Topic 2 - SRI

Question 1

SRI

Answer 1

Socially Responsible Investing (SRI) is a type of security selection, for all or part of a portfolio, in which positive and/or negative screening constraints exist to achieve social as well as investment returns.

Question 2

+ screening

Answer 2

Favor, or constrain selection to, those securities which meet defined criteria for inclusion in the SRI portfolio; effort to look for qualifying securities

Question 3

• screening

Answer 3

Constrain security selection to those which avoid a defined negative social impact.

Question 4

size of SRI

Answer 4

• 8T in SRI portfolios out of 40T total AUM (20% of all professionally managed assets are in SRI portfolios)
• grew 14x over last 20 yrs and 33% in last 2
• 1000 ESG funds at end of 2015

Question 5

fiduciary duty

Answer 5

• general duty of care and loyalty
• putting clients interests 1st
• treating all clients equally & avoid conflicts of interest
• fully disclosing all significant known investment risks
• acting in good faith
• having reasonable base of investment advice
• seeking best execution for client trades

Question 6

ERISA fiduciary duty

Answer 6

-even tougher than ordinary duty (responsible for managing plans ONLY in interests of plan beneficiaries)

Question 7

gov regulators’ attitudes towards SRI

Answer 7

SRI consistent with fiduciary duty if risk/return competitive with alternatives

-it’s ok to invest in SR assets if the asset would achieve equal or superior return on risk-adjusted basis to a non-SRI asset; has to be documented by investor

Question 8

ERISA

Answer 8

governs investments in retirement vehicles like defined benefit plans; investments themselves; & in overseas, the selection of assets to make available to participants in defined contribution plans

Question 9

DoL views on SRI

Answer 9

• seen in Rob Doyle: SRI OK if risk/return profile is competitive with other non-SRI investments the plan considers
• Bush admin released bulletin about documenting analysis of competitive returns
• 2015 issued bulletin, a major step in giving ERISA fiduciaries wider latitude for social investments; signaling more tolerant attitude by DoL towards SRI investments in ERISA plans (ERISA fiduciaries analyzing investments are now free to consider ESG policies of companies as potentially improving risk/return. )

Question 10

why pension plans are significant in SRI and impact investing

Answer 10

• bc they’re HUGE; have a large proportion of total investment space; 63% of total AUM are in retirement plans
• internationally, pension plans are a large proportion of total assets; their involvement with impact investing is crucial
• 33% in defined benefit plans = pay benefits according to set formula; get benefits regardless of pension performance
• rest is in defined contribution = participants have to make own investment decisions and payout depends on individual investment performance

Question 11

charitable (non-profit) boards and SRI

Answer 11

• if you’re an investment manager or trustee of an organization with certain goal, it may well be a part of your duty to you r stakeholders/beneficiaries to consider whether investing in that sphere would be carrying out the goals of the organization
• “In order to fulfill their responsibility to see that the [nonprofit] corporation meets its charitable purposes, [board members] may have a duty to consider whether their investment decisions will further those charitable purposes, or at least not run counter to them.”
• would be true for many organizations w/missions (like universities)
• if you’re Catholic charity w/o constraints on endowment portfolio, this could go against what you want to support`

Question 12

ESG

Answer 12

Environmental, Social and Governance factors in investment decisions

• E = climate change mitigation; sustainability
• S = any social return factor that isn’t E or G
• G = governance; good corporate governance is inherently a social good; CSR, greater board diversity

Question 13

examples of negative screens

Answer 13

– Example: Not investing in tobacco stocks

– Example: Not investing in South Africa due to apartheid (pre-1994)

Question 14

examples of positive screens

Answer 14

– Example: Investing in firms whose products benefit the environment
– Example: Investing in firms where at least 40% of directors are female

Question 15

fund types that can be SR

Answer 15

there’s a wide variety of investment fund types including: mutual funds, ETFs, separately managed accounts, variable annuities, closed end funds

