Lloyd Kurtz Nelson Capital Management Lloyd is a senior portfolio manager at Nelson Capital and lead PM for socially responsible investing (SRI). Before joining Nelson Capital in 2004, Lloyd was a Senior Vice President at Harris Bretall Sullivan & Smith in San Francisco where he served as Director of Quantitative Research and provided research coverage for the healthcare, basic industry and energy sectors. Before joining Harris Bretall in 1995, he spent four years as Senior Research Analyst at KLD, a Boston research firm specializing in social investment research. At KLD, he did much of the initial quantitative work in the development of the Domini Social Index. Lloyd is a Research Fellow at the U.C. Berkeley Haas Business School's Center for Corporate Responsibility, and serves as Program Administrator for the Moskowitz Prize. He has published numerous articles on SRI in academic journals, and authored a chapter on SRI for the Oxford Handbook of Corporate Social Responsibility, which will be published in 2007. He holds a B.A. from Vassar College, an M.B.A. from Babson College, and is a Chartered Financial analyst. In 1999, he received the SRI Service Award for his contributions to social investing.

1. How has the practice of SRI research evolved since you began at KLD?

Perhaps you’ve heard - if you haven’t let me tell you, since I tell everyone - I was employee #1 at KLD.  I worked part time while I was getting my MBA, then spent three years as senior research analyst (senior to the Labrador retriever, as I recall).

I did a lot of the initial database and social research work as the firm was starting out.   In many ways we were doing the same things KLD researchers do today.  We looked at many of the same factors, we conducted our company interviews in a way that would be recognizable today, and we relied on many of the same government and non-profit data sources.

But KLD revolutionized social research in two important dimensions:  scale and structure. 
        
When KLD was getting started, there were no comprehensive social investment databases.  Most social investment firms kept to a relatively small universe of stocks they knew well.  Much of the S&P 500 was, from a social researcher’s perspective, terra incognita. 

But, to build the Domini Social Index, we had to rate every company in the S&P 500, plus 150 non-S&P companies we were adding to the index.  It felt a little crazy at the time to try and write reports on 650 companies, but somehow we got through year 1, then year 2, and bit by bit the process got more manageable.  This ability to scale difficult and labor-intensive research tasks remains a key competency of KLD today.

But an even greater contribution was the structured and thoughtful approach to social ratings.  In those early years there was a lot of discussion about what should be in the database and what shouldn’t.  Were we trying to be a dictionary, an encyclopedia, or a high-level consulting resource? 

I certainly was not fully conscious of the coherence of the structuring decisions we were making at the time, although I strongly suspect Steven Lydenberg was.  In retrospect, you could argue that the metrics in the KLD database were chosen for two characteristics:  relevance and tractability.  We had to focus on relevance because ultimately you must provide information that is useful to the client.  But with scarce resources and a difficult research job, we had to focus on variables where you can develop 650 data points in real time.  And those data points had to be auditable –you had to be able to go back and answer, “Why did this company get this rating?”  That combination of relevance and tractability strikes me as a hallmark of the KLD organization, and one of the reasons it has experienced such success over the years

2. Can you compare the perspective of a KLD analyst to that of an SRI analyst at a venture capital firm?   

There are some similarities.  The quality of the people needed to do the job, for one thing.  KLD analysts have to have unusually broad and well-developed critical faculties, and expertise in one or more areas of research.  And, like their counterparts in the venture world, they are among the first to have to grapple with new analytical issues.  At times – with the solar industry, for example, the KLD analysts will be thinking about major issues at the same time the venture firms are making decisions about which companies to fund.

I would cite one area of difference, which goes back to KLD’s early history.  Venture capitalists ultimately must analyze idiosyncratically.  The best opportunities (think of Cisco or Google) tend to be one-of-a-kind innovators.  Many have tried to develop a list of startup success factors, but ultimately the venture capitalist has to make a very individualized decision.  By contrast, KLD analysts must think hard about common factors.  It is their job to find a basis of comparison among disparate companies.  So my sense is that the KLD analysts need to have more of a systemic focus than their venture counterparts.

3. SRI seems to have joined the mainstream - or at least, it’s now common for corporations to acknowledge SRI concerns. In your opinion, what drove this gradual acceptance? What role do you think KLD’s research and indexes played in this? What world events, consumer preferences, and/or changes in the financial services industry contributed?

Survival drove it.  In my opinion consumers have always wanted good social investment products.  There is such a common sense appeal to what we do.  But for a long time practitioners were reluctant to go along.

In 1988 social investing was taken seriously at perhaps 10 investment firms, most on the periphery of mainstream finance.  But, like chess or football, investing is a Darwinian art.  Things that work stick around.  Things that don’t are discarded.  As time has passed we have seen many financial novelties come and go.  But over 20 years the social indexes have performed competitively, quantitative studies have shown that ESG variables can matter for returns, and social investment advisors have delivered good results with their strategies.

KLD was instrumental in this.  By making its database available to a broad constituency of money managers, the firm created the conditions under which practitioners could experiment, and, ultimately, gain confidence in social investment techniques.  Today many managers have access to the database, and some incorporate aspects of it into their investment strategies.

4. On what issues do you believe social investors have had the greatest impact? Are there issues that haven’t received enough attention, in your opinion?

To this day I believe social investors’ greatest impact was the influence they had on the end of apartheid in South Africa.  Studies have shown that we perhaps did not move markets, but we were part of something that freed 40 million people, which isn’t too shabby.

There is one important issue that social investors have not emphasized in recent years, and it is hinted at in the title of Peter Kinder and Amy Domini’s 1984 book, Ethical Investing.  My own view is that the single most important variable in the success of an equity investment is the character of the management.  Shareholder capitalism is a trust-based system.  When you buy a share of stock you are entrusting your capital to a management group you probably do not know.  Their character matters.  Great business results mean little if they choose to keep the profits for themselves.

And, for whatever reason, character has not been a prominent feature of corporate management in recent years.  We live in an age where multi-billion dollar enterprises are found to have been built on accounting fictions.  Executive compensation abuses have become so widespread we have literally become desensitized.  Consider this sentence from a recent academic study:  “Heron and Lie (2006) suggest that slightly less than 30 percent of public companies that used stock options for executive compensation manipulated at least one grant between 1996 and 2005.”    Caveat emptor.

5. Where do you see the industry heading in the next twenty years?

In many different directions.  The past 20 years constitute proof-of-principle.  We have shown that it is possible to apply social constraints to a portfolio and still earn competitive returns.  This has been an important finding not just for traditional social and environmental investors, but also for many other constituencies who have been emboldened to develop strategies that fit their own needs. 

Social investing captures a great truth:  we are a moral animal.  We have beliefs and values, and they are important in our lives.  Social investors say:  the things that are important to you when you go to church, teach your children, or go hiking with your friends….those things are also important when you invest your money.  You can invest your money in businesses you believe in.

People are hearing that message now, around the world.  KLD’s efforts over the past 20 years have been instrumental in that.