The CSR gap

The bulge-bracket investment banks have been very vocal about their commitment to CSR and sustainable investing over the last decade. Their critics, however, have always accused them of ‘green washing’ – seeking to attract positive publicity instead of demonstrating genuine concern for environmental, social and governance (ESG) issues.

Now Citigroup and JPMorgan have done their best to prove the nay-sayers right, with the cash-strapped banks scrapping their dedicated ESG research teams at the end of last year, just weeks after they were both singled out for praise at the annual Thomson Reuters Extel SRI awards.

Both banks insist they will incorporate ESG themes into their wider equity research but that is unlikely to be a substitute for specialist coverage. With the credit crunch continuing to take its toll, other banks have also been reducing head counts in their ESG research teams and more job losses look set to follow.

‘The cuts at Citigroup and JPMorgan send a very distressing signal that the management of the investment banks really don’t see the value in good-quality ESG research,’ notes Lucy Carmody, a director of Responsible Research, an Asia-based independent research house.

While these swingeing cuts have disappointed some in the world of SRI, however, many still believe the financial crisis could ultimately prove to be a catalyst for the growth of ESG-focused investment, particularly in Asia.

Suspicious minds
The speed with which the credit crisis unfolded has shattered confidence in financial markets and institutions around the world. Many listed companies – especially those in the financial sector – now trade at extremely low ratings not only because their prospects have been dimmed by the accelerating global slowdown but also as a result of a widespread lack of investor trust.

Proponents of SRI and CSR believe the best companies will be able to advance their recovery by taking a more holistic approach that incorporates specific non-financial goals. ‘Public trust and confidence in business and the markets have been seriously eroded,’ Noeleen Heyzer, executive secretary of the UN Economic and Social Commission for Asia and the Pacific, recently told a CSR conference in Singapore. ‘At the core of this crisis is a collapse of trust in the capital markets.’

In order to rebuild this trust, she added, firms must start ‘shifting the focus from short-term profit considerations to long-term sustainable value creation built around corporate responsibility and ethics.’

This view is also held by those operating inside the financial world. Shireen Muhiudeen of Kuala Lumpur-based Corston-Smith Asset Management has just launched a new fund focused on good corporate governance in South East Asia. Working with Hermes, the UK pension fund manager that has been a top cheerleader for good governance, she is confident she can offer investors an attractive risk-reward profile, particularly in light of the financial turmoil.

‘The root of this downturn is bad governance and a lack of transparency,’ Muhiudeen says. ‘Transparency is going to be a major factor in helping to encourage people to put money back into Asia. The whole emphasis of our fund is to have a minimum level of governance. If companies don’t meet that level, you might as well kiss your money goodbye.’

Poor practice
Geoff Williams, chief executive of OWW Consulting, an Asia-focused SRI research house, believes the subprime meltdown has shown up those who paid only lip service to the concepts of governance and transparency. ‘The root cause of this crisis was selling products to people the banks knew couldn’t afford those products,’ he says. ‘The companies suffering the most are those that can’t demonstrate good CSR performance.’

He points to the US auto makers, claiming their downfall was partly due to their failure to engage with ESG issues, and says they will struggle to attract investors until they change tack. ‘These companies aren’t producing low-emissions cars and they have been blackmailing the government over the future of their workforce,’ Williams comments. ‘So you won’t see investors looking at these companies even after the bailout.’

By contrast, companies such as HSBC and Standard Chartered – which have demonstrated a serious if not total commitment to CSR and good governance – have not fared as badly so far. Williams believes they will continue to be seen as ‘safe havens’ for investors despite the fact that they both operate in the much-maligned financial sector.

Asian stock markets have been hit by a massive outflow of capital over the last year, as risk-averse US and European investors have pulled out en masse. Asia-facing SRI fund managers, the majority of which are serving western clients, believe their broad-based approach can help attract money back into the region.

Hard facts
The key question for them, and for anyone interested in the SRI phenomenon, is whether responsible investment is really about outperforming the wider market or just ensuring certain minimum moral standards are applied.

Some pension funds (often those affiliated to religious or educational organizations) see SRI as a way to provide them with portfolios free of companies associated with industries they deem ‘immoral’, such as weapons production, alcohol and tobacco. Other investors, however, still believe SRI funds can outperform the market because they seek to invest in companies that are sustainable in the longer term.

Williams takes the latter view. His firm has run SRI indices in Singapore and Malaysia for the last two years, during which time the Singapore index has outperformed the benchmark Straits Times Index by 10 percent, and its Malaysian counterpart has come in 5 percent ahead of the Kuala Lumpur Composite Index.

That said, business schools and investment houses have so far struggled to come up with solid long-term evidence of SRI outperformance. ‘Is it about screening out or screening in?’ asks Sabine Doebeli, head of sustainability at Swiss fund manager Vontobel, which recently launched its first fund focused on sustainable companies in Asia. ‘We do both. In Asia, general sustainability standards aren’t as high as in Europe. If you can identify companies that are ahead of the curve, it makes an even bigger difference in a market that is behind the curve.’

Accentuating the positive
Nevertheless, Carmody argues that investors will increasingly be willing to ‘give up basis points to have the comfort of things not imploding on them. Because of the paradigm shift in the governance and trusteeship of pension funds, particularly in the US, we’ll see a situation where screening for negative activities becomes much more common.’

In addition, Carmody thinks a number of high-performance clean technology SRI funds will emerge over the next few years as the accession of US President Barack Obama brings with it a renewed determination to deal with climate change.

If more investors become interested in SRI, given the declining quantity of sell-side research on ESG issues, this knowledge gap will have to be filled. The UN’s Principles for Responsible Investment initiative has just launched a new global database for ESG research but it remains unclear who will provide the research, and how they will be incentivized to do so.

Independent research firms such as OWW or Responsible Research, which sell their wares directly to fund managers rather than being reliant on commission payments, are hoping the investment banks’ loss can be their gain.

‘There will be far greater numbers of qualified analysts in the marketplace who will hopefully end up working in independent research houses like ours,’ adds Carmody.