The 2015 Credit Suisse Global Investment Returns Yearbook, released this week, includes a paper from the London Business School about the “growing pressure” upon asset managers to “demonstrate responsible investment behaviour”.
The ‘laissez-faire’ approach to investing – investing where returns seem most promising and ignoring social, environmental and governance (ESG) issues – is losing ground, said Credit Suisse.
Such an approach “embraces dishonesty and malfeasance”, as evidenced by the likes of Enron (false accounting), Lockheed (bribery) and Siemens (corruption), said the report.
The world’s largest asset owners now devote significant resources to ESG, with the UN Principles for Responsible Investment now listing 1,349 signatories with assets of over US$45 trillion (half of the assets of the global institutional investor market).
The Credit Suisse report discusses two options available to investors going down the responsible path: ‘exit’ (divesting) or ‘voice’ (engaging with the offending company).
A comparison of two US mutual funds – the Vice Fund (recently renamed the Barrier Fund) and the Vanguard FTSE Social Index Fund – suggests that taking at ‘exit’ approach may be costly for investors.
The Vice Fund has assets of US$290 million and invests in “industries with significant barriers to entry, including tobacco, alcoholic beverages, gaming and defence/aerospace industries”.
The Social Index fund, on the other hand, tracks an index screened by social, human rights and environmental criteria, said Credit Suisse.
Since the Vice Fund’s launch on 30 August 2002, the Social Index Fund has significantly underperformed it by 1.7 per cent per annum.
“Much of the evidence that we review suggests that, as illustrated by the Vice Fund, ‘sin’ pays,” said the report.
“Investments in unethical stocks, industries and countries have tended to outperform. For those for whom principles have a price, it is important to know the likely impact screening may have on both performance and diversification,” Credit Suisse said.
“Also, ironically, responsible investors should recognise that they may be partly responsible for the higher returns from sin,” it said.
The reason behind the last point, argues the paper, is that when companies have a lower stock price (due to divestment) they offer a buying opportunity to investors who are “relatively untroubled by ethical considerations”.
The paper concludes that responsible investors are better off using their ‘voice’ to engage with ‘sinful’ stocks rather than divesting.
“While it is not for everyone, a strategy of rotating attention to successive engagement opportunities (the ‘washing machine’ model) offers an interesting direction for responsible asset owners,” Credit Suisse said.
