Sold on Social Responsibility(A)

For all its gains over the past twenty-five years, socially responsible investing has remained firmly entrenched on the buy side of Wall Street. Now there are welcome signs that’s changing.
(With apologies to those who already know this nomenclature—mutual funds, asset managers like Trillium Asset Management and individual investors are considered the “buy side” of Wall Street, while brokerage houses that issue research on particular stocks are considered the “sell side.”)
Until recently, almost all the activity around socially responsible investing centered on the buy side of the street—socially screened mutual fund proliferated, assets managed under SRI strategies accumulated, and a growing number of individuals and institutions embraced socially responsible investing. All the while, big brokerage houses typically ignored SRI concerns in their stock research. They often argued these issues were tangential to a stock’s performance or impossible to quantify. Of course, we can quantify how many billions investors lost from ethics scandals like Enron, tort claims as companies got hit with asbestos lawsuits, and falling market share as customers shifted from gas-guzzling American SUVs and trucks to more fuel efficient Japanese hybrids. From these examples and a host of other reasons, the sell side of Wall Street is finally acknowledging what Trillium Asset Management and others on the buy side have known for decades: social and environmental issues can materially affect stock prices, particularly over the long-term and sometimes even in the short-term.
Not only is this not news to socially responsible investors, it’s not even news to many business leaders. The chair of food giant Unilever expressed it well last year in a speech at the London Business School, when he said, “Business is part of society, not outside it. When we talk about corporate social responsibility, we don’t see it as something business does to society, but as something fundamental to everything we do…not just philanthropy or community investment, but the impact of our operations and products as well as the interaction we have with the societies we serve. CSR is not a soft issue or a nice to do activity on the fringe of business. It is central to doing business. It is challenging to manage and it is a hard edged business issue.”
Although it isn’t news that a company’s social and environmental performance can influence its success or failure and thus its stock price, the fact that major sell side Wall Street firms like Citigroup, UBS, Goldman Sachs and others have finally clued into this fact is important news given their influence over financial markets, companies, and economic policymakers.
For instance, last year Merrill Lynch’s top auto analyst wrote a June 2005 research note titled “Energy Security and Climate Change—Investing in the Clean Car Revolution” that said, “The global need to address energy security concerns and the impact of climate change on the earth’s environment is intensifying pressure on the auto industry to create vehicles with higher fuel economy and lower emissions. This is not tomorrow’s story—it is playing out right now in the changing competitive strategies of major automakers.” The research piece goes on to name companies poised to benefit from demand for more fuel efficient vehicles, directing investors to those companies investing the most in clean car technologies. Other brokerage houses have issued similar research reports on which food companies are best addressing concerns about childhood obesity, which companies are best addressing the threats of climate change, and which companies are best responding to social changes in South Africa, to name just a few recent examples. Several brokerage houses like Citigroup, Goldman Sachs, UBS and others have also issued reports that look comprehensively at SRI and social responsibility issues across a range of companies and industry sectors.
There are a number of reasons why brokerage houses are finally giving social and environmental issues some of the coverage they deserve. Some of it is as a result of external prodding.
One early catalyst for more sell side CSR research came from the United Nations Environment Program’s Finance Initiative (UNEP-FI), which works with large financial institutions to promote sustainable development. Over the past two years, UNEP-FI has persuaded nearly two-dozen brokerage houses from across the globe to contribute research to two reports it compiled linking environmental and social issues to stock performance. The first report, titled The Materiality of Social, Environmental, and Governance Issues to Equity Pricing came out in 2004 and included 11 sector-specific studies by sell side research analysts. UNEP-FI just released its second compilation of sell side research, with the catchier title, Show Me the Money: Linking Environmental, Social, and Governance Issues to Company Value. The second report concludes: “(1) ESG [Environmental, social, and governance] issues are material—there is robust evidence that ESG issues affect shareholder value in both the short and long term. (2) The impact of ESG issues on share price can be valued and quantified. (3) Key material ESG issues are becoming apparent, and their importance can vary between sectors.”
Another catalyst for more sell side research that started has come from the Enhanced Analytics Initiative, a coalition of mostly European asset managers and pension funds with over $1 trillion in assets that have set aside a portion of their sell side research budgets specifically for coverage of environmental and social issues. (Speaking of “show me the money….”) In addition to earmarking funds towards ESG research, the Enhanced Analytics Initiative also commissions reviews of sell side research providers and publicly names which are doing the best job covering environmental and social issues, another strong incentive for brokerage houses to address these issues in their analyses. Although the EAI has only operated since 2004, it has sent strong market signals that the buy side expects the sell side to cover ESG issues. That demand has also increased as assets under SRI management continue to grow, and more large pension funds and other so-called mainstream investors incorporate consideration of SRI issues into their investment processes.
In addition to these external catalysts, there is growing evidence that major brokerage houses have come to recognize environmental and social issues as important business issues. Citigroup, J.P. Morgan Chase, Goldman Sachs and other major banks have all adopted their own environmental policies committing to address issues like climate change, which has driven internal awareness about the importance of these issues. In some cases, their environmental policies include specific commitments to address these issues in their sell side research. Wall Street is also under increasing criticism for overly focusing on short-term quarterly results to the detriment of long-term value creation for companies, investors, or society, and consideration of ESG issues injects some much-needed consideration of long-term issues back into sell side research. Finally, in an increasingly complex global business environment where U.S. companies must meet European environmental regulations on their products, instability in Nigeria affects Western oil supplies, and most governments around the world are taking action to address climate change, the materiality of environmental and social issues is now just too obvious to ignore. In short, as UBS wrote in a research note last spring with the provocative title Corporate Social Responsibilities: Why Try to Quantify the Unquantifiable?: “Social risk is business risk and business risk translates into financial risk.” With both sides of Wall Street now increasingly recognizing that fact, the power and influence of socially responsible investing is poised to increase dramatically.