Is a So-Called Ethical Fund Ethical?
Dr Robert Howell
I have been asked if a fund, such as Pathfinder, is ethical. In March 2012 I wrote an article Water published in the NZ Investor (Appendix 1). Since then, I expect that Pathfinder has altered its investments, so then the more general question is, How Does One Go About Evaluating a So-Called Ethical Fund?
The first step is to find out what principles the fund states it is going to use in the selection of investments. These principles should include human-human as well as human-Earth relationships. These human-human and human-Earth responsibilities make up a set of core moral rules and standards that enable principles and practices to be defined for investing ethically: at one end they define immoral behaviour and at the other end, what is good. In between there are issues that are still under public debate, such as euthanasia, or eating meat. If the fund does not clearly define principles that are acceptable, then it has failed the first step.
It may be asked why not choose principles such as recommended by the United Nations Principles of Responsible Investment (UNPRI), or The Responsible Investment Association of Australasia (RIAA). These are not valid measures. At a conceptual level the UNPRI says one should use an environmental, social and governance approach. The problem with ESG definitions is that these are not moral terms and measures. What social behaviour is morally right or wrong? What environmental impact is moral or immoral? What governance standards are acceptable or unacceptable? The ESG framework is lacking in this moral dimension. Moreover one of the Co-Chairs of the Expert Group that drafted the United Nations Principles of Responsible Investment, has stated that the Responsible Investment community has not been more responsible than the investment community generally.
“(T)he trillions of dollars controlled by RI asset owners, managers and consultants are not deployed consistent with long term investment strategies that would conduct our economies in a direction consistent with sustainable development, environmental protection, and greater economic justice – which would imply radical departures from what the market feels comfortable with and the valuation it puts on the large cap listed shares that dominate most global portfolios”.
The point is illustrated by the NZ Super Fund promoting its membership of the UNPRI but investing in evil companies (see The Government’s Evil Investments ).
RIAA has debased the notion of responsible investment (see The Bankruptcy of Responsible Investment: How Can We invest Ethically? )
In addition to the uselessness of these sets of principles, I would go further and say that people adopting these are likely to be greenwashing, or indicating an ignorance of the steps necessary for establishing the validity of measures, or a naivety of the moral issues involved. Referring to these standards then becomes a clue that there are likely to be problems in a fund trying to establish whether it is ethical.
Selection of Companies and Exclusions
The second step is to decide what companies the fund is going to, or is, invested in, and what companies and types of companies are to be excluded. The investigation of the companies is a way of identifying the interpretation of its principles and values.
A number of years ago I invested my Kiwisaver in ASB Bank because they invested in the Al Gore Fund. But on further investigation they did not practice what they preached. See Appendix 2:
Why I took my money out of the Al Gore Fund. (David Blood joined with Al Gore to create the Fund, making it the Blood and Gore Fund.)
The selection of companies can be tactical. This is because some funds invest in companies in order to be able to engage. In 2011 I asked Domini why it invested in JP Morgan Chase Bank, the second largest bank in the US. Adam Kanzer, Domini’s social investments spokesperson, replied as follows, and quoted in my book Investing in People and the Planet .
“Approval of a company for our funds, particularly a company of the size and importance of JP Morgan Chase, is never an easy decision. These firms often present a mix of positive and negative characteristics. The financial sector is particularly difficult – no major financial institution is without controversy.
“JP Morgan Chase has a complicated story. The company is the largest small business lender in the U.S. In 2010, we understand that the company extended $10 billion to small businesses, about $800 million in financing to nonprofits, and $100 million to community development organizations, and it provides lower interest rates to businesses that are creating new jobs. The company has also contributed billions in financing for renewable energy companies. In these areas, the bank is far ahead of its peers.
“However, the bank also has serious problems with foreclosures. While the company has processed over a million loan modifications in the last two years, it has been repeatedly criticized for mishandling foreclosures. On balance, we've felt that JP Morgan Chase has been willing to help homeowners to stay in their homes, but we do have concerns.