Question 16

topics important to institutional investors for 2016

Answer 16

• most important = conflict risk (terrorist or repressive regimes)
• following: climate change/carbon, E (general), S (general), G (general), board issues, exec pay, human rights, tobacco…

Question 17

MSCI Indices

Answer 17

• biggest provider of indices in this space
• after acquiring KLD 400, created of large family of SRI indices
• MSCI Global Sustainability indexes
• MSCI Global SRI Indexes

Question 18

MSCI KLD 400 Social Index

Answer 18

• 400 primarily large-cap US corps
• Designed to be like the S&P 500 except including set of (negative) SRI screens
• acquired by MSCI in 2010

Question 19

MSCI Global Sustainability indexes

Answer 19

• Target highest ESG-rated companies making up 50% of market cap in each sector of underlying index
• Ex. MSCI World ESG index = large and mid-cap securities in developed countries; Include companies with high ESG rankings relative to sector peers

Question 20

MSCI Global SRI Indexes

Answer 20

Target highest ESG rated co’s making up 25% of market cap in each sector of underlying index. Targeting 25% instead of 50% of parent index = more rigorous screening

Question 21

MSCI IVA

Answer 21

• intangible value assessment
• MSCI’s methodology for generating company scores on various SRI/ESG measures to qualify or disqualify a company (or bond) for index inclusion in MSCI World Index (every stock of a certain size in developed markets)

Question 22

MSCI IVA

Answer 22

• intangible value assessment
• making a partly subjective judgement from 1-5 for companies
• MSCI’s methodology for generating company scores on various SRI/ESG measures to qualify or disqualify a company (or bond) for index inclusion in MSCI World Index (every stock of a certain size in developed markets)

Step 1: Identify Key ESG Drivers of Risks and Opportunity for Each Industry
Step 2: Evaluate Risk Exposure and Risk Management Step 3: Rate and Rank Each Company against Sector Peers

Question 23

DJSI

Answer 23

• 1st global sustainability benchmark

- Include only companies that fulfill certain sustainability criteria better than majority of peers

Question 24

Calvert Investments

Answer 24

• Asset manager, mutual fund family with proprietary index
• Separate foundation promotes SRI & CSR
• performs social audit on 1000 largest US Co’s in DJ Total Market Index; evaluates products, environment, workplace, integrity

Question 25

How MSCI builds index

Answer 25

– Run negative screens on companies with stocks in parent index
– Run positive screen for companies with the highest ESG ratings comprising 25% of the market cap in each sector and region of the index
– Threshold scores

Question 26

how to create socially screened portfolios

Answer 26

• Start with a universe and/or benchmark
• Screen companies for specific concerns:
-use blended ratings from multiple raters
-use internal/proprietary screens
-CalPERS Corporate Gov Focus list
-MSCI ESG IVA [Intangible Value Assessment] methodology
Step 1: Identify Key ESG Drivers of Risks and Opportunity for Each Industry
Step 2: Evaluate Risk Exposure and Risk Management Step 3: Rate and Rank Each Company against Sector Peers

Question 27

CalPERS Corporate Governance Focus

Answer 27

list of poor performers that have been targeted for activism by CalPERS

• Barber: post-addition returns outperformed S&P 500
• CalPERS adopted confidential strategy rather than public “name and shame” Focus List

Question 28

Geczy, Stambaugh and Levin (2006)

Answer 28

-is there a cost to SRI Investment?
• On an aggregate basis, the SRI constraint does not tightly bind for a typical optimal equity mutual fund investors seeking the highest ex ante reward-to-risk tradeoff
• In addition, in the case of market index investors, the expected SRI cost appears low for reasonable parameters
• However, the SRI constraint has expected costs when one believes that
– “style” matters, or
– fund managers have skill, or
– pricing models in the industry have flaws

[cost of SRI constraint is relatively low if you’re na index investor; however if you think that investment style is important and you want to have a style tilt, or if you’re seeking alpha, SRI constraint is considerably more costly]