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Your Connection to Social Investment Solutions
December 04, 2002
KLD INDEXES
Setting the Standard
for Social Investment
Domini Social Index (DSI 400) is the first equity benchmark for social investors.
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SocialSM Index(LCSI) is the large cap equity benchmark for social investors.
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SocialSM Index(BMSI) is the comprehensive US equity benchmark for social investors.
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Disclosure: “The Best of Disinfectants” The SEC’s Proposed Regs on Proxy Voting
Publicity is a justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman. -Louis Brandeis (1913)
History doesn’t repeat itself, but it does play variations on repeated themes. The controversy over the SEC’s proposed regulations requiring money managers and mutual funds to reveal how and why they vote shares they hold in trust is a reprise.
Disclosure & the Progressives
Ninety years ago, Louis Brandeis and the Progressive Era reformers made disclosure the centerpiece of their campaign to reform investment banking. Only happenstance and the occasional Congressional investigation revealed the bankers’ use of ‘other people’s money”.
That money – mobilized from the banks and insurance companies – bought shares in companies which the House of Morgan, among others, consolidated into huge companies. Thus came into existence the Steel Trust (later U.S. Steel), the Tube Trust and dozens more. For their trouble, the bankers took upwards of 25 percent of the proceeds from the IPO and seats on the board through which they controlled the business and its finances.
Brandeis and the Progressives argued the public had a right to know how the banks were using the assets they controlled to alter American business and, not coincidentally, American politics. “Power breeds wealth as wealth breeds power”, he wrote.
Disclosure 2003: A Fiduciary Duty
The controversy over the SEC’s proposed regulations on proxy voting centers on a different principle, but it leads to an end Brandeis would surely praise.
Last month’s @KLD Newsline, noted the regulations’ proponents include most of the SRI mutual funds, including Domini, Pax and MMA Praxis. They argue that money managers and fund managers have a fiduciary duty to vote proxies in the interests of the beneficial owners of the shares they hold. There seems no disagreement on this point, since no one has argued the contrary.
The controversy lies in whether the beneficial owners and the public should know how and why the votes were cast.
The proposed regulations would require managers to disclose the criteria applied in deciding how to vote proxies and the votes themselves. Institutions opposed to the regulations argue that the public would be able to apply pressure to them to vote in particular ways. Also, they would cut off the quiet diplomacy the institutions conduct with companies over proxy issues.
It seems a hard argument to make that managers should not have to listen to the persons to whom they owe a fiduciary duty, much less account to them. Worse, from a practical standpoint it means only the companies have the ability to lobby the managers over their votes – if, in fact, this quiet diplomacy is going on at all.
Trust or Light?
This argument brings to mind the wooden nickels actor/ writer/ director/ publicist Mel Brooks handed out during the first run of “Blazing Saddles”. Its head featured the immortal Brooks’ profile capped by a war bonnet surrounded by the legend, “Hi! I’m Mel. Trust me.”
The great lesson of Brandeis and the Progressive and New Deal reformers was that investors should trust only what sunlight and electric light revealed.
Sources & Resources:
Louis D. Brandeis, Other People’s Money & How Bankers Use It (New York: Frederick A. Stokes Co., 1914).
@KLD Newsline, Oct. 2002.
http://www.kld.com/newsletter/archive/102902.htm
Comments on the SEC’s proposed regulations are due to the Commission on December 6.
Very Important: Refer in your letter to File No. S7-36-02 (on the mutual funds rules) and File No. S7-38-02 (on the investment adviser rules). Be sure to include the file number in the subject line of email messages.
Submit your comments by email to rule-comments@sec.gov: (The SEC will post your emailed comments to its website.) Or, mail your comments (in triplicate) to the following address:
Jonathan G. Katz, Secretary Securities and Exchange Commission 450 Fifth Street, NW Washington, DC 20549-0609
Additional Information:
For more information on how to submit comments to the SEC, visit http://www.sec.gov/rules/submitcomments.htm
The Shareholder Action Network (SAN) (www.shareholderaction.org) serves as a clearinghouse of information and analysis on shareholder advocacy to socially responsible investors. The SAN website includes a discussion of proxy voting, and a comprehensive list of financial institutions that post their votes and voting guidelines. SAN is a project of the Social Investment Forum, the trade association for the socially responsible investment industry.
