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Responsible investments worth their weight in gold

Oliver Jones

More funds are seeking to do good while making money

In his October policy address, Chief Executive Donald Tsang Yam-kuen called for the development of an Islamic bond market in Hong Kong.

Sharia-compliant funds are designed to appeal to Muslims and invest only in companies that adhere to a specific set of values codified in Islamic law.

More broadly, value-based funds are called socially responsible investment (SRI) funds and put their money where their conscience is.

They seek maximum returns while considering social values. They limit their investments to companies that meet certain social requirements - corporate governance reform, a commitment to the environment, workplace diversity - while sometimes rejecting those involved in areas they oppose, such as gambling, alcohol, weapons or abortion.

Mainstream funds typically use financial ratios to choose stocks, while SRI funds often exclude companies for ethical reasons before considering financial performance and prospects.

'There is a view that there's an opportunity cost if a fund manager is constrained [in terms of non-financial factors] in the universe of stocks he can invest in,' Amar Gill, CLSA's head of thematic research, says.

But SRI funds, which early on were formed by religious groups, anti-war activists, labour unions and anti-apartheid organisations, have exploded in popularity and hold more than US$2.15 trillion in assets, according to the Social Investment Forum's 2003 Report on Socially Responsible Investing Trends in the US.

In Asia, they are growing, too, and so are their returns. Nancy Lee, assistant director of Taifook Asset Management, who oversees the Taifook Asia SRI fund, notes: 'We use a negative screening process to avoid industries which are damaging - such as tobacco and gambling.'

The fund is benchmarked against the MSCI Far East ex Japan index - a standard index compiled by Morgan Stanley to track Asian stocks, weighted according to their market capitalisation. The Taifook fund is not, however, a passive fund - one which just aims to track the benchmark - rather it seeks to outperform it.

Besides negative screening, the Taifook fund uses 'positive screening on criteria relating to industry practices', such as better safety records for mainland manufacturers.

'We like Hong Kong due to higher corporate governance standards,' Ms Lee says. 'We combine this with a scorecard where we ask companies questions that apply to environmental, ethical and social aspects.'

These include queries on labour practices and whether or not the company can produce figures for its carbon emissions. Such questions help the fund manager assess which firms are aware of social concerns.

'SRI fund managers tend to ask a lot of questions,' Stephen Frost of CSR Asia says. 'The interesting thing is that the kind of questions [they] have been asking over the past one or two decades are now being asked by mainstream investors.'

Certainly, asking a lot of questions has not done Taifook's SRI fund any harm: it was up 57 per cent by the end of last month. Returns have averaged 28.98 per cent annually over the past five years.

Ms Lee cautions that the 'small size of the fund makes it difficult to do a lot of diversification' and that it is, therefore, quite volatile. The fund has about HK$44 million invested in 29 stocks. Its top five holdings are China Mobile, Hong Kong Exchanges and Clearing, Ping An and two Korean companies, DC Chemical and STX Pan Ocean.

Larger global funds which apply SRI principles include Credit Agricole Asset Management's (CAAM) Green Planet Fund, UBS' Eco Performance B fund and Pioneer Investments' Global Ethical Equity fund. At the end of October, the UBS funds' largest holdings were General Electric, Intel, Vodafone, Roche and Citigroup, while Pioneer Investments counted Vodafone, HSBC, Swiss Re, Microsoft and 3M among as its top five.

Recently, HSBC reversed a decision to raise the limit on ATM withdrawals in Hong Kong after it drew criticism that it was failing to uphold its social responsibilities. The incident highlights the fact that categorising companies as socially good or bad is fraught with difficulties.

Global companies have numerous stakeholders with conflicting demands. BP was supported by SRI activists for its early recognition of global warming, while ExxonMobil was chastised. More recently, however, BP suffered a loss of reputation due to safety problems while ExxonMobil was perceived to have better processes in this regard. Whether such complexities reduce or increase the value of SRI is open to debate.

Thematic funds focused on environmental industries offer an alternative approach to responsible investing. Bowen Capital Management's managing director, Jeremy Higgs, does not, however, view the Green Dragon fund he co-manages as an SRI fund. He remarks that, while he pays attention to environmental, social and governance factors, his primary focus is on financial performance. At the same time, the fund donates 33 per cent of the management fee to NGOs and registered charities 'dedicated to and active in environmental conservation and education in Asia', suggesting a genuinely socially responsible approach.

The Green Dragon fund is up 49.1 per cent since its inception in October last year. Its top five holdings are Praj Industries, Suzlon, CB Industrial, Babcock & Brown Wind and Daiseki, which are focused on the biofuel, wind power and waste management subsectors. More investments are in the water, geothermal, green transport and environmental services.

Mr Higgs notes that the fund is invested in companies which stand to benefit as environmental regulations are tightened while seeking to avoid those which will lose out. The fund has invested in an engineering company that produces more efficient equipment for converting palm oil into bio-diesel. Another investment, Indian engineering firm Praj Industries, commissioned the first ethanol plant in Britain last month.

But CLSA's Mr Gill cautions that 'the [environmental opportunity] concept has been hyped up', resulting in hefty valuations.

Moreover, many thematic funds, such as Green Dragon, are relatively high-risk-high-return propositions. Green Dragon is targeted at institutional investors with a minimum investment of US$100,000.

Other options include CLSA Capital Partners' Clean Resources Asia and Clean Water Asia, which invest in listed companies in addition to taking pre-IPO private equity positions, and global thematic funds such as Schroders' Global Climate Change Equity Fund, formed in Hong Kong earlier this year.

The launch of such funds shows changes in the environment are likely to have unpredictable repercussions, requiring specialised fund managers.

But these changes extend beyond so-called environmental industries. For example, the demand for alternative fuels affects agriculture - as sugar cane is used to produce ethanol in addition to sweetening coffee.

More broadly, every industry is being impacted by the fact that the internet has lowered the barriers to stakeholder activism. SRI fund managers cannot insulate investors from risk, but they are mandated to consider a broader range of issues than mainstream investors.

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