The stark reality of sustaining your ethics

Dubai: An Inconvenient Truth, the documentary that won an Academy Award this year about former United States vice-president Al Gore's quest to tackle the challenge of global warming gave a fillip to thousands of green groups the world over.

It may have given a prompt to investors who are looking for a possible reconciliation between their investments and sustainable development.

With growing awareness of climate change and ways to tackle emissions of greenhouses gases, sustainable investing as a socially responsible investing (SRI) approach is gaining momentum.

What has come to be known as socially responsible investing (SRI) or ethical investing has been on a rising trend in Europe and the US for over a decade now, and is increasingly catching on in emerging regions. It essentially designates investments in accordance with moral values, screening out companies involved in prohibited or 'sinful' practices or in businesses such as alcohol, tobacco, gambling and pornography.

While SRI has yet to become popular as an investment strategy in the Gulf or the Middle East, investment bankers of the region say that not only is there an increasing interest in it, but in fact some of the government-held companies and private business houses have been investing in global mutual funds and equity dedicated to SRI.

"We register a rising interest in these products as Gulf investors are starting to discover that these products show good-to-excellent returns with comparable (or even lower) risks," says Fideliz Goetz, chairman of Bank Sarasin-Alpen in Dubai.

"Investors willingly accept that in order to achieve this result a broader regional diversification is a prerequisite. It is a chance to diversify from a home bias in one's portfolio."

Bank Sarasin-Alpen and Bahrain based-Dexia Asset Management are among some of the investment banks and asset management companies offering SRI products that include bonds, equity, fixed income and structured products in the fields of sustainable energy. While Dexia has about $18 billion worth of assets under sustainability management, Bank Sarasin manages around $5 billion.

"In line with the increasing sophistication of regional investors, we have noted an increased interest in SRI across the region and the types of institutions," says Firas Mallah, head of Middle East office, Dexia Asset Management.

"As an investment philosophy established worldwide, and one that raises issues only when markets reach a certain level of maturity, we believe that the market here is starting to enter that phase where investors understand the typical risk/return trade-off and are now looking for more interesting perspectives, particularly concerning off balance sheet risks."

Sustainable investment

The sustainable investment approach considers sustainability-related issues in each sector and how companies integrate them into their day-to-day business.

Once the entire gamut of companies under sustainability is defined, principles of traditional asset management are applied to generate a diversified portfolio and investors can expect to have a risk/return ratio managed in the short, medium, and long terms.

To maximise financial returns for investors, SRI as an investment style may make sense for two reasons: (i) companies with a good environmental and social track record have fewer legal, reputational and regulatory risks, and (ii) integrating the environmental and social issues into a company's strategy opens up new opportunities such as renewable energy, organic food etc. Today more than 100 billion euros are managed according to core SRI criteria in Europe and more than 1,000 billion euros according to broader definitions.

Many of the sustainable investment funds manage mandates from pension plans, which are necessarily looking at styles that fit their need of managing portfolios with a long-term investment horizon.

Transparency is said to be the key for the development of SRI products.

"In Europe more and more companies communicate the ways to tackle environment, social and governance issues," says Mallah. "In certain European countries pension plans have to state to what extent they invest in SRI. And asset managers offering SRI can voluntarily disclose their method of screening applied in their SRI retail funds via the eurosif [European Social Investment Forum] Transparency Guidelines."

SRI research is simply a case of classic due diligence. "It is not only a question of 'how good a company is and what an investor should be willing to pay.' It is the question beyond: 'Why is the company in this state now and where is it going? Could it face certain environmental and social challenges that might pose future problems?'" Goetz adds.

But according to a Merrill Lynch Report on SRI released last month, though carbon reporting will become the norm, it is unlikely to be so in the short term due to a lack of resource and reporting mechanisms in place. "Investor initiative is likely to push this through more quickly than government regulatory or accountancy standard changes," the report states.

The performance of sustainable funds overall has been found roughly equivalent to that of traditional investments, in some periods outperforming the overall stock market and in other instances underperforming.

In theory, says Ali Termos, assistant professor of economics at American University of Sharjah, SRI is part of the larger pool of investments and so there should be no difference in their return compared to regular investment.

"SRIs are subject to market fluctuations like any other mutual funds. In fact they outperform the market when environmental awareness is on the rise, with 'green companies' in demand.

"However, SRI might be losing edge in full diversification scheme, particularly if the market performance of the 'sinful' industries is outdoing other industries. For example, nowadays in times of war, American corporations like Carlyle, Halliburton, are enjoying huge success through an enormous rise in demand for their goods and services. These companies are excluded from SRI portfolios.

SRI and Shariah

In the broader sense, SRI and Shariah investments both seek ethical approaches to investments. However, as Mallas points out, "although both approaches exclude the same industries, the SRI dimension screens investments based on a set of mostly qualitative criteria, whereas the Shariah-compliant dimension goes further, examining debt structure, the capital composition, interest revenues and financial ratios, adding a quantitative dimension to the screening.

Put simply, Shariah-compliant investments are usually a subset of the SRI universe, due to additional layers and types of screening."

Though no SRI fund has been launched in the Gulf region, Nick Robins, head of SRI Funds at London-based Henderson Global Investors believes it's just a matter of time before that happens. "It is inevitable. The question is obviously what particular mechanisms, that is what investments will be used in the region. With the amount of property investment going on, [one has to ask] how much of that really takes account of sustainability concerns? That's probably the first place to start. From what I have picked up, [as regards] private equity in the region and investors from the region going out people are interested in the sustainability themes."