The mutual fund proposal will be found at: http://www.sec.gov/rules/proposed/33-8131.htm The investment adviser proposal: http://www.sec.gov/rules/proposed/ia-2059.htm For more information on the proposals, see last month’s @KLD Newsline http://www.kld.com/newsletter/archive/102902.htm
Apples to Apples: SRI Benchmark Indexes
“It’s like comparing apples to oranges....” So, we believe, is gauging a screened portfolio by an unscreened benchmark. For the markets SRI indexes measure look quite different from those represented by their unscreened peers.
A spate of recent publications in Europe suggests the need for another look at benchmark indexes and their purposes.
A benchmark is a standard against which something is measured. Miles or kilometers, for example, tell us how far we’ve walked. Most investors take “the market” as their gauge for their portfolio performance. But, what is “the market” to which to compare a screened portfolio?
Screened vs. Unscreened
KLD’s screens represent the social criteria applied to investments by the mainstream of US social investors. These screens eliminate about half of the S&P 500's companies and close to 800 of the Russell 3000's. Attrition of that scale alone calls into question the appropriateness of using unscreened benchmarks for screened portfolios.
Market-capitalization weighting magnifies the attrition. The absence of mega-companies, such as GE and Wal-Mart, from KLD’s Domini 400 (DS 400) and Broad Market (BMSI) indexes makes for significantly lower average and mean market-capitalizations than similar unscreened indexes.
SRI’s categorical exclusions, such as tobacco and gambling, lead to sector weightings different from unscreened indexes. Qualitative screens, especially envi-ronmental ones, can lead to dramatic tilts in some sectors – energy most notably and least surprisingly. The DS 400 has an energy component of under 1 percent while the S&P 500's is over 6.5 percent.
Do the Differences Matter?
Whether the differences between unscreened and screened indexes matter depends on one’s understanding of and uses for benchmarks.
KLD has constructed its indexes with the goal of representing the markets of equities mainstream SRI investors buy. KLD has adapted models familiar to US investors – from the Russell, S&P and Nasdaq indexes.
But, KLD’s indexes never replicated the sector weightings or performance of their models, because they gauged markets with different weightings and perform-acne. In that regard, KLD’s indexes stand on their own.
Yet, in July 2002 Commerzbank Securities noted in a report: “[Very] few SRI investors use the corresponding SRI indexes as a benchmark against which they measure ... their investment portfolios. Usually, fund managers have their perform-ance measured against a broad market index, plus some (varying) element of peer group comparison. We find this strange, invalid and somewhat worrying.”
Commerzbank’s analysis indicated that two major European screened indexes had different risk profiles from analogous broad market indexes. In both instances, the tracking error exceeded 2.5 percent.
So, why are managers sticking with gauges that aren’t analogous to the portfo-lios they’re managing?
Some Hypotheses
An explanation may lie in the varying usages of “index”.
Particularly in Europe, the term may describe passively-managed model portfolios designed to test a style of investing. SRI index creators tend to measure the performance of relatively few stocks selected according to a theme: sustainability, engagement, light-green, and the like. Their narrowness both in terms of their number of constituents and their screens make them inadequate benchmarks for a general SRI market.
These variations reflect the fluidity of the European SRI market, which is only 20 years old. In contrast, the US market is some 15 years older. From its modern inception, it has had agreed upon characteristics, such as the exclusion of “sin stocks”. A European sustainability index recently added BAT Industries, the re-named British-American Tobacco.
This lack of consensus on an SRI approach would matter less if Europe had a broad SRI market like that in the US. But the number of SRI participants in the European equity markets is quite small – and more heavily institutional and govern-mental – when compared to the US. So, at the moment creation of broad market SRI benchmarks for Europe looks very difficult.
