The panellists

Paul Palmer (chair)	Victoria Woodbridge	Emma Howard Boyd
Cass Business School professor of voluntary sector management	EIRIS senior client relationship manager	Jupiter Asset Management head of socially responsible investment and governance

Henry Boucher	Nicola Donnelly	Adam Ognall
Sarasin deputy chief investment officer	UBS director and investment manager on the Charity Team	UK Social Investment Forum deputy chief executive

James Dutton, Charity Commission, senior legal policy adviser

There are still plenty of people who remain sceptical about the effectiveness of ethical investment. That can be attributed in part to a perception that ethical funds find it hard to generate returns – even though the evidence that such funds can be successful is now plentiful – but also because, the sceptics suggest, there’s a danger that any attempt to introduce moral judgement into investment decisions leads to interminable arguments among trustees as to where certain lines should be drawn.

One response to that problem has been a tendency to try and take the word ‘ethical’ out of the equation, and talk instead about socially responsible investment (SRI), or sustainability, but that still doesn’t necessarily end the unproductive philosophical debates.

Trustees need to find some way to avoid that stage. After all, there isn’t time for endless arguments at investment committee meetings. Instead, trustees need to know how and where to make a start, says Victoria Woodbridge.

“Trustees tend to have three basic questions,” she says. “The first is ‘can we do it?’, referring to the legalities of it. The next one is ‘would it affect our fiduciary duty’, are they going to be able to make as much money as if they didn’t invest ethically? And the third, perhaps most complicated question is, ‘how do we do it?’ And I think that’s where people get confused, certainly in a lot of smaller and medium-sized charities.”

Trustees seeking to develop an ethical investment strategy are most likely to use the Charity Commission’s Guidance on the subject (CC14) as a starting point. The relevant chapter of this document was based on the 1991 “Bishop of Oxford case”, now regarded as the case that established the principles of ethical investment by trustees.

In this case the Bishop of Oxford challenged the investment policy of the Church Commissioners, specifically on the extent to which companies doing business in
apartheid-era South Africa should be excluded from investment consideration. The
Guidance outlines and expands on the principles established by that case.

The first is that a form of investment can be ruled out of consideration whether or not there’s any risk of economic detriment to the charity, if that form of investment is manifestly incompatible with the charity’s mission. An obvious example would be a cancer research charity not investing in tobacco stocks.

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The Bishop of Oxford case judgement also suggested that, short of direct incompatibility with a charity’s mission, it was also possible to envisage instances where trustees might feel that the making of a particular form of investment could reduce the level of public support it enjoyed, or make beneficiaries or potential beneficiaries reluctant to use the charity’s services.

“In this context [the judge] said trustees were entitled to perform some sort of balancing act: to weigh the risk of loss of supporters against the risk of loss from excluding the relevant investments from consideration,” says James Dutton.

“And finally he said that, in those cases where the trustees couldn’t perform this balancing act, they might exclude it from consideration if there was no significant risk of economic detriment.”

The Guidance is designed as a dynamic document that can be updated and amended as necessary. But in essence it provides the foundations upon which charities can develop the guiding principles of their own ethical investment strategies, in line with their own ethos, mission and overall investment objectives.

It is also intended to overcome the fear among some trustees that SRI is in some way an illegitimate use of assets, and a subversion of fiduciary responsibilities.

Fund managers can also play a useful role in helping trustees understand the choice of products now available, says Emma Howard Boyd. “There’s a need to help the trustees understand which might be the most suitable route for them to take, before they even start choosing between X fund management product and Y fund management product,” she says.

She believes there’s still not enough knowledge in the charity sector about the extent to which fund managers have evolved new products that enable charities to pursue a wide variety of strategies. “In most conversations that I’ve had with trustees, the starting point is that it’s about avoiding parts of the stock market, as opposed to the very different options that now exist,” she says. “It’s about understanding the range of options that might be suitable.”

Nicola Donnelly stresses the value of the fund manager applying the same rigorous modelling and analysis to the potential impact of pursuing SRI strategies as they would to any other change in an investment strategy. She warns of the importance of putting that process in motion as quickly as possible, because of the timescales associated with the workings of an average charity investment committee.

