Building Sustainability Indexes

Building sustainability indexes is a specialist function for index architects. The Domini 400 Social Index has been running since 1 May 1990 as a benchmark for the obvious question: including ESG factors in selecting large US companies, how does it impact performance. The ETF tracks at iShares FTSE KLD 400 Social Idx Fd (ETF) (Public, NYSE:DSI). Over the years the DS400 has come to send many other messages, and practitioners know the strengths and weaknesses of this specific index, but it has established the role for the sustainability index. The purpose of an index must be clear in order to create focus for any sustainable investment approach. At SinCo we recommend that any index must be succinctly defined. Sharpening the sustainable investment focus is critical. Criteria matter. So does longevity. Many interesting variations will emerge in the design, development and ongoing execution of the index, and tensions within the mission and current programs may be expected. Maintaining focus prevails on the choice of work and work partners and the design of selection criteria. The Dow Jones Sustainability Index is now 10 years old [see the latest review with DJ here] and some of the people who helped build it like Alex Barkawi have moved on.

Our experience of sustainability indexes provides the empirical basis for design directions and development, interpreted by experts in sustainable investment and the role of indexes. The emergence of country-level indexes rather than international (for example DJSI Global) or themes indexes (for example, carbon or water). South Africa is an obvious example in emerging markets with the JSE SRI Index [up this year, together with Brazil (BOVESPA ISE) launched by the IFC in 2005, and India (S&P CRISIL/KLD/IFC), as well as emerging country examples in Egypt, Spain and South Korea, together with newer thematic indexes such as the Healthy Living Index (SAM) and international initiatives like the Carbon Leaders Index – CDLI (CDP/Innovest).

• SAM Sustainable Healthy Living Fund is designed to invest from the global stock universe in the most attractive enterprises along the health value added chain. For this purpose those trends which influence the Healthy Living-sector decisively are investigated in the first step by means of macroeconomic analysis.
• Carbon Leaders Index – CDLI (CDP/Innovest) The CDLI scores for the Global 500, Europe, FTSE 350, and S&P 500 companies are now used by index provider Markit to create a family of equity indices.
  

Index architecture must map to the investment case and the index proposition. We will cover the impact of sustainability indices separately, other than to say now that sustainable investment indexes have an impact, but a complex model is needed to assess the impact. Indexes (and indexed portfolios) are actively managed investment instruments that are constructed according to objective criteria and are compiled and marketed by financial services firms such as FTSE Group/Financial Times [www.ftse.com/Indices], Morgan Stanley Capital International Indexes [www.msci.com], Standard & Poor’s Indexes [www.sandp.com] and Dow Jones Indexes [http://www.djindexes.com/].

Index membership literally confers “investment grade” on firms because numerous managed funds are benchmarked to, or directly invested in, these indexes. Where the index is themed, selection into the “club” confers a certain halo effect or positive association for that company because there has been a dramatic increase in the scale of funds that directly track market indexes. Gaining and maintaining membership in an “index club” is often a critically important goal for company executives. As with any differentiating characteristic, companies seek to gain competitive advantage with investors, prospective employees, and other stakeholders, and a high ranking in an index can give them such an advantage.

When a company is ranked or included in an influential or prestigious index such as the Dow Jones Sustainability Index (DJSI) or the Fortune 100 Best Companies to Work For, the company will reference that fact, especially when that firm is looking to present credentials as being “world-class”. For example, Brazil petroleum major Petrobras [Petroleo Brasileiro SA (ADR) (Public, NYSE:PBR)] lists five accreditations on a full-page color advertisement in a magazine targeted at investors and company executives (Bloomberg Markets magazine, December 2009), including membership in the DJSI. On the other hand, exclusion from an index can encourage companies to pledge changes. When Daimler [Daimler AG (Public, ETR:DAI] and Bayer [Bayer AG (Public, ETR:BAYN)] were excluded from the DJSI STOXX, their reaction in the German business paper Handelsblatt on 8 September 2008 ranged from pledges to improve (“We will definitely intensify our efforts regarding sustainability”, according to a spokeswoman from Daimler AG) to surprise at being excluded (Bayer commented, “We are not happy about it and we will try our best to be included again, since this is increasingly relevant to us on a financial basis. However, it will be more and more difficult to achieve inclusion in this benchmark.”). Our experience is that ratings, rankings and indexes may be a powerful tool for driving forward sustainability and creates a signaling effect across sectors and stakeholders. At this time we do not delve into the detail of ratings, rankings and indexes. There exist many different approaches, and characteristics of each of the three may be quite different, offering different value propositions that the index leadership must address at the outset of their goal and objective setting stages. Indexes are a feature of any discussion, a reference point, and quite literally a benchmark. Sustainability indexes can be even more so.

