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.

Over the Horizon II/II: Hyperdermics Overboard

The past week has had me pondering the role of whistleblowers, and the ethics of average people looking to do business. The Year of the Whistleblower [2002] seems more than just five years ago, but that was when Enron, Worldcom et al were still fresh in our minds [see excellent Business Week article 2002 Year of the Whistleblower: The personal costs are high, but a new law protects truth-tellers as never before]. Aside from Homer Simpson, I know no employees at nuclear facilities, but there is someone I would love to talk with. Media reported the sentencing of the nuclear plant engineer in Eerie, PA who fudged reporting of a six-inch steel core corroded by acid to within millimeters of a breach of a nuclear plant owned by FirstEnergy Corp. No luminous fish have been found! AP reports from Ohio:

Jurors on Tuesday convicted a former nuclear plant engineer of hiding information from government regulators about the worst corrosion ever found at a U.S.reactor. Prosecutors said Andrew Siemaszko and two other workers lied in 2001 so the Davis-Besse plant alongLake Erie could delay a shutdown for a safety inspection. Months later, inspectors found an acid leak that nearly ate through the reactor's 6-inch-thick steel cap.

What was he thinking? The fracture leaked again during patching in January of this year [where was Homer?!], and the company aims to request another two nuclear operating licenses.

Front page this week was news that a Halliburton man admitted to millions of dollars of bribes [US$180m] to win natural gas contracts in Nigeria in the 1996-2000 period, when current US Vice President Dick Cheney was CEO. The man faces years in prison, but no word on the Nigerian side of the deal, nor the living conditions of the man’s wife and children and their gilded lives his lifestyle must have afforded. Coverage of the case makes for fascinating reading, including the indirect path to the case, following on an unrelated case in France that led investigators in France, the US and Switzerland to hunt down the frauds. Bribing officials subjects executives and their companies to prosecution under the U.S. Foreign Corrupt Practices Act. A French magistrate began looking into the matter in October 2003, uncovering shell corporations in Gibraltar and bank accounts in Switzerland. U.S. investigators joined the hunt in January 2004, according to Halliburton SEC filings, all of this monitored by accountability activists. Perhaps the SEC investigation will pick up further interesting stories... Elsewhere, whistleblowers face an uncertain future. Merck & Co. has agreed to pay $650 million to settle two long-standing lawsuits involving whistleblowers over Medicare pricing practices and related marketing activities. But Wyeth had a suit brought on vaccine training dropped. The landmark Sarbanes-Oxley Act of 2002 gives those who report corporate misconduct sweeping new legal protection. An executive who retaliates against a corporate whistleblower can be held criminally liable and imprisoned for up to 10 years. But this week the US Department of Labor, charged with enforcing the federal law protecting corporate whistleblowers at publicly traded companies, was revealed to have been dismissing complaints on the technicality that workers at corporate subsidiaries are not covered. It was left to Vermont Democrat Sen. Patrick Leahy, who helped craft the whistleblower provision as part of the Sarbanes-Oxley corporate governance act [2002], to say the law was meant to cover workers in corporate subsidiaries. "Otherwise, a company that wants to do something shady, could just do it in their subsidiary". [reported in WSJ 4 Sept 2008].

Then there is the case of sailors and the decisions they make, over the horizon. I hiked another piece of the Appalachian Trail this week with an ex-merchant marine officer who spent some time on coastal freighters carrying crude oil up from the Gulf of Mexico to New York and Boston harbours in the 1970’s and 1980’s. You have time on a hike to think, aloud or alone, and to talk or not talk, as the rhythm of your footfalls and your thoughts dictate. The path is steep to the alpine zone about 3 miles up. As we hiked boulder by boulder, we talked through his experience of sailors making decisions over the horizon, in “international waters” where no-one may see, and where no-one may care what happens, and law is in the eye of the beholder. This is a long way from the moves by food companies this week that pledged not to use cloned livestock meat nor milk, a voluntary action responding to a survey by Center for Food Safety. Of course, my local VT favourite, Ben & Jerry’s, is represented by Unilever, the Anglo-Dutch parent, but in a reflection of how far things have come, includes Kraft, Wal-Mart and Tyson Foods.

What is the business case for maritime pollution? Stories of marine pollution are disappointing. Yes, they make me angry. In 1975, the US National Academy of Sciences [NAS] estimated ships dumped 14 billion pounds of garbage at sea. BILLION. Weak enforcement of the United Nations/International Maritime Organization International Convention for the Prevention of Marine Pollution (MARPOL) fails to prevent ships to illegally dump waste oil from bilge and storage tanks into the ocean. A 2001 study from the [NAS) reports that:

Approximately 10–25% of commercial ships violate MARPOL and discharge more than 65 million gallons of waste oil at sea each year, nearly 3 times the amount spilled in catastrophic oil tanker accidents.

One of the stories the ex-officer described shipping of oil north along the US East Coast. After delivering the different grades of oil to NY or Boston the grades of aviation fuel, gasoline, heater and heavy oil, the ships would head south to the South for the next pickup. All the freighters were of similar design, and their tanks had a small inefficiency where a trace amount of oil remained behind that could not be sucked out. Before loading the next load of grades of oil, the ship would pump out the old using seawater. Pure oil, intentionally pumped directly out into the ocean, would jet out of the tanks for a few minutes until the tanks were cleared. The practice was usual. For every one of the loads.
For every one of the ships.
For years.

