Where is the sweet spot for SRI information to investors?An intriguing paper out from sustainable investment specialists on the quantitative team of Geneva-based private bank Pictet & Cie presents an argument tha " Less Can Be More..." (Christoph Butz, Pictet & Cie, March 2005). The paper is controversial, but honest enough to offer a foreword by Phillipe Spicher, Executive Chairman of SiRi Company (the consortium of SRI research firms which includes KLD in the US). The foreword sets the intrigue as Spicher references "an honour and a challenge" before pointing out "I cannot fully subscribe" to the arguments Pictet make. What is the storm in a teacup?
SiRi's comments are important because of the role they play as the most global SRI house. SiRi Company Ltd. (Sustainable Investment Research International) was launched in November 2003, after having served as an informal network between leading analysis companies for socially responsible investments in eleven countries: Sweden, Germany, Switzerland, Italy, the Netherlands, Spain, Belgium, the United Kingdom, Canada, Australia and the United States. Together, the SiRi Companies have over 100 analysts, which makes SiRi Company Ltd. the world's largest independent analysis group within SRI. Through the partnership in SiRi, independent local expertise on the world's most important financial markets is made available. KLD cover the USA.
Pictet suggests "current sustainability research is at a crossroads". Sustainability covers investment research looking to the fundamentals of a firm and how the environmental and social and corporate governance factors demonstrate whether the company has the ability to exist into the future with a business moidel that can succeed in a world of diminishing resources and increasing social demands.
Pictet points to companies' "questionaire fatigue" suggesting that too many questions are being asked of firms, questions that add nothing new to an analysis, and may instead introiduce noise to analysis. They push for retaining "a few relevant indicators", while admitting "we do not pretend to have found the holy grail ...fully-fledged research methodology". They want to "through the first stone" in the debate.
The argument about a marginal cost vs marginal utility of information makes for a neat economic underpin to their argument. Intuitively the concept is appealing. It is reasonable to expect that as more information is discovered and presented, the cost of reaping that information starts to outweigh the utility of that information, paired with the actual value of that information in informing the decisions.
Pictet has a dig at analysts, suggesting the educational foundation is weak and the ongoing evolution of curricula is poor, that few have the experience, and may well be replaced by students and/or sophisticated software! I agree that this new field has attracted many non-financial types, but I do not think they are educationally weak. Firstly, the pool has partly to be explained by the rigid thinking of the financial analysis students and frankly the blinders that any SEE factors have some impact on analysis or a place at the table. Secondly, as SRI research analysts evolve in small firms fighting for legitimacy, the ability to glide while upping the education of analysts is not necessarily a viable opportunity. Thirdly, with the same mobility as financial analysts and portfolio managers, as SRI firms try to differentiate, they have not resolved how to develop talent without empowering competitors because they may not have the cash incentives to hold onto the analyst after they have been so well trained. In terms of moving educational standards forward, I have opened discussions with CFA Institute, the home of the CFA designation and the leader in investment accreditation. They were decidedly cool. I am currently seeking other accredited investment standards bodies to engage in discussions, mindful over the flop that followed the drive to "Certified MBA" while aware of the success of the "Six Sigma blackbelts".
From a methodology point of view, Pictet points not just to the cost of generating this information, but how it is used by investors. Pictet suggests that because the information is aggregated into some rating which can then be implemented into one rating, inflating the number of indicators diminshes the weight of any one of them. This fight for survival should be replaced by an increased experimentation with weightings and by knocking off superfulous ratings.
Pictet went about looking at the Automobile and Aviation industries in more detail and leaning heavily on their quantitative/statistical roots they look at different proxies for proxies, coming to factors like fuel efficiency and job creation as markers that they feel generate sufficient utility of information. While their analysis is interesting, they dodge the dichotomy produced by their "job creation" proxy as giving the best indicator for sustainability (at least over three years) but the failure in financial markets, and walk away with a shrug of " of course, much more research is needed to confirm or refute this finding".
I like the idea of the average fuel consumption of a car manufacturing firm as being its best indictor - the senstitivity of Detroit to US Federal minima for miles per gallon signal that this may be a material signal. But I am unconvinced on the job creation proxy.
In Pictet's search for "a more pragmatic and practicable proxy for a company's sustainability performance by way of specifying sector-specific key impact factors" remains more lost than found. Intriguing, some good concepts, but as a business leader I would not change my SRI analysis on these grounds. Yet!
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