Victoria's Secret Trims Pulping the Boreal

Chainsaws down! Millions of men in the 18-35 demographic are relieved: Limited Brands just helped them reduce the size of their environmental footprint, and prevented the 2007 version of the The Victoria's Secret Fashion Show 2006 being greened out. Victoria's Dirty Secret is safe [see also SRI Extra, Monday, February 12, 2007]. After fumbling along without a leader in the C-suite on sustainability issues, it seems Limited Brands has empowered the SVP of Community and Philanthropy to help it get its head in the game. It is not clear on the power dynmaics, or where this will be in 2 years time. Any investor would worry a little about the poor reputation strategy management, especially for a FMCG firm, yes?! Or was that arrogance that LTD/VS could build a brand like Victoria's Secret on the basics of brand management, but the same laws would never apply to it? It is actually the VS sister company, Victoria's Secret Direct, that mails more than 400 million of its sexy catalogs per year, offering intimate apparel, women's clothing, and footwear. At somewhere between 20-32 pages, that’s a lot of bright shiny, ink-covered pages, many of which last about a week or hour until they are trashed.

While the announcement in San Francisco, Dec. 7, 2006 by ForestEthics of their pact on environmental stewardship with Victoria's Secret is good news, it will probably require ForestEthics keep the target companies feet to the fire. Annual checkups like Banktrack.org has done supported by WWF, RAN and FOE on lending practices after the Equator Principles is a good idea, and wherever possible, making the business case in laymen’s terms, for their motto after all is “because protecting the forest is everyone’s business”. An environmental impact scorecard or index like we covered for the Business Ethics 100 at KLD, perhaps in partnership with major media, will keep the trend toward more sustainable forest and paper policies in the news regularly, and cover all those moving forward like Patagonia, but also raise awkward questions in board rooms which have surprisingly shown stubborn resistance particularly endangered forests like some of the US industry's largest companies, including Sears and Lands' End.

The ForestEthics and Limited Brands, parent company of Victoria's Secret, announcement of a “new forest protection policy” included “several landmark environmental measures and ensures that the pulp for the company's catalog paper will not come from endangered forests” [I have a visceral dislike when corporate-speak trots out terms like “landmark”, “benchmark” and innovative”. Do you too?].

"We consider environmental stewardship to be an essential part of our values, and we're proud to take a leadership role," was the PR by SVP Tom Katzenmeyer, but one had to wonder where that “leadership” had been lurking the previous two or ten years… No word on whether Dan Howells, Paper Campaign Director for ForestEthics, smiled, grimaced or fidgeted when these words were spoken.

ForestEthics had been advocating with the catalog industry for several years to reduce their environmental impact on the Canadian Boreal leading two years ago launching a campaign against Limited Brands/Victoria's Secret, and deftly beginning “discussions” with the company. In June 2006 in St. Louis, MO they led local and national activists to rally at the Victoria's Secret store at the St. Louis Galleria, with Unitarian Universalist activists, Young Religious Unitarian Universalists (YRUU), the Missouri Forest Alliance, the Boston Coalition for Sustainable Logging, and other local activists. Those discussions must have been fun...! ForestEthics’ campaign has been about the impact of catalog production on Canada's Great Boreal Forest. ForestEthics statistics are alarming:

Stretching from Alaska to Canada's Atlantic coast, the Boreal contains 25% of the intact, roadless forest remaining in the world and is a key regulator of global climate, providing one of our first lines of defense against global warming. It is critical habitat for many species, including endangered caribou and half of North America's songbirds, and provides $93.2 billion a year in ecosystem services like air and water filtration. Currently, the Boreal is being logged at a rate of two acres per minute, 24 hours a day, and paper production accounts for nearly 50% of that logging.

