Pension funds are thinking seriously about sustainable investment

Sustainable investment, aka Socially Responsible Investing (SRI) or Environmental Social and Governance (ESG) oriented investing to many people has the image of being the domain of fringe do-gooders. That's not so if one is to judge by events like the recent workshop held at U of Toronto's Rotman School (that's a management school, not a sociology or arts school). The workshop (U of T press release here) had a lot of pension industry heavyweights from Canada and around the world like the CPPIB, Ontario Teachers, Caisse de Dépôt, TIAA-CREF, CalPERS discussing what was worth doing and how to do it. U of T has made available the workshop notes here. The notes have links to background papers and to headliner Al Gore's (yes the real Al Gore and he actually took part in at least some of the workshop) paper on Sustainable Capitalism.

There is a lot of emphasis on investing with a long-horizon, an idea that seems to unite pension funds and socially/environmentally focussed people in the five main topics the workshop covered - stranded assets (what happens when climate change or price of oil destroys business models), integrated reporting (going beyond financial-only reporting to include social etc), evils of quarterly earnings guidance (stop being so obsessively short-term!), executive compensation (wrongly structured and excessive) and constructive investor behaviour (i.e. acting more like a long-term investor)

Some notable comments:

• executive compensation "...the current executive compensation situation constitutes a ‘market failure’ situation in the sense that there is no obvious relationship today between executive performance and the levels and structures of executive compensation. ... the sense in the room that a strong, coherent collective action initiative is needed " If the big pension funds develop an activist stance on compensation and do it the right way, maybe they can break through the incestuous self-reinforcing cycle of upwardly ratcheting executive compensation, a problem I have written about before.
• constructive investor behaviour "The key concept here is the broad adoption of ‘concentrated long term investment mandates ’ that require investor engagement. This would be a radical departure from the traditional Keynesian ‘beauty contest’ style of active management, and also from the broadly-diversified ‘formula’ style of passive management. A high number of workshop participants judged this to be a potentially high-impact initiative at the individual fund level." In other words, the pension fund people attending think this is worth doing and they see themselves doing it. Unlike joe average investor who can only influence by voting with his/her feet, when a giant pension fund calls, or several do, big-shot CEO and aloof Board are likely to listen. The swipe at passive index-ETF style investing is interesting - most individual investors in such ETFs are probably there because they believe the mantra of investing for the long term yet because of the passivity they can only take what they get, including those companies who operate only with a short-term horizon.

Good Corporate Environmental, Social & Governance Performance is Good for Investors

Worth reading - a couple of studies suggesting that companies which rate highly on ESG factors will outperform financially and on the stock market.

1) The Value of Governance by professor Anita Anand of the U of Toronto on the website on the Canadian Coalition for Good Governance - "there is a strong consensus in the literature that corporate governance is linked positively to firm value"
 
2) The Impact of a Corporate Culture of Sustainability on Corporate Behaviour and Performance by professors Robert G. Eccles, Ioannis Ioannou, George Serafeim of Harvard U. - "High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance. The outperformance is stronger in sectors where the customers are individual consumers instead of companies, companies compete on the basis of brands and reputations, and products significantly depend upon extracting large amounts of natural resources". In true academic cautious fashion, they stop short of claiming that the adoption of ESG policies causes the outperformance, as opposed to merely being associated with it, which is what they emphatically demonstrate. However, the study shows that the High Sustainability behaviour preceded in time the outperformance, which is highly suggestive of causality.

Unfortunately for those looking for investment leads, there is no list of the 180 companies they found to be in the High Sustainability group.

Worse, the intricate and extensive rating process to figure out which companies are high-ESG is beyond the reach of average joe investor. We cannot hope to collect the data, which comes in part directly from the companies and in part from laborious combing through company reports. Nor can we afford to buy the data from the various specialized ESG rating shops like those on page 13 of this Bloomberg slide pack or Bloomberg or Thomson Reuters. And it's not provided by discount brokers or on free stock search websites.

Our only recourse is to buy, or look at the holdings of, ESG-based ETFs like iShares Canada's XEN or the various US-based ETFs such as those in ETF db's Socially Responsible category. Since the message of ESG studies seems to be that high-ESG pays off on average over a long period of years, for small investors an ESG fund with many holdings is probably a better option. As usual the problem with these specialized ETFs is that their MERs are higher (by 0.4% or more) than plain old index funds, which will put some people off.

Worse still, as the big institutional investors round the world have become convinced that ESG pays and are making it an integral part of their investment selection process (e.g. see the Canada Pension Plan Investment Board blurb on why and how they do ESG), individual retail investors have so little enthusiasm for such ETFs that one of them - Pax World's North American NASI - is closing in mid-March! XEN itself has a puny $18 million in assets despite being in existence since 2007 and outperforming the gigantic market benchmark iShares TSX 60 XIU by almost 0.5% on average per annum after fees (1.91% vs 1.44%) over the past 5 years.

Socially Responsible Funds: Who's Got it Right - RBC or iShares?

Here's an interesting situation. Compare the standard iShares Socially Responsible Canadian equity fund XEN with RBC Asset Management's version RBC302. XEN is passive and has an MER 0.55% while RBC302 adds a layer of active stock picking after applying the same Jantzi social screen as XEN and it sports a much higher MER of 2.1% (on series A, non-advisor class).