“If we don’t do that in time,” she says, “then I think we find that they go for the ‘get rid of the issue’ solution, saying ‘oh, it’s going to have an impact on the financials, let’s not go there’, and they come to a statement which says ‘we thought about ethical considerations, but we’re not going to include them, because it would impact performance’.”

This is undoubtedly one of the reasons why less than five per cent of total investable assets in the charity sector are currently held in SRI funds. The sceptics, of course, would argue that this is no bad thing. Among them are some of the world’s most high profile philanthropists, including Warren Buffet, one of the most successful investors of the last half century, who maintains there is little point in basing investment decisions on anything other than hard business logic.

Adam Ognall responds by pointing to the principle of a charity or foundation aligning its investments with its mission. “For some foundations it might not be appropriate to exclude, or to positively screen, unless you see a growth area in clean technology which you think is important, or if that links in with your grant-making,” he says.

“But as a large, long-term investor you’re looking for long-term returns. This factors in social, environmental and governance issues as an impact on companies, both because that might improve the company’s performance over the medium to long term, and also as a foundation looking to improve society and seeking social and environmental good.”

If a foundation doesn’t exclude any stocks, he argues, its investments might undermine the activities it funds: “If you are investing in companies which are heavy polluters, in an area where you’re funding environmental groups to clean up pollution, is that the most effective use of your resource?”

Ognall also wonders why these foundations are not seemingly so interested in the example being set by foundations elsewhere, such as the Wellcome Foundation, that seek to influence the practices of the companies in which they invest.

“They are actively speaking to the management of the companies they own, to make sure they are looking at environmental, social and governance issues, not saying ‘you’re a bad company’, but saying ‘are you aware of the risks that climate change is exposing your company to? We are concerned about these in terms of your ability to deliver us long-term performance’.”

Perhaps another important difference between perceptions of SRI on opposite sides of the Atlantic is the extent to which the green agenda has entered the political mainstream in the UK. “One of the most significant things to have happened in the last couple of years was the publication of the Stern Review,” says Howard Boyd. “I think that has moved the environmental agenda to a completely different area.” But the new environmental focus has also brought with it additional complexity.

“It’s something new coming into the whole investment universe, and people are beginning to ask questions about what carbon emissions really mean, or how far carbon pricing is going to go,” says Henry Boucher.

“The whole idea of the monetisation of carbon: is it going to extend into the monetisation of water? What are the long-term investment implications? If I’m going to try and make a statement in my investment policy to try and cut down the amount of carbon emissions, where do I draw the line? Coal-producing investment is clearly very bad, but can you turn round to your fund manager and say ‘cut out all coal’? What about gas? How bad is agriculture? You get into all sorts of quite complicated thought processes. And I think it’s gone beyond ethics. For many people it’s gone into practicality.”

Meanwhile, adds Donnelly, rampant oil prices mean that investment in green technology is now more viable than in the past. Rising green consciousness seems to have led to more private clients and large institutional investors asking fund managers what they are doing in this area, which is having a knock-on effect on the services and products being offered to charities.

Market forces

Paul Palmer wonders whether or not it matters whether the apparent ongoing conversion of large swathes of the financial sector to SRI is based on market forces rather than genuine affinity with more altruistic, socially responsible goals.

“As long as something’s being done, there would be a school of thought that would say it doesn’t actually matter why,” says Woodbridge. “At this stage I think anything that’s being done, certainly towards the problems of climate change, is progress.”

Boucher points out that most companies now need to indulge in a certain amount of greenwashing. “Even some of the most unsustainable businesses, who have fairly difficult business models, like big retailers, have to take very significant action to prove their greenness, and I think fund managers are going in the same direction,” he says.

He also notes that fund managers that offer environmentally sustainable products also now need to dedicate far more internal resources to the task than in the days when an ethical service could delegate responsibility for negative screening to an entity like EIRIS.

But there could be problems in cases where a fund management company is claiming a greater level of expertise than it actually possesses. “Having one or two consultants around who’ve got a bit of a green tinge to them doesn’t provide the same expertise as people with real specialists,” says Boucher, “because I think you’ve got to have more than just a nodding acquaintance with the issues.”

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But even if there are good new funds available, and fund managers armed with the requisite expertise, the responsibility for putting together the investment policy still rests with trustees.

Boucher says many of the investment policies he sees are poorly drafted documents. “I think people haven’t really got their heads round the issues, basically paying lip service to the rules,” he says. “I don’t really see many good quality documents.”

