WEALTH: Financial & Lifestyle Perspective from Northern Trust - Summer 2008 - The Evolution of Socially Responsible Investing

The growth of socially responsible investing is providing investors a host of conscientious vehicles for smart long-term investing.

For years, the notion of socially responsible investing (SRI) — putting your money into companies that represent and uphold your personal values — was considered a fringe strategy.

No longer. Last year, $2.71 trillion — roughly one of out every nine dollars under professional management in the United States — was invested in companies based on their environmental or social records, according to the Social Investment Forum. That’s up from $639 billion of SRI investments in 1995. As interest in — and acceptance of — these so-called “fringe” investments skyrocketed, they have become an investment force to be reckoned with.

Once Fringe; Now a Force
In 1971, PAX World launched what is widely regarded as the first publicly available SRI mutual fund, the Pax World Fund (now called the Pax World Balanced Fund). The Fund’s founders, Dr. Elliot “Jack” Corbett and Rev. Dr. Luther Tyson, a pair of United Methodist ministers, sought to screen out weapons manufacturers and other businesses whose values didn’t mirror their own. This introduced the concept of screening to the investment world, and began to attract investors who felt uncomfortable profiting from companies that went against their values.

The options available to socially conscious investors have multiplied. Where once they were limited to one or two funds that screened out companies based on very limited factors, investments now can screen based on a variety of ethical considerations to match an investor’s personal values. Today, “mainstream” mutual fund companies offer as many as 250 SRI funds, up from just 55 in 1995, according to the Social Investment Forum. Some of these represent newly conceived mutual funds and indexes. While others repurpose and refocus existing ones.

Focusing on the Future
One of the newest strategies to arise from the SRI evolution is the idea of sustainability investing. Investors interested in sustainability proactively seek out companies engaged in good behavior, rather than passively exclude those engaging in bad. These investors believe that companies with sound environmental, social and governance (ESG) policies are not only better ethically, but financially.

This new branch of SRI advocates marrying ESG research and traditional financial analysis (price-earnings, cash flow, return on equity, etc.) to aid long-term evaluation, as companies that ignore these issues often are more likely to incur financial, institutional and public relations risks in the future.

“It’s become increasingly clear to individual investors and fiduciaries that having prudent environmental policies, ethical corporate organization and well-thought-out supply-chain management helps protect corporations over the long term,” says Thomas Kuh, managing director of indexes at KLD Research and Analytics in Boston. KLD is an independent investment research firm and one of the leading authorities on social research and indexes.

Performance Counts
Regardless of their origins, the influx of cash committed to SRI strategies also reflects that many of these vehicles are earning well-regarded, appealing returns. For investors, that means it can pay to put their money where their convictions are.

“There is now overwhelming evidence that you do not sacrifice performance by investing in this way,” says Joe Keefe, CEO of Pax World Funds in Portsmouth, N.H. “It has become apparent that this second layer of research (for sustainability vehicles) provides a better view of a company’s long-term potential.”

Introducing the Northern Global Sustainability Index Fund

Northern Trust recently launched the Northern Global Sustainability Index Fund. This fund mirrors the composition and performance of the KLD Global Sustainability Index, a benchmark of companies that demonstrate superior management of environmental, social and corporate governance (ESG) issues. The fund seeks to balance attention to social benefits with the pursuit of attractive financial returns by taking a sector-neutral approach to limit risk, and by assessing companies in all industries to draw from a broad investment universe.

To find out how socially responsible or sustainability investing may enhance your overall wealth management program, or to receive a prospectus for the fund, please contact your relationship manager or visit northerntrust.com/sri.

Before investing, you should carefully read the prospectus and consider the investment objectives, risks, charges and expenses of the Northern Global Sustainability Index Fund. The prospectus contains this and other information about the fund. Northern Funds Distributors, LLC is not affiliated with Northern Trust.