After a year-and-a-half of advocating, the EU is finally sanctioning this practice. Apparently, the shipping companies and the sailors who manned them needed some kind of bureaucrat to write some kind of regulation to deter the activity. It is likely however, that thousands of gallons of commodities are spewed over the side when no-one is looking over the horizon, when no-one is looking. The impact of business-as-usual is accumulative, and must be making the oceans more dirty, not more clean, according to Oceana.

The pollution of the sea from hydrocarbons (crude oil, fuel, petrol, oily waste, etc.) is a global problem that entails between two and ten million tonnes of these products reaching the sea each year. Although the bulk of public attention is focused on the oil slicks caused by major oil tanker accidents, chronic dumping of these substances – in other words, the residue from ordinary maritime traffic – is three times higher. Washing out the tanks of oil tankers, dumping bilge water and minor spillages on board or in port are the main sources of hydrocarbon pollution of marine origin.

A mid-July, 2008 investor conference call with ExxonMobil and sustainability investors illustrated some of the challenges we face in the sustainability+investment practice integrating ESG factors into investment practice. Scheduled to cover ExxonMobil Environmental/Climate Change initiatives and reporting with the VPs for Safety Health & Environment and Public Affairs, while the PPT slide deck covered a range of issues, no answer was available live nor within 24 hours on what number of tankers shipping XOM oil, and what percentage of tankers, are double-hulled and which are double-skinned. Of these tankers, how many transport XOM oil in environmentally sensitive harbor areas like San Francisco, Valdez etc? Perhaps this is unsurprising from a company that still fought the Exxon Valdez case through 2008, all the while touting corporate citizenship and their technologies for hybrids in full-colour multimedia advertisements. The XOM climate change webpage has not been updated since 29 Feb. 2007. Maybe Gabelli's new green theme investment may offer some answers: Gabelli's eponymous firm is making more noises about exploring the alternative energy and green space. The CEO of Gamco Investors said in a Bloomberg Television interview that he is launching a hedge fund to invest in environmentally-friendly companies. This week the DJSI announced its revisions for 2008, and Alex Barkawi, MD for Indexes at SAM that calibrates the index, commented that "there remains significant room for improvement and thus wide scope for a continued strong sustainability momentum". WSJ even posted a full page congratulatory advertisement on p.C7 tucked in the Money & Investing section, in black & white.

Integrity is not cheap. A working definition of integrity is what one does when no-one is looking. Perhaps it was because I was getting a little more fatigued near the top of Mt Lafayette on the Bridle Path 9 mile loop in Franconia Notch State Park past Falling Water, but I could not understand why sailors and engineers on ships would try and be “company men” by taking short cuts to save “the company” some amount of dollars. The “Company Man” fascinates me: how the average worker calculates the risk and returns of their actions, and expects what they do for “The Company” is good for them vicariously through the company. The sailor that has seen crewmen eject pollutants overboard after regulations direct it is illegal, by the authorities and their company which sought to comply with the rules, and be tacitly and explicitly rewards with a nudge, a wink or a pat on the checkbook by their bosses. There are some happy endings, including this report from the NJ Star-Ledger:

Federal authorities will collect $4.75 million in fines and payments from a Danish company that admitted responsibility in federal court in Newark Thursday for illegally discharging oil sludge and oil-contaminated bilge water into international waters in 2006.

In another report from 2000 in Canada, a military patrol plane first documented a 12-kilometre long slick while on routine surveillance in mid-October, 1999, leading to the successful prosecution of a Singapore-flagged vessel owned by a Scots firm. Identifying cuprits is made somewhat easy by oil having a particular "fingerpint" based on where it originates from. Ahead of the last weekend of summer this year [these dates are officially established in the US, summer is officially over!], the Labor Day weekend, there were dramatic media reports that prime beaches in New Jersey were shut in part in Avalon due to medical garbage washing up on shore. The sizeable legal community in the NY/NJ/PA tri-state area will no doubt be bringing in experts to inflate to the right economic costs. Avalon was named by National Geographic Adventure magazine as one of the nation's 10 best places to live, work and play. TV captured the hapless Mayor valiantly trying to sound more on top of this mini-disaster than FEMA following Katrina, while seeming friendly enough to attract the beach crowds his local businesses relied upon. Early on the investigation expected that someone dumped medical waste off the coast, as had been cleaned up many times before. Turns out a 30-year veteran dentist had taken his boat out and dumped the junk over the side. The dentist is from a once grand section of suburban Philadelphia, Wynnewood, an early stop on the R5 from 30th St Station on the way out to Villanova. What was he thinking?

The dentist is charged with unlawfully discharging a pollutant and unlawful disposal of regulated medical waste. Each charge carries a maximum prison term of five years. Fines could total $125,000 if he is convicted on both counts. No word on the environmental costs, nor ruined walks at sunset along a clean beach. At least this nasty little incident offers some very pointed, local sound-bites for the Net Impact conference at Wharton 13-15 November [the Investments track continues to build nicely].

What was he thinking?

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Update: Suzlon are now reported to be speeding their integration plans for the German wind firm REpower they purchased to speed the technology transfer. Perhaps they are seekin solutions to the high speed/high load failures reported on 2.1MW turbines by Deere & Co. and Edison Mission Energy.