“We have approved a substantial number of Canadian banks because they were more conservatively managed and have avoided many of the risks and questionable practices of their U.S. counterparts. We have excluded a significant number of the very largest U.S. banks and financial companies for these very reasons, including Bank of America, Citigroup and Wells Fargo, along with a host of others.
“JPMorgan Chase and American Express are among the few U.S. banks that have survived our scrutiny. We continue to monitor these, and balance their negatives and positives. In general, companies are reviewed for major developments and generally undergo a full review at least once every 18 months.
“Several years ago, Domini was part of a small coalition of shareholders that convinced the bank to hire its first Director of Environmental Affairs, and adopt a comprehensive set of environmental policies, with a very strong focus on climate change. … We have also discussed human rights issues with the bank, and were pleased to see their adoption of a human rights policy. …
“We are currently in dialogue with JP Morgan Chase about its political activity. We are seeking to convince the bank to publicly disclose all of its political contributions, including payments to trade associations used for political purposes.
“We are also questioning the bank’s role as a board member of the U.S. Chamber of Commerce. Our shareholder proposal went to a vote at the bank's annual meeting this year and received a very strong vote of 37 per cent.”
No company is completely ideal. Hence there is always room for improvement through shareholder engagement. Shareholder activism is a way in which shareholders can influence a corporation's behaviour by exercising their rights as owners. They do so by engaging with the board and management through direct contact and/or by submitting resolutions to Annual General Meetings (AGMs). There are many reasons for this behaviour, including ways the activist believes could improve the financial performance of the company, through to the company changing behaviour to align itself more with the advocate’s values.
The most successful shareholder advocates are the Interfaith Center for Corporate Responsibility founded in 1971 in the USA by Catholic, Protestant and Jewish investors. They have successfully persuaded companies such as GE and Nucor (the largest steel producer in the United States) to reform. The Australasian Centre for Corporate Responsibility is engaging with mining advocacy groups. My chapter in my book Investing in People and the Planet focuses on the latter type of activism. This activism does not necessarily decrease the profits of the company. There are summaries of activity in the USA, UK, and Australia and New Zealand. I initiated and helped establish the ACCR in Australia in 2012.
The fourth step in deciding whether a company is ethical is whether it reports on its engagement efforts.
Conclusion: Four Steps
There are four steps involved in making an ethical investment. First, define your values but include human-human and human-Earth values that enable core moral principles to be stated, so that your choice of investment (or your instructions to your advisor), including your pension funds such as KiwiSaver, reflects your values.
Second, decide what types of investments you do not want to invest in (negative screens). This step can also include deciding the types of funds you wish to invest in (positive screens). Some funds exclude quite a lot, and others very little.
This is because the third step is choosing how to engage with organisations to persuade them to change. The best example is how South Africa was starved of funds and decided to abandon Apartheid.
The last step is to ensure that regular reports of actions and commitments are made. This step is often left out.
APPENDIX 1. NZ Investor March 2012
Dr Robert Howell, Chair, Council for Socially Responsible Investment
Water is essential for life. Yet there is evidence to indicate that availability of quality water is in severe decline, particularly with the rundown of fossil aquifers in Saudi Arabia, China and the USA. This threatens food production and business activities. Some experts say water is a greater risk than climate change. Research on global companies shows that very few have identified these risks, and few have taken action to minimise these risks. While investment opportunities in water companies has increased in recent years, water rights advocates state that privitisation has been shown to be ineffective in dealing with the threats to water. Market limitations affect the ability of private investment to meet water scarcity. In New Zealand it is in investor’s interests for the Government to take seriously the recommendations of the Land and Water Forum.
The problem of water is in availability and quality. By 2030, demand will exceed supply by 40%. Yet the way we currently obtain water, and the way we use water, is unsustainable.
