PROJECT M: Gentlemen, before discussing SRI opportunities, are there any sectors you exclude in your SRI approaches for ERAFP and Metallrente?

Desfossés: The only exclusions we exercise are based on issues like the death penalty, torture or military use of children. We exclude no sectors. This can be an issue. For example, we get environmentalists saying we should not invest in nuclear. Well, we invest in nuclear because we think a solution can be found to nuclear waste and because, in the short term, it will play a role in reducing CO₂. Heribert, what is your take on nuclear?

Karch: We do not absolutely exclude nuclear. We changed our approach a while back from negative screening to best-in-class. We mainly invest in stocks in the Dow Jones EURO STOXX Sustainability Index, so we can invest in an oil or nuclear company if listed and there are no other misgivings or objections.

Desfossés: I cannot say exactly how much one can expect in terms of financial outperformance by implementing an SRI approach. It is too early and difficult to assess additional performance gain. What I am sure about are the risks in not implementing SRI. For example, if you don’t review your portfolio now in terms of energy efficiency, you could have a nasty shock when you sell in five years. The hidden cost of the energy inefficiency of many investors’ portfolio is huge but it will not stay hidden for long. We all know what new emissions trading schemes will reveal, so there is no time to lose. An SRI investment process is a systematic way to assess and filter out such risks.

To move to the crisis, I think it makes everyone obliged to reassess exactly what their investment process should be. For me, this means we should return to common sense. Was it sound to expect returns on equity assumed to be fourfold of the long-term growth rate? That was just nuts. Good can emerge from the bad, and I think this crisis gives us the opportunity to rethink investment process and prices.

Miller: So you see this as an opportunity for SRI?

Desfossés: Sure. Look at real estate. Some 25% of oil and energy consumption and 40% of CO₂ emissions in France comes from buildings. There is huge potential for a win on both CO₂ and economic growth by refitting buildings and changing construction methods. It would not be a free lunch, but it would have an impact if we take the initiative. This is just one example.

Miller: Heribert, what’s your opinion? I note some companies are cutting back or closing dedicated SRI research teams. This would seem a threat to broad acceptance of SRI, or is it an opportunity for those still active in the field?

Karch: I see an opportunity to raise a necessary debate about how to act with ethics in the financial world. It is also an opportunity to assess SRI strategies. But while the crisis is an opportunity, it is not a foregone conclusion that SRI will benefit. The result will depend on the debates the SRI community is prepared to get involved in. I think, from much of the related research, it is fair to say that SRI investments have a tendency towards less business risk. However, I think we need to revisit risk management and adjust the SRI criteria with which companies are estimated. We also need to be involved in the discussion on banks and their behavior. It is here that the SRI community can make a valuable contribution in terms of responsibility and transparency. Gunnar, how do you see it?

Miller: It actually strengthens the SRI arguments. Recently there was a poll that showed seven out of 10 people believe responsible corporate behavior is worth more in tough times than in good economic times. The Financial Times also reports that the environment is still a concern of consumers, despite the economy.*

And institutional investors are specifically asking for affiliation with ESG and SRI organizations from their asset managers. It is almost a mark of commitment to sustainability. People are also seeing the strong linkage to ESG criteria, which has as much to do with transparency as long-term performance. The current situation definitely strengthens the argument. So, if fund managers, brokers and other entities abandon ESG because of the tough times, they’ll find themselves out of step with investors.

Project M: What do you think the main drivers will be?

Karch: One driver in Germany is definitely climate change. It is the headline pushing consumers towards a more moral approach, what is sometimes called the “moralization of markets.” I congratulate Philippe and ERAFP on their achievements in France, but, unfortunately, we are not as developed in Germany in terms of SRI.

The government needs to do more through regulation and legislation to support and protect SRI investment by institutional players. Another significant aspect is how pension capital is invested in Germany. It is mainly invested in insurance, and insurance companies do not yet appear to be prepared to change their investment behavior towards SRI. I think the insurance industry needs to have a deeper look into this issue.

Desfossés: One question is when will we be able to demonstrate what a real integrated SRI approach – not just green-washing – can deliver? If we demonstrate that it delivers the same yield for less risk, or more yield for the same risk, then it means we wouldn’t have to do more in terms of selling it. People will accept it. If we cannot achieve this, SRI will remain a niche, an area where people with a conscience invest, but accept lower yield for feeling they are doing good. I believe we can do both: prove equal or superior yield and give people the feeling of doing right.

Karch: We agree that we want to deliver more yield than could be delivered by traditional approaches.

Desfossés: Or less risk for the same yield.

Karch: Yes, of course! However, the SRI debate always revolves around more yield or not? What should we do in a period when SRI does not have the same success as traditional approaches? Abandon SRI strategies? I would argue, “No.” These results and comparisons always depend on the time frame, service approach, asset universe and so on. So, results will vary. The relevance of SRI must not depend solely on such comparisons. It should be developed to achieve better, less risky forms of investment.

Desfossés: The problem is everyone is so used to thinking short term. To explain why we should be able to assess performance return on a five- or 10-year basis is now quite difficult. But here the current crisis may be relevant. Some institutional investors had tremendous returns for six, seven or even eight years, but they have burnt through 10 years of gains in one year. One leading French banker recently said, we are trying to run a marathon, but have to stop every 100 meters to measure performance. That’s crazy!

ERAFP will pay pension benefits for a long time, so we are very prudent and the rate we use to discount our reserves is low. ERAFP is investing for the next 20 or 30 years, so we look long term. Too many investors were just interested by the quarterly dividend!

Miller: With time running out, I would add that I expect within the next five years that much of this terminology – SRI, ESG, sustainability – will disappear. I think these approaches will become more integrated into the mainstream. How do you see the future?

Karch: Well for Metallrente, I think in the next years we will remain with or look for asset classes that are as transparent as possible. We will stick with SRI and not depend on the short-term performance approach. But in Germany as a whole, we have a lot of work to do.

Desfossés: I agree with Gunnar. This integrated approach is how we developed our SRI policy from the start. I am confident that SRI will become mainstream. It will be more integrated into the investment process rather than just another layer in a spectrum of products. You will see this within five years, but it is probably more like 10 before it fully takes effect.

PROJECT M: So, it seems you agree that SRI will develop and provide part of the solution to two critical issues: the financial crisis and climate change. Not so much through negative screening, but rather involving a more fully integrated approach. Gentlemen, thank you for your time.

 * “Staying on course in a tougher climate,” 8 October 2008

Published by PROJECT M in June 2009

(Illustrations: Berto Martinez)