' business management •A'reputational" badge in stakeholder communications • To gain access to ethical and socially responsible investors' funds Nongovernmental Organizations (NGOS) • A list to screen potential partners and donors • A mechanism to contribute to the encouragement of responsible and sustainable business practices throughout the world • For use within their own investments (e.g. trusts, foundations, and pension plans) — Jerry Moskowitz FIRST QUARTER 2008 47 SHAREHOLDER VALUE companies are eligible, provided that they meet the inclusion criteria. Some companies are excluded based on indus- try, as dictated by globally accepted standards. For example, FTSE4Good screens out companies in- volved in production of nuclear weapons or whole weapons systems, as well as owners of nuclear power stations. Companies eligible for inclusion in FTSE4Good must be able to prove that they meet requirements in the following five areas: — Working toward environmental sustain- ability; — Developing positive relationships with stakeholders; — Upholding and supporting universal human rights; — Ensuring good supply chain labor standards; and — Countering bribery. Each year, the FTSE4Good criteria evolve to re- flect what constitutes good practice globally. The criteria are reached through a market consultation process in which independent experts from the in- vestment community, the corporate sector, govern- ments, NGOs, consultants, and academics contrib- ute. Companies in the index and those looking to become part of the index accept that requirements to meet global corporate responsibility standards and to remain in the index will increase over time. Since inception in 2001, FTSE4Good has tightened environmental and climate change criteria and supply chain labor standards, and has introduced FTSE s own CSR practices FTSE Group is active in managing its own corporate responsibility. It defines its stakeholders as six separate groups: employees, shareholders, suppliers, cli- ents, loca! communities, and the environment. It is continually working towards managing and minimizing risks that may affect these groups. Environmental conservation figures largely in FTSE Group's practical com- mitment to socially responsible issues. Over the last year, FTSE has recycled some 87 percent of the company's waste paper, a contribution in energy usage and waste generation that shows each FTSE employee saving the equivalent of 2.7 metric tons of greenhouse gas each year. FTSE also works closely with UNICEF, contributing more than $2 million to the organization since the two began working together in 1999. — Jerry Moskowitz "countering bribery" criteria. By continually rais- ing the bar for its constituent companies, FTSE- 4Good is able to keep up to date with global SRI standards and maintain its reputation as the lead- ing global standard for determining and measur- ing responsible investment. As standards evolve, the FTS£4Good team works closely with constituent companies to help them meet the stringent criteria and remain in the index. What can boards do? A recent study conducted by FTSE in conjunction with Insight Investment, one of the U.K.'s largest institutional investors, and Business in the Com- munity, an association of companies dedicated to CSR, sought to defme and report on the role that corporate boards should play in directing CSR. The study found that boards should be charged with: — Setting values and standards; — Developing CSR strategy; — Being constructive about regulation; — Using internal control to secure responsi- bility; — Aligning performance management; — Creating a culture of integrity. Boards are meant to govern rather than manage. In that light, they must establish CSR standards and directives and recruit executives who will imple- ment them. The board should be concerned with ensuring that CSR standards are explicitly stated, are con- sistent with the values of the business, and are ef- fectively communicated to employees. They should take into account the conditions, challenges, and risks specific to their markets and defme appro- priate strategies and responses to these problems. Rather than wait for imposed regulation, the board should support self-regulatory standards and en- sure that the company meets its own goals. Internal audit systems should be established to ensure com- pliance with these standards. Finally, responsible behavior by executives and other employees should be rewarded over both the short and long term, and corporate values should be cultivated top down from the organization — by fostering a culture in which responsible behavior is expected and irresponsibility is penalized. • The author can be contacted at jerrv.moskowit2@ftse. com. 48 DIRECTORS a BOARDS

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