2009 Lane Reports

What's Next for Socially Responsible Investing?

The Lane Report, March 2009
Sunday, March 1, 2009
by Marc J. Lane

Starting with the Quakers and other religious groups such as Wesley's Methodists in the 1700s, Socially Responsible Investing (SRI) initially provided a way for investors to express their religious views. Today, SRI provides investors the opportunity to select investments for their portfolios that advance a wide range of environmental, social justice, and/or corporate governance (ESG) values. Since its beginning, such investing has been done through the exclusion of what is often referred to as "sin stocks." However, recently that has changed.

Today, investors have the option of using an inclusionary investment process known as Advocacy Investing®, and with its introduction, SRI or perhaps better described now as "principled investing" took a giant leap forward. The concept of Advocacy Investing® is to seek out prospective common stock holdings in portfolios through affirmative selection criteria (be it environmental, social justice, or corporate governance issues), on a "best of class" basis. This approach avoids the diversification risk associated with traditional exclusionary screening and has allowed "values-based" investing to move 180 degrees from the "one size fits all" standard employed by most mutual funds and Portfolio Managers to a highly customized approach that truly reflects each investor's values.

By positively focusing screening criteria on an individual investor's core set of beliefs or values, a Portfolio Manager using the Advocacy Investing® approach builds a fully diversified portfolio of individual stocks that directly reflects a client's personal values. Additionally, since the portfolio is fully diversified, this is done without sacrificing expected future returns. This change in focus to "screening-in" companies reflecting desirable company behaviors as opposed to "screening-out" entire industries has provided us with a methodology that avoids the performance sacrifice often seen with purely exclusionary approaches as a result of the obvious diversification risk. Additionally, by choosing the best rather than simply avoiding the worst, the Advocacy Investing® approach gives investors a voice for their values and concerns by making them owners of those companies and through their direct ownership they have voting rights and the ability to influence corporate boards.

The challenge is that this process is much more difficult that simply using exclusionary screening. To make Advocacy Investing® work, there must be availability of information, significant research and a through analysis of securities. The Portfolio Manager and his team must first apply the meticulous financial analysis that must be done for any well managed portfolio. Typically this initially involves a top down view of the market making well thought out sector adjustments. Then rigorous fundamental analysis of the securities within a sector is completed to establish a pool of potential securities financially acceptable for inclusion within each industry sector and/or sub-sector. These acceptable securities within each sector are then evaluated against the values of the particular investor and through the combination of strict financial analysis and faithful application of ESG criteria a "best of class" security is identified, allowing the portfolio manager to then select a portfolio of fundamentally sound securities that also reflect the core ESG values that each client or group of clients want to support, while maintaining full diversification across all economic sectors. Desired corporate behavior is effectively "screened-in" as opposed to simply carving out whole industry sectors and/or sub-sectors, thereby preserving expected future return while maintaining the portfolio risk level associated with a fully diversified portfolio. Once companies are selected for portfolio inclusion, they are continuously monitored to ensure that they continue both to demonstrate sound fundamentals and to reflect the clients' specific ESG values.

Where do we go from here?

Advocacy Investing® has been a huge step forward for the industry. Despite the enormous swings we have seen in the market, the approach has demonstrated market beating performance for 1Y-3Y-5Y. So what is next?

Unfortunately, the information required to manage accounts using this approach currently only meaningfully exists for very large publicly traded U.S. companies, and much of it is available only as a result of public pressure, rather than regulatory requirement. Even this information is not as complete as it should be. The next step must be to expand the availability of operational information to include all publicly traded securities. Investors must demand not only financial transparency but also operational transparency. Companies seeking to attract investor dollars must be willing to share information about not only the money that they claim that they have made but information about how they made it.

In the Advocacy Investing® portfolios we manage, we have over time, seen positive correlations between the performance of companies with strong corporate governance and responsible behavior, and their corporate profitability. It is logical to conclude that this dynamic will also apply to both smaller firms and non-U.S. companies. As investors, we must demand full disclosure from all publicly traded companies. Today, many companies and their investors still take an extremely short-term financial view that sacrifices long-term viability for the sake of a slightly better "quarterly" return. The standard must become full transparency of not just of "the numbers," but also of a company's policies, practices and methods of doing business. If there is any lesson to be learned from the financial meltdown of 2008, it is that all the old rules still apply. Boring, well run, responsible companies do better than high-flying, poorly run companies no matter how "slick" they appear. Now, we need to demand the tools to figure out which is which.

Marc J. Lane (mlane@marcjlane.com) is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law.

Reprinted with permission from Crain Communication Inc., Copyright 2009

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The Lane Report newsletter is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2008 The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.


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