Between 1960 and 2000 pumping of groundwater more than doubled. Water tables are falling and wells are going dry in around 20 countries, including China, India and the USA, who produce half of the world’s grain. A major concern is with fossil aquifers (aquifers that do not recharge) in the USA, China and Saudi Arabia. The Saudis have stated that their fossil aquifer will run dry very soon, and that their last wheat crop will be in 2012. Saudi Arabia has bought or leased land in several other countries, including two of the world’s hungriest, Ethiopia and Sudan.
In the USA the Ogallala fossil aquifer underlying the Great Plains is in decline. It covers eight states from South Dakota to Texas. It provides about 30% of the USA’s ground water for irrigation. With diversion of irrigation water to cities, USA irrigation has likely peaked. Roughly 20% of US grain comes from irrigated land. The USA is now dependent on nonrenewable groundwater for 50% of its water.
In China, 80% of its grain comes from irrigated land. Overpumping in the North China Plain of its fossil aquifer is a major concern. One third of the corn and half of China’s wheat come from this area. It is estimated that 130 million Chinese are dependent on unsustainable water.
In India 60% of its grain is dependent on irrigation. A World Bank study in 2005 stated that grain for 175 million Indians was produced by overpumping water. Water levels in water tables and going down and wells are drying up.
Nearly 80% of humans live in areas where rivers are highly threatened. In the Global South 90% of untreated sewage and 70% of industrial wastewater is put into lakes and rivers. Half the world’s hospital beds are filled with people suffering from waterborne disease.
In a summary of a recent State of the Environment Report of the Chinese Government, it identified that 60% of China’s river water can make you sick. This includes 17% that is so contaminated that it is not fit for any use. Of its lakes, 40% are turning green and choked with algae.
Professor Biswas from the Third World Centre for Water Management predicts that by the deadline of 2015, more people will suffer from water pollution that when the UN Development Goals were adopted in 2000. Aaron Wolf from Water Conflict and Management and Transformation, Oregon University, states that “The current water crisis is bigger than all the crises bought on by HIV/Aids, malaria, tsunamis, earthquakes, and all of the wars in a given year”.
In New Zealand, a Land and Water Forum was held in 2010 that involved 58 organisations with a stake in water including central and local government. It recorded that the quality of our water and systems is declining, especially in lowland waterbodies. Urban waterways are highly polluted. About two-thirds of monitored lakes in pastoral landscapes are eutrophic or worse. The Forum made a number of recommendations to the Government but only some of these have been taken up.
The Right to Water
The laissez-faire economic policies of Reagan and Thatcher in the 1970’s encouraged the policy of privatization of water. The World Bank, The World Water Council, the World Business Council for Sustainable Development, and some of the UN programmes supported these policies.
There has been opposition to privatisation of water services. The main arguments are that, first, privatisation increases costs and penalises poor people. This is illustrated in Thatcher’s UK when millions had their services cut when they could not pay their water bills. The second reason is that the needed investments to provide services (particularly in the developing world) did not occur. The third reason is that funding for water services through aid and financial development agencies diminished.
There are difficulties with unregulated markets. New Zealand has seen that with the leaky housing disaster, the Pike River mine disaster, and the immoral and illegal behaviour of investment companies. While there are examples of private water companies in regulated markets providing responsible services, there are also examples of irresponsible behaviour.
But the main question for advocates of privatisation is that the trends described above with fossil aquifers, widespread pollution of rivers and lakes, and the increasing droughts through climate change, are conditions for market failure. A laissez-faire economic approach has little chance of dealing with these. Rationing through market prices is likely to lead to poor people being denied access to water and food. Public intervention with conservation programmes, and some form of community and government rationing system, will be required, and even then the gloomy scenarios of large scale death and destruction may not be avoided.