The Challenge
The European experience resonates in North America due to the cross-border consolidation of the financial services industry in the quarter of the globe the two continents share. But, it does not reflect either the reality of the US SRI market or, we believe, the quality of the benchmarks available to gauge this market.
Now that the 30 years war in the US on SRI performance is all but over, measurement is the next challenge. Will investment managers continue to compare apples to oranges or will they try apples to apples?
Sources and Resources:
“Green with Envy”, Commerzbank Securities (London), Mar. 18, 2002.
“Boxing against Green Shadows”, Commerzbank Securities (London), July 19, 2002.
Erik Kroon & Jaap van der Geest, “Does Socially Responsible Investing Cost Extra Money?”, VBA Journal, vol. 18, no. 1, Financial Publishers Group (the Netherlands), April 2002. The authors are with ABN AMRO Asset Management.
Erik Kroon, “Socially Responsible Investing Indexes”, Riscio & Rendement, no. 35, Kluwer Publishers Group (the Netherlands), June 2002.
“Social Screening does not harm performance”
“Social Screening does not harm performance” read the headline of a Septem-ber 16 Op-Ed piece by John B. Guerard, Jr. and Bernell K. Stone in Pensions & Investments. The article summarizes a working paper that relies, in large part, on KLD screening data.
You can get copies of the P&I article from: Info@kld.com . Copies of the working paper, you can receive by e-mailing Mr. Guerard at Jguer43756@aol.com . Mr. Guerard is an Adjunct Professor at the University of Pennsylvania. Professor Stone is a Harold F. Silver Professor of Finance at the Marriott School at Brigham Young University.
“Socially Responsible Investment: A Global Revolution”
Just as Newsline was being put to bed, Russell Sparkes’ fine new book arrived.
His is the most comprehensive survey of our field yet attempted. Socially Responsible Investment (Chichester, UK: John Wiley & Sons, 2002) gauges how far SRI has come as a global phenomenon.
While pointing to areas of consensus, Sparkes appraises the many differences in SRI approaches. US readers will get from Socially Responsible Investment a clear, carefully annotated statement of the British and European perspectives on SRI. That is a great service.
The financial services industry has become increasingly transnational. At the same time, deep differences have emerged in national approaches to environmental and sustainability questions. Sparkes offers thoughtful appraisals of these differences.
In a time when people spend much time talking past each other, efforts to create a common basis for discussion deserve wide readership. Socially Responsible Investment is just such an effort, and it belongs on your bookshelf.
WebEx Training & Support for SOCRATES & PASS Users
To provide better training and support for its SOCRATES and PAST clients, KLD has recently added WebEx capability.
WebEx is an online meeting services provider. It will allow KLD conferencing. Best of all, it will allow users to work directly with KLD’s staff either on advanced techniques or support issues.
In the January @KLD Newsline, KLD will announce a schedule of training and educational sessions. In the meantime, we’d like to hear from you on the topics you’d like to see covered. Please contact your CRM contact or Annie Lacourt Alacourt@KLD.com
KLD Research & Analytics Inc. supplies social investment research, benchmarks, and compliance and consulting services to leading investment institutions worldwide. KLD is the creator of SOCRATES, a comprehensive online social research database, and of the Domini 400 Social IndexSM (DSI 400), KLD Broad Market Social IndexSM (KLD BMSI), and KLD Large Cap Social IndexSM (KLD LCSI). Visit our website at www.kld.com.
Copyright © 2002 by KLD Research & Analytics, Inc. All rights reserved. No portion of this material may be reproduced in any form or medium whatsoever without the express, written, prior permission of the copyright holder. For information, please contact:
Peter D. Kinder
KLD Research & Analytics, Inc.
530 Atlantic Avenue, 7th Floor
Boston, MA 02210
(617) 426-5270 (vox)
(617) 426-5299 (fax)
PDKinder@KLD.comDisclaimer. This material is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the authors are not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Adapted from a Declaration of Principles jointly adopted by the American Bar Association and a committee of publishers.