SRI funds have provided investors with solid historical returns, as evidenced by the long-term performance of the Domini 400 Social Index, which comprises 400 primarily largecap U.S. corporations selected based on social and environmental standards. Begun in 1990 by KLD Research and Analytics, the Domini benchmark is not only the first SRI index of its kind, it has also consistently outperformed the S&P 500. The Domini index was up 10.85% between its inception May 1, 1990, and March 31, 2008, compared with 10.41% for the S&P 500 during the same period.

Getting to the Heart of the Matter
Profitability matters, but SRI at its heart still represents an opportunity to use investments to drive real-world change. A cornerstone of sustainable investing, this concept has withstood the evolution of SRI and remains an overarching consideration in many advocates’ portfolios. Awareness that ESG factors affect a company’s bottom line also has fostered increased shareholder advocacy and community investment.

“Voting on proxy statements is so important,” says Peter Kinder, president of KLD. “You have to ask, ‘Who is being nominated to the board of directors? What are a corporation’s compensation provisions?’”

What Is Sustainable Development?

Everyone seems to be talking about sustainability — typically a shorthand for the concept of sustainable development. Is this just the latest corporate buzzword, or does sustainable development really mean something?

KLD Research & Analytics, Inc. has developed a very specific — and measurable — definition of sustainability for its KLD Sustainability Index, which rates companies on their business practices in this area. According to KLD, in a global economy, sustainability pertains to the effect corporations have on:

Key stakeholders, such as employees and communities: supply chain management is critical because of its human rights, labor rights and community relations implications.
Society in general: the effect of corporate activity on public safety and public health; whether and how companies externalize costs and how those costs might be shifted to future generations.
The environment: how air, water and land pollution define a firm’s environmental footprint; its efficiency and pollution-prevention initiatives; environmental management systems.
Governance: governance practices; ethics policies and practices (i.e., related to bribery and corruption); lobbying activities; compensation.

Understanding the Terms of SRI

Proponents of socially responsible investing (SRI) seem to speak their own language. And if you’re new to the topic, it can be hard to follow. Here is a quick primer to some of the more common SRI terms.

Community development: Supporters of community development use their investments to inject cash into areas that otherwise would not have access to it. They typically do this by extending loans to people in lower-income communities that commercial banks avoid because of the credit risks involved. The more recent micro-credit phenomena could be considered an offshoot of community development as well.

Screening: When investors who didn’t want their investments to support the Vietnam War began looking for alternatives, they introduced the concept of screening to the investment world. Today, investors can screen out companies engaged in a wide range of behaviors or doing business in certain countries. Screening remains the most prevalent form of SRI today.

Shareholder activism: Shareholder activism attempts to use shareholders’ power as owners of a company to encourage corporate responsibility or force companies to change how they operate. This is the second most common form of SRI.

Sustainability: Many investors now are shifting their focus to a broader approach to SRI by focusing on companies with policies, products and services that promote the development of a sustainable economy. Investors following a sustainability approach believe a company’s environmental, social and governance (ESG) factors not only benefit the environment and society overall, but also the company’s current and future profitability.

Often this shareholder advocacy also can inspire a company to focus on particular issues that have become important to shareholders.

For example, the Vietnam War took center stage during the late 1960s and early ’70s as investors began to avoid investing in companies profiting from the war. In the 1980s, many active SRI investors divested their portfolios of companies involved in South Africa, a move that eventually helped end apartheid. Today, workers’ rights in Asia, human rights issues in Darfur and global environment — especially climate control — are issues of concern for many shareholder advocates.

This environmental concern has sparked the creation of SRI-related exchange traded funds (ETFs) that track indexes related to water, clean technology, alternative energy and the crisis in the Sudan.

Your Ethics, Your Portfolio
Although sustainable investing is challenging many of the established business maxims, some tried-andtrue principles remain sound. Most experts agree that investors wanting to follow an SRI approach should view it as part of an integrated long-term investment plan. Here are a few guidelines to help you get started in SRI investing:

As SRI continues to evolve, more and more investors are discovering that socially responsible investing need not be driven by good intentions alone but also can help you pursue appealing returns.

“It’s a historical shift,” says Keefe. “Investors are coming to the realization that their investments no longer need to be out of alignment with their values. And they’re taking advantage of the opportunity to do so.”