Risk to Companies
In a study of 2000 global companies, it was found that 54% are exposed to water risks. Only 0.22% have adequate management systems, policies and reporting mechanisms in place to tackle the risks. Sectors such as oil and gas, mining, power generators, semi-conductor plants, retail chains and agriculture are heavily reliant on water and show high water risk exposure. Of those companies exposed to water risks only 9.7% have set either short or long-term targets on water consumption. Furthermore, only 9.7% have set targets on water quality.
Randeep Sanghera, report author and lead water analyst at EIRIS said "The era of cheap and easy access to water is coming to end for companies. This poses a potentially far greater threat to business than the loss of other natural resources, including oil, yet the majority of companies and investors remain unaware of the risks they face".
The large majority of water services have and are being provided by state owned public utilities in the developed world. The main exception is in France (although with public financial support), some parts of the USA, Brazil, and since Margaret Thatcher, the UK. In France, Veolia was started in 1853, and Suez in 1880. Both American Water Works, and Aqua America commenced in 1886. United Utilities and Severn Trent came out of Thatcher’s decision to privatise UK water systems (company websites).
In New Zealand, Pathfinder Asset Management based in Auckland, has a global Water Fund. It has stock in Veolia, Severn Trent, American Water Works, United Utilities Group, Companhia de Saneamento Basico do Estado de Sao Paulo, Aqua America, Suez, and other water related companies. The Pathfinder Fund excludes companies involved in armaments, tobacco, alcohol, bottled water, and fun park companies from the portfolio. They recognize water companies who operate in an unregulated environment are likely to disadvantage the poor. They have engaged with some companies (John Berry, personal correspondence). I have chosen three companies to investigate their environmental credentials: Aqua America; Hylflux Ltd; and Suez Environnement.
Aqua America provides water and wastewater services to approximately 3 million people in 12 states in the US, and has taken a number of steps to become environmentally responsible. Aqua America are members of the Water Sense Program which promotes conserving and decreasing water use. They have attempted to estimate the impact of climate change on their business. Aqua have installed solar thermal and photovoltaic energy systems, gone to paperless billing, use recycled car tyres, achieved more efficient use of fuel, introduced efficient lighting systems, bought some hybrid vehicles, and produced a Sustainability Report. They have made a variety of efforts to reduce water loss and minimise waste. They, through Water For People, have donated time and funds to Honduras and Guatemala to help improve water system efficiency in those countries. Improvements could be made by the company committing to company low carbon and water targets, comparing achievements, and having results audited independently. But overall, on its published material, the company can be classed as environmentally responsible.
Pathfinder are also invested in Hylflux Ltd, a company in based in Singapore. It specialises in innovative desalination plants, but they also are involved in water recycling, waste treatment and water purification systems in 400 locations around the world with a focus in Asia (especially China), the Middle East, North Africa and Europe. The company is aware of issues like climate change but states that environmental sustainability can only be achieved through careful renewable resource management. There is no description of how the company is working to achieve this. The work that it is doing in water systems is important, but in comparison with Aqua America, it is not environmentally responsible.
Suez Environnement traditionally has had a focus in Europe (especially France), and it is one of the larger water companies internationally. In their reports they state that they take seriously global threats, such as those identified by the Intergovernmental Panel on Climate Change. Its first sustainability Report was in 2008. Their first priority is to assist in the transition to an effective economy that respects the environment. The “circular economy” is a proposal for a system based on waste recovery and conservation of water resources. They have committed to 12 main areas including water, waste, GHG emissions, energy efficiency, and renewable energy. In their 2010 report they welcomed the adoption in 2010 by the General Assembly of the United Nations of the resolution recognizing access to safe water and sanitation as a fundamental human right. They said that Suez Environnement has always supported the recognition of this human right by international institutions and their member states. They have recognised that a private ownership model is not appropriate and have developed a 4P model of Public-Private Partnerships. They use a number of sustainability measures including Dow Jones model incorporating SAM; and the Global Reporting Initiative. The former is not a valid measure as it does not enable and adequate assessment of an environment impact. The latter is more reliable: Suez Environnement achieved a B+ grade on 2009.
