Christine Arena asks if the SRI industry is doing its job properly

There is a continuing debate about the methods, standards and practices used by the SRI industry. The debate involves corporate leaders, research houses, industry analysts, reporters, bloggers, activists and investors themselves. It also involves trillions of dollars in assets, some of which are arguably being channelled in the wrong direction.

A few weeks ago Jeff Swartz, chief executive of clothing giant Timberland, wrote an article for the Fast Company website outlining his perception of a growing problem.

Swartz said: “We’ve earned a decent reputation as sustainable business and responsible brand … and yet SRIs only hold about 1% of our shares. If anyone can share similar data on the SRI percentages of the top 50 CSR companies, I’d be very interested to see it … because my guess is we’re not alone.

“CSR funds need to take a more thoughtful approach to company screenings, in recognition that as the world of CSR has evolved, so too their criteria for judging a company’s performance should be more sophisticated.”

Several days later, SRI research house KLD Analytics responded to the post, arguing that methods used by the SRI industry were more sophisticated than Swartz realised. The KLD author Alan Petrillo wrote: “Mr Swartz specifically criticised ‘index investing’, which he described as investors ‘weighting their entire portfolio as per the market’. Petrillo points to the views of KLD Indexes Managing Director Tom Kuh who indicates that these criticisms have more to do with market cap weighting than with indexing per se. Investors who focus on large-cap stocks may hold less Timberland simply because it is small.

“The FTSE KLD 400 Social Index is a ‘long view bet on socially responsible companies’, to use [Swartz’s] phrase. Due to its construction, the FTSE KLD 400 holds Timberland at about twice the weight it would have in the S&P 500 – if it were in the S&P 500, which it is not.”

Broken filter

Data indicates that SRI screening criteria allow questionable company selections to slip through the cracks. In 2008 Critical Sociology magazine reviewed the largest 41 US SRI funds, and noticed that three of the top eight holdings were AIG, Bank of America and Citigroup. Similarly, in the October 2008 issue of Ethical Corporation Jon Entine observed that both Calvert and the Domini Social Index included JP Morgan, Citigroup, Goldman Sachs, Wachovia, Lehman Brothers and Wells Fargo among their largest investments.

In all, billions of investor dollars that could potentially support publicly traded companies such as Timberland, Wainwright Bank & Trust, Herman Miller and Interface – companies that deliver utmost social, environmental and financial value through the products they sell – are instead funding the institutions at the heart of the financial crisis.

The real question is: is this what socially responsible investors really want?

Reader comments on KLD’s blog shed some light on this issue. “Investors like me don’t care so much about companies investing in so-called CSR programmes,” says one commenter. “The companies that are worth the most to me are the [ones] producing the products and services that the world really needs.” Another commenter says: “As an industry we need to pay more attention to documenting how the principles that [underpin] SRI and CSR contribute to a company’s valuation. We spend too much time debating excess alpha and not enough time establishing the authentic, measurable contribution of positive externalities.”

Measuring positive externalities – the triple bottom line benefits against costs to communities around the world – is something many organisations are still trying to get a handle on. To what extent do companies make the world a better place? This basic question may prove to be the greatest indicator of a company’s ultimate worth, and rightful place in a socially conscious investor’s portfolio.

If ever there was a time to debate standards, criteria, methods, motives and goals out in the open, it’s now, on the anniversary of the near-collapse of the global financial markets.

Here are the first questions to address:

• Is the SRI industry effectively meeting the needs, wants and desires of today’s investors?
• How is the industry diverting funds from the companies that perpetuate environmental, social and economic crises, and channelling funds toward the socially and environmentally just companies that rebuild our economy?
• What are the industry’s goals, and what will it take to achieve them?