Some trustees also seem to believe, wrongly, that their fund managers should help write the policy: a clear conflict of interest. “It’s an argument for trustees to employ investment consultants to prepare this sort of statement independent of the prospective investment manager to whom the trustees propose to delegate, the investment function,” says Dutton, “but this costs money.”

At the same time, regardless of exactly how a policy is written, it also needs to be coherent.

“The policies that I see tend to be quite general,” says Woodbridge. “They tend to have the potential of encompassing quite a few different areas and different issues. Some of the less specific policies that we’ve seen have included ‘making the world a better place’, which is lovely, but it’s sometimes quite challenging to try and find out exactly what’s meant by the policy statement. In terms of perhaps making the world a better place, are there environmental concerns, or something to do with human rights? Indeed, do they actually understand what the different options are that are available to them?”

Ognall thinks the charities that have enjoyed the most success in this area are those that have considered the question within the context of the overall investment policy.

“If they’re a medium-sized charity which only invests in common investment funds, there’s no point in developing a really detailed policy, because if they move down the SRI route it’ll be about choosing another common investment fund,” he explains.

“So for a lot of this process trustees are able to think about doing it within their normal sphere; so if they have a long-term relationship with one fund manager, asking them, or if they use common investment funds, looking at all the different options. It’s about simplifying this process.”

Policy making also can’t be completed entirely in isolation from the views of stakeholders. As we have already seen, those views can be anticipated, either within the investment policy or in relation to specific investment decisions.

But trustees may also face a rough ride from supporters or service users if they invest (knowingly or unknowingly) in companies involved in practices of which the stakeholders disapprove: in a retailer that sells stock manufactured in sweatshops for example.

But a charity that finds itself in that position should return to the fundamental principles outlined in the Commission’s Guidance, says Boucher. “You’ve got to balance, risk and reward, and if you’re setting out a policy, it’s got to come from the bigger picture investment objective,” he says. After all, if the stakeholders can find objections in one large retailer, they can probably find reasons not to invest in most of the companies in the FTSE 100.

On the other hand, notes Dutton, there may still be legitimate grounds for the charity to pull out of such an investment. “Trustees are entitled to balance the risk of disinvesting from [the retailer] against the risk of alienating [your stakeholders],” he says. “The investment may be perfectly sound, it may be perfectly justified, but the trustee could still be entitled to replace it if they felt, after going through this balancing exercise, that it wasn’t in the charity’s interest to retain that investment.”

But, in the end, SRI policies need to be grounded in the reality of the charity’s wider investment portfolio, warns Ognall: “The reality is that very few charities that start dealing with this issue are a brand new charity who can say ‘we’ve got £50 million, let’s wipe the slate clean and start with an investment policy’. For most charities, however long they’ve been around, however long they’ve been investing, what they’re looking to do is make small changes. Yes, staff will have debates about ‘should we be investing in X?’, but actually they’ve been investing in all these other companies in the FTSE 100 for a number of years.”

At the same time, says Howard Boyd, the average charity simply can’t make too great an investment in the most morally pure green fund, because it would unbalance the portfolio. “So a charity might feel comfortable with a five, 10, 15 per cent allocation towards that sort of product, but you’ve still got to come up with the right overall portfolio that’s going to suit the financial needs of the charity.”

The final problem faced by charity trustees lacking in-depth investment expertise is the selection of a fund manager. How can they make sense of the figures presented by different fund managers? “I think if you look at any investment style, [it] will perform well when various factors are in its favour, and will perform less well when not,” says Donnelly. “A good fund manager, over the cycle, will be able to add a bit of value around the edges.”

“You do have to bring it back to the individual fund managers and track records that they are producing,” says Howard Boyd. “Because in any type of fund management there are going to be good fund managers and bad fund managers, and you’ve got to look at the track record of an individual house and what they’ve been able to bring in this area. But I think you’ve also got to understand the portfolio characteristics."

Ethical investment has certainly come a long way in the last ten years, with the variety of fund management options now available greater than ever before.

True, there will probably always be a need to compromise ‘pure’ ideals, and to make the green agenda at least partly subservient to the organisation’s overall investment objectives. But charities are now in a much better position to try and do ‘good’ through those investment policies as well as through their other actions – even if it is still extremely difficult to say exactly what ‘good’ really is.

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