National Advisors Trust Conference
Hilton Head, South Carolina
April 24, 2008

SRI’s Moment

I’ve been deeply involved with socially responsible investing – SRI – since 1983. Three times since then I’ve heard, “SRI’s time is here!”

I heard it first in the late 1980s, following the South Africa divestment legislation and the Exxon Valdez disaster. SRI grew, but not exuberantly.

Again, I heard it following Enron and the dot-com bust. SRI continued to grow, but not exponentially.

Now financial services experts are saying SRI’s time is here, in the wake of the credit crisis. This time, they’re right.

The reasons why SRI has arrived will have an impact on your business across the board – not just the business you’re doing or might do with SRI clients. And that’s what I’m going to talk about this afternoon – the changing environment’s impact on you.

KLD & Its Clients

KLD provides advisors, managers and institutional investors with SRI research, benchmarks and compliance products. SRI is all we’ve ever done, all we’ll ever do.

In 2005, we invoiced 250 clients. In 2007, 476. We crossed 500 a month ago. Why are those numbers significant to you?

“Old” & “New” SRI

Since KLD’s founding in 1988, our client base has been advisors and money managers. Starting in 2004, we began to see new types of clients with different approaches to SRI from those of our traditional clients. Both categories of client hold importance for you.

Before I go any further, I want to say something about “old” and “new.” These words imply values. “New” is better than “old” – except of course when “old” is better than “new.” They really don’t make it like they used to; one’s reaction is either “too bad” or “thank God!”

“Old” and “new” are especially unhelpful in talking about SRI. What’s new in SRI is that large institutional investors are entering the field. “New SRI” is an approach suitable for these mega-institutions.

Two examples: the California Public Employees Retirement System (CalPERS) and the Canada Pension Board (CPB).

Just last week, CalPERS announced it had adopted innovative – if not unique among US institutions – proxy voting policies on environmental and diversity issues.

The CPB has broadly incorporated social, environmental and governance criteria in its investment decision-making for at least five years.

CalPERS and CPB are leaders and early adopters amongst the new entrants. Others are following them into the field.

Traditional SRI

Meanwhile, new “old” social investors are still entering the field in ever-growing numbers. So let’s start with who they are because they’re likely to be your clients.

Our traditional advisor clients served individuals and small to medium-sized mission-based organizations who wished to incorporate their values in their investment decision-making process. That’s the classic definition of socially responsible investing.

Note the word “incorporate” in the definition. Social investors do not substitute their values for sound financial practices. They add non-financial – social, environmental and governance – criteria. The result is a different – and I believe – deeper and richer view of their investments.

Originally, our clients’ individual clients were people of high net worth. While they continue to be important, they no longer predominate and haven’t for ten years. Today’s social investors span the entire range of individual investors.

In the past, typical institutional clients were mission-driven organizations, such as religious and environmental groups. Roman Catholic orders, for example, have played a leading role in SRI since the late 1960s. The Sierra Club has sponsored SRI funds for nearly a decade.

Our clients’ clients want alignment of their money and their missions to the degree prudently possible. So, they’ll demand companies with better environmental records, for example, or bar companies promoting casino gambling.

That’s traditional social investing. And as I’ve noted, it’s continuing to grow.

ESG & other “New SRI” Criteria

The new institutional entrants have different motivations than traditional SRI investors. They see environmental, social and governance factors – the ESG criteria – as value drivers or inhibitors. Their concern is with performance – or more precisely, risk – not alignment of their investments with their values. They look at companies such as PetroChina and their questions aren’t just about whether doing business with Sudan’s government is right or wrong. The new entrants ask what risk doing business in Sudan poses to the company’s reputation, or whether it risks material losses from the ongoing genocidal war.

The answers to those questions will vary with the investor, just as differently posed questions about Sudan would yield a variety of answers from traditional social investors. But the phrasing isn’t nearly as important as the asking.

The new entrants avoid identifying themselves with traditional SRI. They do not want to appear to allow values to enter their investment decisions. But how they describe what they do is less important than what they’re doing. They are using what are traditionally considered non-financial criteria in their investment processes. This is a positive development, representing the expansion of SRI and its transformation from values-based practice to a fiduciary perspective.

The Important Role of UNEP FI

The new entrants call themselves ESG investors or Responsible Investors. This last term is the one favored by the United Nations Environmental Programme’s Finance Initiative. It’s known as UNEP FI – doesn’t that roll off the tongue!

UNEP FI is the key to understanding why SRI is the current and next new thing – and to its impact on you.

UNEP FI began in 1999. Its objective was to bring large and ultra-large institutional investors – pensions, investment banks, insurers, charities and the like – into the discussion around climate change, and then to get them to do something about it. After many false steps, and some outright disasters, UNEP FI succeeded.