Barlow is very critical of Suez (amongst some of the other water multinationals) in her 2007 book Blue Covenant. Her criticism is that they have used the United Nations and international bodies such as the World Water Council, to promote a privitisation agenda. A number of Suez’s projects in developing countries have not been of substantial benefit to its poorer citizens. The more recent publications of Suez briefly summarized in the previous parargraph would indicate a change of heart and direction. At this stage I would need more independent assessment to have full confidence in this redirection.
A socially responsible and environmentally sustainable company will have a positive environment impact, and treat its stakeholders fairly and with integrity. A responsible water company will in addition recognise that water is an essential component to life, and support and observe adequate regulations to ensure access to quality water for all. It will recognise the threats to the supply of quality water through depletion and pollution, the market limitations to that supply, and promote international, national and local community initiatives to address these threats.
In New Zealand, it is in the interests of investors that the recommendations from the Land and Water Forum be taken seriously. I think that Pathfinder Asset Management should be given serious consideration if you have funds to invest.
A prudent investor will recognise the strategic risk of water to all companies, and consider investment in those companies that recognise those risks and have taken steps to minimise them. The EIRIS research shows that few companies either realise those risks, or have taken steps to deal with it. Ask your advisor or fund on how the strategic risk of water is being dealt with by any investments you have.
Barlow, M. (2007). Blue Covenant. The Global Water Crisis and the Coming Battle for the Right to Water. NY: The New Press.
Barlow, M. (2011). The Worsening Global Water Crisis. Retrieved from www.phase2.org.
Brown, L. (2011). World on the Edge: How to Prevent Environmental and Economic Collapse. NY: Norton and Cpy
Hall, D and Lobina, E. (2006). Pipe Dreams: The Failure of the Private Sector to Invest in Water Services in Developing Countries
Land and Water Forum. (2010). Retrieved from www.landandwater.org.nz/summary_report.pdf
Pathfinder Asset Management. (2011). Retrieved from www.pfam.co.nz
Sanghera, R. (2011). Retrieved from www.eieiris.org/media.html#WaterRiskReport
Watts, J. (2011). www.guardian.co.uk/environment/blog/2011/jun/03/report-card-for-china-environment
APPENDIX 2: NZ Investor August 2011
Why I took my money out of the Al Gore Fund
Dr Robert Howell
Chair, Council for Socially Responsible Investment
If you were asked to choose two words to associate with Al Gore, I am sure the majority of people would say climate change. Al Gore has worked tirelessly and at personal cost to promote through many decades the cause of avoiding the dangers of climate change. He held the first USA congressional hearings on the climate change and global warming. Millions have seen his presentations throughout the world and his film An Inconvenient Truth. He is a co-recipient of the 2007 Nobel Peace Prize for his environmental work. So when he started Generation Investment Management in 2004 that planned to create environment-friendly portfolios, you would have thought that the first criteria that they would have used, would be to ask about the environmental and climate impact of the companies they invest in. Right?
Generation Investment is primarily an institutional investment management firm, operating at the wholesale level (major pension funds, foundations, family offices and a smaller number of insurance companies) rather than the retail level. The exception is the arrangement with Colonial First State, the distributor of the Generation fund in Australia, that constitutes about 1% of Generation Investment’s total investments. New Zealand Investors are able to put their money with the Al Gore Fund through ASB Group. That is how and why I chose to link up with them.
Last year when researching investments options that are based on best practice, I looked at the Al Gore Fund in more detail. Their web tells an impeccable story. Their approach is that sustainability is a key factor in determining the long term performance of companies. The issues include climate change and environmental degradation, poverty and development, water, natural resource scarcity, health, demographics, migration and urbanisation. Corporate Governance, stakeholder engagement, bribery and corruption issues are also considered. Generation Investment management combines sustainability analysis with traditional analysis. Its first fund was Global Equity; the second, established in 2007, was Climate Solutions. The latter invests in private equity, restricted public equity, and unrestricted public equity. This fund focused exclusively on deploying capital into companies that are part of the transition from a high-carbon to a low-carbon economy. It has four areas of focus: renewable energy generation and distribution; energy efficiency and demand destruction; carbon markets and climate-related financial services; and solutions for the biomass economy. (Generation Investment Management, 2010).
