The Myners Review of Institutional Investment: Is SRI the answer?

Summary

Claros Consulting considers that Socially Responsible Investment (SRI) may help answer the concerns over a lack of long term investment that underlie the Myners Review.

The SRI community has lead the way in exploring long term themes in investment, such as sustainable development. In addition, the work done by Nottinghamshire County Council on a long-term investment strategy identified clear links to socially responsible investment.

Furthermore venture capital is increasingly recognised as a form of socially responsible investment, and recent increased interest in SRI among pension funds may help encourage investment in venture capital.

The challenging issues of corporate restructuring and plant closure are starting to be considered by SRI investors. While industrial change is inevitable, it can be managed with varying levels of competence. To encourage best practice in this area attention is starting to focus on the use of tools such as "managing change" reports and the improved measurement of corporate reputation and human capital.

Interest in SRI has increased substantially among institutional investors because of the new regulation requiring pension funds to state their policy, if any, on social, environmental and ethical issues. A similar measure could be considered to encourage a longer-term perspective to investment strategy.

Most importantly and in view of the need for joined-up policy within government, the Review should place a high priority on dialogue with the socially responsible investment community and on understanding the potential synergies.

Full Statement

On May 16th the consultation paper for the Myners Review of Institutional Investment was published. It outlines the key questions that the Review will cover, and make clear that the Review is intended to be far-reaching and fundamental in its scope. Claros Consulting welcomes this review, as addressing some real and important issues.

However, it is important that the Review identifies synergies with existing activities, and that the recommendations to the Government are "joined up" with other policy initiatives. In particular, Claros Consulting calls on the Myners Review to explore the synergies with the Socially Responsible Investment (SRI) industry in the UK, and with recent policy actions in this area.

As the Review’s fundamental goal is to help to ensure that British institutional investment is adequately long term and works in the interest of the United Kingdom, the Review should recognise that it shares substantial common ground with the SRI community. Many SRI investors already have a longer-term view of their investments and are aware of their broader responsibilities to society. The potential role of SRI is particularly pertinent in view of the recent regulation requiring pension funds to disclose their policy on social, environmental and ethical issues. This comes into force on the 3^rd July, and has already increased interest in the various approaches to SRI among institutional investors. [It is important to stress that SRI has long moved away from simple negative screening of "sin" stocks to consideration of complex issues such as the treatment of employees, environmental management, and human rights with an growing emphasis on understanding how they link to management quality and shareholder value. Furthermore a wide range of approaches to implementation are used ranging from shareholder engagement to independent ratings.]

In particular, it is worth noting that SRI investors have been at the forefront of exploring long-term themes in investment. Notable is the work done on investment and sustainable development by a number of socially responsible investors. Such investors analyse the opportunities and constraints imposed by sustainable development, and identify companies likely to contribute to, or benefit from, these changes, on basis that such companies are likely to produce superior long term returns. Responsible forward thinking businesses already recognise the importance of sustainable development and welcome such investors. In the view of one investor "An analysis of the environmental and social aspects of industries contributes to a rational long term view of long term value, thereby providing a logical and practical basis for an investment strategy". In a complementary move, a major inquiry into a long term investment strategy conducting by Nottinghamshire County Council (possible the only such inquiry undertaken in recent years by a pension fund) concluded that social and particularly environmental issues appeared highly relevant in shaping a long term investment policy. While much of the focus to date among SRI investors has been on environmental sustainability, recently interest has grown substantially in social aspects of sustainability. The fundamental goal of such investors remains to invest for the long-term in companies able to achieve sustainable, long-term growth.

On the key issue of venture capital, many in the SRI community recognise that venture capital can generally be regarded as a form of socially responsible investment. The principle reason is because of the major positive impact on job creation. In addition, venture capital tends to be focused in areas that are generally considered more "ethical" (with the possible exception of biotechnology). In my recent book on SRI for pension funds and institutional investors I recommend that pension funds firstly recognise their investments in venture capital as part of their SRI policy and secondly consider increasing their allocation in this area as part of a positive response to the disclosure initiative. (It is worth noting that PGGM, the €50bn Dutch pension fund, has acknowledged venture capital as part of its SRI strategy and indeed has apparently recently increased its venture capital allocation from 5% to 7.5%.) While it is too early to say how great an impact the disclosure regulation might have on asset allocation to venture capital, it provide a useful additional argument for such investments.

While not explicitly mentioned in the introduction to the Review, it is clear that an underlying issue for the Review is the issue of jobs and corporate restructuring, particularly in the light of events at Longbridge and Dagenham. Here the SRI community can provide some practical assistance and ideas for the way forward. Firstly, the SRI community recognises clearly (and perhaps more consistently that the UK government) that the best prospects for the UK are likely to come from investing in industries and companies with sustainable, long-term growth prospects. That said, there are clearly challenges with older industries and with restructuring (including events such as mergers, acquisitions, disposals and outsourcing), and such companies and events cannot be ignored. Here, some interesting research and possible solutions are emerging from the SRI community (with much work being done in this area in continental Europe). There is concern among SRI investors that far from enhancing shareholder value much restructuring destroys it in the longer term, often because of the damage done to vital assets such as corporate reputation and human capital.

Thus socially responsible investors are at the forefront of seeking to understand such forms of intangible capital – if such value can be more clearly identified, it will be easier to identify the damage and to resist short term pressures. Evidence is emerging that companies that treat their employees well do indeed prosper in the long term. In addition, while change is inevitable in a fast moving world economy, it is also clear that it can be done well or badly, and that policies and procedures to encourage best practice are desirable. One suggestion for addressing the issue of restructuring has been made by a high-level working group for the European Union. This is that companies should develop policies in this area and publish a "managing change report". This should cover, inter alia, what major changes the company envisages; how it will deal with them and how the employability of employees will be maintained. It is an idea that should find substantial support among SRI investors and they are likely to take the lead in encouraging its adoption, for instance through shareholder engagement. (It should be noted that if institutional investors take a longer term attitude to investment then the important of good corporate governance will increase sharply).

There are also a number of practical lessons for the Review that could be learnt from the SRI community as it has sought to gain acceptance among institutional investors and long term fund managers, including pension law, the role of consultants and benchmarks. These will be covered in more detail in a separate document. (One key area, which Claros is currently researching, is a new financial benchmark that would much more clearly link institutional investment and UK jobs.) However, the experience of the regulation on disclosure of social, environmental and ethical issues by pension funds has some useful general lessons for the Review. After a period of initial scepticism and hostility the financial community has started to work out how it can include social environmental and ethical issues in its investment practices in a practical and more positive way. While it is still early days it is clear that a relatively simple measure which does not impose major regulations or force major change can have a significant positive effect. One possible option for the Review might therefore be to recommend expanding the disclosure requirement to include mention of long term strategy and venture capital explicitly.

It would be wrong to claim that the SRI community has all the answers to the issues of long term investment. However, it is certainly the section of the investment community that is likely to have the greatest interest in exploring this area and to recognise its broader responsibility to society as a whole. Secondly it is likely to have useful technical experience in understanding the analysis and investment approaches required to make long-term investment a practical reality. Finally, the practical experience of the obstacles SRI has faced getting accepting will help identify some key issues for the Review. Thus a dialogue with the SRI community is likely to be highly productive and should be a priority for the Review.

23^rd May 2000

© Mark Mansley / Claros Consulting. Reproduction permitted with attribution.

This document does not contain investment advice