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SRI won’t lose you a third of your retirement fund – think again 10X

24 February 2014

A recent blog by 10X Investments, which was subsequently carried by, attracted attention with its claim that socially responsible investing is not necessarily in the best interests of investors. A subsequent interview on CNBC Africa Power Lunch appeared on under the rather more headline-grabbing title: “Want to lose a third of your retirement fund? It’s easy – sign up for Socially Responsible Investing” This claim was largely based on the argument that the FTSE/JSE All Share Index has outperformed the JSE SRI Index by 1.6% pa over the past 10 years, which under 10X’s hypothetical scenario would result in a 26% reduction in savings over a 40-year period. Furthermore, 10X argues that SRI assessment is subjective and is applied selectively.

However, 10X’s argument is based on a mischaracterisation of sustainable and responsible investing. It sets up various straw men and ignores recent evidence that contradicts it argument. The reality is not as clear cut as is presented, and some of the underlying reasoning appears to be clouded by 10X’s vested interest in the debate between active and passive investment management.

Sustainable investing not just “negative screening”

10X characterises the “current application of SRI” as being “based on screening companies, and excluding ‘non-compliant’ businesses from the investable universe.” While some so-called ethical funds still employ this strategy, this assertion fails to recognise the shift that the sustainable investment community has made in recent years towards a best-in-class approach and the integration of environmental, social and governance factors into investment decisions. These represent a very different approach to the negative screening that 10X presents as being reflective of SRI.

High ESG ratings correlated to market-based outperformance

Another reason provided by 10X to avoid SRI relates to the problems of relying on the JSE’ SRI Index as being representative of South Africa’s “ESG compliant” companies. On this we can agree. Kigoda Consulting has previously argued that the bar for inclusion in the JSE SRI Index should be raised and the company assessments made public if the Index is to be more than a PR tool for companies. However, despite criticising the JSE SRI Index, 10X then uses it as its only measure for consideration of the relative performance of sustainable investing against the All Share Index.

While evidence from South Africa showing that sustainable investing can yield superior investment returns might be lacking, various international studies have shown that outperformance can be achieved. In June 2012, Deutsche Bank published a report which found that 89% of the 100 academic studies, 56 research papers, 2 literature reviews and 4 meta studies it considered showed that companies with high ESG ratings saw market-based outperformance. The report also found strong evidence that companies with high ESG ratings have a lower cost of capital, which effectively means they are lower risk.

With respect to negative screening based on ESG factors, Deutsche Bank found that this strategy showed “little upside, although it does not underperform either”. Many investors might be readily prepared to accept this trade-off, especially if it allows them to benefit from other non-financial objectives such as the alternative tangible upside of knowing you’ve done some social good, or the important behavioural upside of feeling more comfortable with the portfolio. If this provides investors who would otherwise sit on the sidelines with the confidence to invest, the overall effect on their total wealth could even be significantly positive despite the trade-off at the level of specific investments. Over the long term it is much better to be in a slightly inefficient investment than not invested at all (even before counting the added social returns).

Mainstream investment analysis is also subjective

10X’s notions that the assessment of ESG factors is subjective should also be questioned as it ignores the subjectivity of other investment decisions. Clearly investment decisions incorporating ESG factors will be influenced by subjective factors such as personal preferences and risk appetite, but this applies equally to more traditional financial metrics too. Investment analysis based on future cash flows are uncertain and cannot be objectively assessed. Nor are investment decisions based on ‘rule-of-thumb’ factors, such as P/E ratios, objective. All investing involves subjective trade-offs between somewhat subjective measures – the future is inherently uncertain, preferences are unstable, and decisions are strongly influenced by the immediate context (interestingly, this is one of the strong arguments in favour of the passive investing approach advocated by 10X). No investment process is entirely objective, and information deemed ‘subjective’ should not be ignored.

In the eye of the beholder

10X might not have a view on BHP and ArcelorMittal’s ESG credentials, but this does not mean that it is not important to have one. These companies have been shown to have repeatedly transgressed South Africa’s environmental laws and are the subject of various Department of Environmental Affair’s enforcement proceedings. To suggest that environmental compliance is “in the eye of the beholder” is, given the irrefutable evidence that these companies regularly break environmental laws, clearly wrong. To ignore this evidence is also a risky investment strategy and ethically dubious.

While the assessment of compliance might be based on past behaviour, it can offer insight into corporate behaviours such as risk appetite and can be an indicator of management quality. When the “beholders” include regulators that can levy fines, institute legal action or, as happened in ArcelorMittal’s case, issue instructions to cease operations for non-compliance, investors should pay attention. Failure to do so can be catastrophic. In the 3 years prior to the Deepwater Horizon blowout, the US Occupation Safety and Health Administration issued 760 Egregious Wilful Citations, , 97% of the total number, for safety violations at BP’s five US refineries.

Whose interests?

Finally, the assertion that “a further concern is that SRI only targets investors” further reflects 10X’s misconception of what sustainable investing is about. 10X states that “retirement fund members do not have a voice”, but part of the motivation behind sustainable investing is to ensure that asset owners, including pension funds, can mandate asset managers to look after their money in their best interests. These interests are not necessarily restricted to the greatest financial return to the detriment of all other factors, especially if these returns are not sustainable. SRI does not unfairly target retirement investors, but aims to ensure that the financial system does not unfairly compromise their retirement goals, as happened to those workers who retired at the onset of the global financial crisis.

SRI is not, as 10X alleged, only about social good. It is also about assessing risk and opportunities. It takes the concerns of other stakeholders, not just shareholders, into account, as it understands that this is necessary in order to act in the best interests of pension holders. One only has to look at the current issues in South Africa’s mining sector to understand that employees, communities and the environment are integral to the long-term sustainability of these companies. It is not SRI that fails to serve retirement investors’ interests, but the failure to adequately consider material ESG factors that affect the long-term sustainability of investments.


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