Because Generation Investment is primarily an institutional investment management firm, their web site gives no information about the companies they invest in. But the information is available through other websites. Global Equity, its flagship fund, concentrates on 30-50 companies that are high-quality businesses, with high-quality management teams, that can be bought at the right price. As at 30 June 2010, it had an investment in Varian Medical Systems (who provide technologies for cancer treatment); Northern Trust (who manage investments and funds); Becton Dickinson (who provide medical technology); Henry Schein, (a health care company); Quanta Services (who provide specialised services for power, gas, and telecoms); Plum Creek Timber, (a forestry and timber operation); Qualcomm Inc (a communications company); Paychex (who provide payroll and payroll tax services); and C R Bard, (a health care company). These investments were 57% of the fund, the total of which was valued at $2.6 billion (Stockpickr, 2010).
Varian Medical Systems accounted for 8.24% of Generation Investment Management’s $2.6 billion investment. At that time there was no assessment of Varian Medical Systems’ environmental impact on its website, apart from statements of legal risk. Its Annual Report stated that it is subject to a variety of environmental laws regulating the manufacture and handling, storage, transport and disposal of hazardous materials. It follows procedures intended to comply with existing laws but acknowledges that it can not completely eliminate the risk of non-compliance (Varian Medical Systems, 2010).
Varian’s Corporate Communications & Investor Relations Director, Europe, stated Varian “committed to have a Global Reporting Initiative (GRI) based report available for public consumption and posted on our website by the end of 2011... Varian has always been socially and environmentally responsible, with initiatives dating back some 20 years, and we have much to be proud of. The missing link is that we’ve been very poor at communicating these achievements”. When asked about carbon emissions, renewable energy, fuel and water use, the company answered that they were working on these matters for the 2011 report. Its Salt Lake City operation has signed up to purchase ‘green power’ through its local utility. It has not adopted the Natural Step or its equivalent, although it does have environmental and health and safety prescribed operating practices. (N. Madle, personal communication, 2010).
So why was Varian Medical chosen? Even if they are as good as they claim, the fact that they have poor records and inadequate communication, means that they cannot have been chosen because they are part of the climate change solution.
ASB Group were very helpful last year in linking me up with people in the Generation Investment Management’s office in Sydney, and the Sydney office helped me this year to meet a Director in London. She confirmed my misgivings. She said that the approach GIM take is based on a sector differentiation. For the health care sector, companies considered for selection are based on whether the companies are meeting health care needs. Whether they had done a serious environmental impact assessment, and working to a low carbon and other desirable ecological outcomes, was not factored into the selection process. Rather they were chosen because they were leaders in meeting health care needs.
When I returned to New Zealand I wrote to Al Gore and David Blood laying out my concern. I received a reply that stated “We recognise that there will be times when people choose to disagree with our methodology, however we are comfortable that our investment process is executed in line with our mission, and will continue to focus on the integration of relevant and material sustainability factors as a key part of our investment analysis”.
That is when I decided to withdraw my investment. ASB Group – you should now provide alternatives to Kiwisaver investors that are based on sustainability and take the environment threats, including climate change, seriously. Al and David - you have to walk the talk. Let me know when you do.
Howell, R. (2011). The Challenge of Sustainability for the Financial Sector. The International Journal of Environmental, Cultural, Economic and Social Sustainability. Vol 7 Issue 1. http://ijs.cgpublisher.com/product/pub.41/prod.67
Howell, R. (2010). Transitions to Sustainable Investment. Available from www.nzsses.auckland.ac.nz/conference/archive.htm