Driving the process were the enthusiastic personal support of then-Secretary General Kofi Annan; leadership and resources from Mercer Consulting and a number of Canadian, European and Australian institutional investors; and a creative, can-do UNEP FI staff. With some notable exceptions, Americans did not enter the discussions significantly until 2004. UNEP FI launched its Principles of Responsible Investment in 2005.

UNEP FI & You

UNEP FI succeeded because the issue of climate change has penetrated the public consciousness. Apart from some well-financed dead-enders here in the US, no one questions the existence of the climate change problem. What does UNEP FI’s success mean for you?

First, North American Signatories include Bank of America, Bank of Montreal, CitiGroup, Merrill Lynch, Royal Bank of Canada, and State Street. You can’t get any more mainstream than they are. SRI is here.

Of course, there are huge differences of opinion on what to do about climate change. Look at the renewed debate among investors on nuclear power: is it part of the problem or part of a long-term solution?

Some SRI funds, for the first time, now hold nuclear utilities. KLD’s Global Climate 100, for instance, holds Florida Power & Light. FPL is a nuclear utility but it’s also the nation’s leading wind power generator.

Institutions & Rising Water

Why have institutional investors reacted to climate change? I think it came down to a metre stick.

From my office window, I look out on the Fort Point Channel, an ugly man-made extension of Boston harbor, and the Federal Reserve 30 yards beyond it. I can see the Channel’s 25-foot-high west wall. Even a storm-driven high tide at the equinox stays a comfortable six feet below the top of the wall.

These days, the conservative estimate – the very conservative estimate – is that we’ll have a one metre sea level rise by century’s end. That’s 40 inches on a fair day. With low pressure and a wind behind it, the water’s over the top of the Channel wall and onto the grounds of the Boston Federal Reserve.

Suppose you’re an institutional investor holding City of London or Wall Street real estate. This sort of mental exercise focuses the mind like the prospect of hanging. The Thames floodgates would no longer protect the City. Both financial centers would see significant water intrusions. And then there’s Amsterdam….

Do any of you have clients in REITs with coastal holdings?

So it’s little wonder that sophisticated European investors for years, and American investors of late, have factored global warming into their investment research and decision-making.

The Dyke Breached

When I first got into SRI in the 80s, South Africa was the hot issue. Pension fund and endowment executives would tell me, “Look, if we divest, we’ll have to do a dozen other kooky things. We’re only going to consider the financial merits. We’re not going to let you breach the dyke.”

Harvard, for example, despite 25 years of negotiations, demonstrations, building occupations and the like, never divested its South Africa holdings. As recently as two years ago, Harvard Management Co. was still arguing against SRI.

Of course, the anti-divestors were right – sort of. Once you admit an extra-financial criterion may have a general effect on investments, WHOOSH! The dyke has just been sucked out to sea. The prospects of global warming and sea-level rise breached the dyke – permanently, I believe.

Global warming is far from the only extra-financial criterion that may have an effect on investments. Consider the looming crises in food and water. Consider the reaction to corporate political contributions and lobbying.

UNEP FI’s Principles for Responsible Investment commit their signatories to consider environmental, social and governance (ESG) factors in their investment decision-making. They now have over 160 signatories representing over US$13 trillion.

SRI’s Future & the Advisor
What does SRI entering the mainstream mean for you?

First, there’s a significant upside in understanding the demand for SRI products and offering them to potential clients.
SRI assets increased more than 18% to $2.71 trillion from 2005 to 2007, compared with a less than 3% rise for the broader universe of professionally managed assets. That’s according to a widely reported SRI trends study by the US Social Investment Forum.

Understanding this demand will put you well ahead. But the experience of most advisors I’ve talked to is that you will have to ask about a potential client’s concerns in this area. Many do not know they have options. The level of awareness of SRI has risen steadily over the years, but it is still low.

Second, products to meet this new demand are entering the market every week. Some are broad-based like our ETFs with Barclays; others are narrowly focused on clean-tech or water. Watch for new fixed-income products and a host of global vehicles later this year.

Third, increasing knowledge about non-financial criteria will change the norms of fiduciary duties – what a fiduciary must consider when making investment and portfolio decisions.

Fiduciary duties evolve with the times and with our knowledge of what factors affect investments.

In the early 19th century, whether equities were ever suitable trust investments was an open question. Harvard argued they weren’t in the case that gave us the Prudent Person Rule. Diversification entered the trustee’s duties after World War II. Preservation of nominal capital value only departed the fiduciary’s canon after the inflation of the 1970s.

The financial services industry is learning what SRI has known all along: Environmental, social and governance factors affect investments. So, they will also affect your fiduciary duties.

Fourth, the investment research you rely on – directly or indirectly – is changing. Research from a growing number of providers is incorporating ESG factors.

SRI is Here!

Whether you choose to serve SRI investors or not, SRI is going to change how you and your clients invest. More importantly, the factors underlying SRI are changing how you and they look at the world.

SRI is here. And it’s here to stay.