Extractive industries had been targeted long before firms down the pulp and paper supply chain, as the WSJ reported back in 2001 [not on the editorial pages] Wall Street Journal -- Big Firms, Environmentalists Join To Save Canada's Boreal Forests by Christopher J. Chipello. They adopted the classic regulatory route, calling for government action not positively establishing their own private sector standards for the 10% not in government hands, including chunks in company leaseholds. Of the four big natural-resources companies that announced they will join with a coalition of environmental and native groups to persuade the Canadian government to protect much of the country's vast boreal-forest region, according to officials involved in the effort, only one firm, pulp producer Alberta-Pacific Forest Industries Inc., was expected to make a commitment to have its forestry practices certified by the Forest Stewardship Council [FSC], the leading standards organization. Of course, Gary Larson's Far Side would surely cartoon the irony of a oil sands firm calling for forest protections [does that include unpolluted groundwater from mining operations?], Suncor Energy Inc. extracts oil from the massive oil-sands deposits in northern Alberta.

The measures make for interesting reading on what a leading NGO had been able to negotiate with an industry major, based on willingness to negotiate and how material the impact may be:

1. Limited Brands will partner with its primary paper supplier to eliminate all pulp supplied from the Boreal Forest (Alberta's Rocky Mountain Foothills) and British Columbia (Inland Temperate Rainforest).
2. Shifting its catalogs to either 10% PCW or at least 10% Forest Stewardship Council (FSC) content during 2007.
3. A preference for FSC certification, the only credible certification for sustainable logging. Limited Brands has partnered with one of its principal suppliers to shift four of its mills to FSC.
4. Overall catalog paper reduction.
5. A commitment to continual improvement on environmental attributes of catalog paper and paper use. Progress will be audited by an independent third party and made public.
6. A commitment to phase out of endangered forests.
7. One million dollars committed to research and advocacy to protect endangered forests and ensure leadership in the catalog industry [is this the cheapest marketing spend ever for a billion-dollar consumer brand with a sustainability themes problem?].

No word on what the CFO had to say. When will the case be put in compelling business terms, explicitly linking damaging the natural resource bases irreparably as a cost to society and therefore to business? Fortune's Marc Gunther had in September covered the Canadian forest issue in Are Kleenex tissues wiping out forests? referencing Kimberly-Clark being targeted by Greenpeace and other environmental groups for misleading the public on its sustainability practices and reports, the unfortunately common practice of “greenwashing”, referencing the Domini work on FSC sourcing. Kimberly-Clark Corporation (NYSE:KMB) is a US$16 billion a year forest products firm whose brands include Kleenex, Huggies, Scott, Pull-Ups, Cottonelle, Viva, Kotex and Depend. Greenwashing is a business characteristic that will perpetually offer ratings firms like KLD, Innovest, EIRIS and GES a daily wage. I will be watching for what the Forest Service Employess for Environmental Ethics has had t say. FSEEE is made up of those public servants and retired workers who actually care about what they did at the environment service and its forest philosophy, although I am sure same little in-fights happen along the way. I still think the whistle-blower is the most powerful component of any corporate governance or ethics protocol.

Victoria’s Secret has been a phenomenon and a shining star for LTD. Lingerie, especially VS's expensive lingerie has along with conspicuous luxury items like handbags for Coach [NYSE:COH] been a strong consumer trend in affordable luxury segment – you need more than one, right, Dara?! The branding masterstroke was to use the annual fashion show as a TV event, like SI’s annual swimsuit edition [although the latter suffers withholding from fathers and librarians who are getting increasingly nervous]. I'm still waiting to be invited, and will let all know as usual on the EVENTS page! It really would be a sad understatement to regard the photos from the VS catalogue like the cataloguing of equipment in say Runner's World or Chainsaws Monthly, yes? Never having heard of VS before coming to America in Feb. 2002, I often wondered how the prudish American TV sensibilities allowed the dressed up lingerie to wiggle through onto primetime TV like at The Victoria's Secret Fashion Show 2006.

No word yet on greening the fashion show for 2007, using wind turbines driven by all the hot flushes, perhaps…