TACOMA, Wash. - Ethical investment management styles such as screening out "sin stocks" have no significant impact on investment performance compared with non-screened portfolios, according to John Ilkiw, global consulting practices director at Frank Russell Co., Tacoma.
New research comparing the performance over 10 years of the screened Domini 400 index produced by Kinder Lydenberg Domini & Co. Inc., Boston; the Standard & Poor's 500 and the Russell 4000 indexes showed the three benchmarks behaved in almost the same way.
In fact, the Domini index marginally outperformed the other two, but Mr. Ilkiw said this outperformance was "not statistically significant." The volatility of the three indexes also was almost identical, he added.
This will be good news for religious endowments, foundations and public sector plans that often use ethical screens in their investment strategies.
But ethical screens have been rarely used by U.S. corporate plans because of concerns that socially responsible investing may, under ERISA regulations, make them vulnerable to litigation from plan members. Corporations tend to take a more hard-nosed approach to investing.
`You are toast'
"If there is any indication that the intention (of investing) is other than meeting the financial requirements of plan members, you are toast," said Mr. Ilkiw.
Corporate sponsors also are concerned that screens could interfere with their plans' strategic asset allocations, said Craig Mackenzie, ethics unit director at Friends Ivory & Sime PLC, London.
An "engagement" approach that does not exclude "sin stocks" but challenges companies on ethical issues might be a more acceptable option, Mr. Mackenzie said.
Dutch pension giant PGGM recently appointed FIS to run an engagement overlay on e5.5 billion ($4.9 billion) in European equities managed in-house by the e53 billion plan.
But engagement of company boards of directors as a socially responsible investment strategy is in its infancy in the United States, said Mr. Ilkiw.
And it is also very rarely applied to international portfolios, as few U.S. money managers offer that option, said Kellie Scheurell, principal at William M. Mercer Inc., Chicago.
FIS officials believe they have spotted a hole in the market and will this month begin marketing its so-called Responsible Engagement Overlay product to U.S. plan sponsors for use with their EAFE or European mandates. FIS manages L1 billion ($1.4 billion) in U.S. assets, 10% of which is for institutions, and has L37.4 billion in total assets under management.
FIS' overlay approach does not screen out companies, but highlights those companies in an investment universe that might have negative social, ethical and environmental impacts in areas such as human rights, environmental management or climate change. Members of FIS' ethics unit then will meet with company management and discuss the business case for adopting "best practice" on these issues, said Mr. Mackenzie.
The aim is to avoid potential pitfalls or reputation risks that could affect the company's position "to deliver long-term value to the shareholder," he added.
Mr. Ilkiw noted that this can be quite a time-consuming activity for the money manager, and might be quite an expensive approach.
But Gary Mairs, FIS' managing director for retail and institutional business, believes their fee rate is not out of line. The firm would charge an annual fee of between 30 basis points and 55 basis points for both managing the assets and applying the overlay approach.
The fee charged for just the overlay service, as is the case with the PGGM mandate although he would not give details of that specific arrangement, would be negotiated and would depend on the number of companies selected for engagement.
Hard to pinpoint
The overlay product was launched 18 months ago. Mr. Mackenzie said the nature of the approach made it difficult to pinpoint the exact impact on overall performance.
Welsh clothing company The Peacock Group PLC, Cardiff, is an example.
At the beginning of last year Peacock, which receives many of its products from emerging markets, had no policy on child labor. In the wake of adverse publicity for Nike Inc., related to poor labor conditions in its Asian factories, child labor has been identified as an issue that can affect long-term value for shareholders, said Mr. Mackenzie. FIS encouraged Peacock to follow current industry best practice, which is to state a policy on child labor and then encourage suppliers around the world to sign up to a code of practice on employment conditions if child labor is used.
Peacock is of drawing up a code of practice. This is not an act that in itself will bolster the share price, but it might limit damage to the company's reputation and sales going forward.
Mr. Mairs hopes to win business through the FIS' ability to apply ethical overlay to international portfolios. The firm's asset management and social engagement skills are in European and international equities rather than U.S. equities, he said.
Ron Madey, U.S. practice leader for the asset consulting group at Towers Perrin in New York, suggested FIS' approach might be more consistent with shareholder activism than ethical investing.
"This approach is clearly not in the mainstream of SRI investing here," he said.