RBC302's annualized 5-year return of -0.12% (per Morningstar), including the all-important adjustment for fees, beats XEN's -1.12% (per the Globe Watchlist) by a whopping 1% per year!! and the benchmark cap-weight market fund iShares XIU's -0.83% (also from Globe WatchList) by 0.71%! Of course, the data might not be strictly comparable coming as it does from different sources - why the heck can't the data providers give us ETFs and mutual funds together since most investors want to compare the two?! That's right, an actively managed high-MER mutual fund has beaten the index by a good margin, even after fees.

What explains the difference?
1) RBC has been good at excluding a number of stocks that have been losers. RBC's final investment decision-making step, after the initial screening for the Jantzi social criteria, is to pick stocks with "... above-average financial fundamentals while considering broader factors, such as economic trends, interest rates and the outlook for profits, valuations and stock prices". We only have the top 25 stocks to look at, since RBC doesn't reveal the whole portfolio, but the holdings differences between RBC302 and XEN are significant. 8 stocks are different. The spreadsheet shows in red, which stocks do not appear in the top 25 of the other. Of the 8 in XEN, but not in RBC302, six have significantly negative annualized 5-year total returns.
2) RBC seems to be fairly good at picking winners. As for the stocks in RBC302 that have replaced those losers, 5 out of 8 are 5-year positive and the positives are stronger than the negative. It's interesting that RBC302 is much less concentrated than XEN. It's top 25 only add up to 56.8% of assets vs 82.2% for XEN. RBC is no closet indexer with this fund!

Is "socially responsible" inclusion partly in the eye of the beholder?
Not a single one of the red stocks in the top 25 holdings of RBC302 appears anywhere in XEN, not in the top 25 of XEN, nor within the 61 total holdings of the XEN. Yet all of these stocks are large enough to appear in cap-weight benchmark XIU. What is going on? XEN is strictly a Jantzi index tracker so those stocks must have been screened out as unacceptable according to socially responsible criteria. How the heck does RBC get to put them back in? Unfortunately, the Jantzi index composition and its exact methodology are not disclosed so we cannot go back to the true source to figure this out. It would be ironic if RBC has been beating the virtuous socially responsible index by cheating!

Thanks to Ken Kivenko for the pointer to the RBC Jantzi funds.

SRI and ESG Issues for Corporations: What the Press Talks About

Presuming, a) that public opinion obliges corporations to respond and, b) that newspapers reflect and shape that opinion, the Trends in Sustainability website's online analysis tool tells us what is important these days. It does that by counting buzzwords and phrases in such newspapers as the Globe and Mail, the National Post, the Vancouver Sun, the Toronto Star and the Toronto Sun (but not any elsewhere in the country) day by day going back to 1990. It also contains the results for 110 other newspapers around the world. Take a look at the graph below I pulled up from the tool.

Human rights and Climate change are the hot topics, much dominating such issues as child labour, air pollution, poverty and biodiversity. Another take on this is through their other metric, which they call concepts, in which Sustainability is the tops in newsprint in Canada and around the world (including the USA), ahead of business ethics, governance and citizenship. It is also interesting to note that Canada leads the world average in such concern, or at least in writing about it! (though I must also note that Australia is even more interested in Climate Change and Sustainability than Canada) In any case, this more or less sets the corporate agenda in what to address, whether it is with mere words or with action.

Investing Morally: ESG and SRI Ain't Easy or Simple

"The BP disaster fits very well here. The company was ranked best-in-class by many socially responsible funds and indices such as FTSE4Good and the Dow Jones Sustainability Index. The disaster really highlights some of what the ESG industry is actually rewarding right now, which is the transparency and reporting found in glossy reports." Thomas George, Co-manager of the TD Sustainability Fund, quoted in Benefits and Pension Monitor, September 2010

"... bcIMC tried for a decade, if not more, to make changes at a macro level. We recently reduced our investment exposure to the Japanese market because we found there just did not seem to be an appetite or a willingness to bring fair and reasonable practices into its public equity market. ... That decision about Japan was very much a difficult one to make, but it was largely based on governance concerns." Susan Enefer, Manager of Shareholder Engagement, BC Investment Management Corporation in the same magazine issue

Not even the pros who specialize in SRI (Socially Responsible Investing) and ESG (Environmental, Social and Governance) find it easy it seems. The bottom line from the magazine roundtable's article is that making PRI and ESG a core part of the investment process is: a) in its infancy, but the way of the future, b) a worthwhile risk-reduction effort, c) successful only by digging below the surface stats.

As it happens, my SRI stock pick, Waterfurnace International (WFI), gets a middling rating on governance from the Clarkson Center for Business Ethics and Board Effectiveness of the U of Toronto Rotman School. WFI got only a 77 score out of a 100 in the small and medium company 2010 report. Its main deficiencies have to do with lack of a regular and formal process to assess the Board and its members, as well as too little Board member independence. There are always compromises. ...

Waterfurnace Renewable Energy YE2010 - Trudging Along

The 2010 annual report and conference call (on Newswire.ca) for WaterFurnace Renewable Energy (TSX: WFI) are now available. What do they tell us (I do own some) shareholders?

The financial results bring no great surprises. Earnings in the last quarter followed the trend of 2010, being down from 2009, which itself was down from 2008. Sales went up a bit, at much lower profitability, as the company only in late 2010 implemented a price increase to try to recoup some of the input price rises, notably copper.

The company has continued its fairly dramatic shift away from the moribund new US residential housing market to the residential replacement and commercial sectors.

Strangely, given the big drop announced today in US housing starts (to 480k in February from 620k the month before and the analyst forecast of 580k) the tone from management on the conference call (yesterday) was quite positive. They said they expect an upside of 15 to 20% in 2011 from residential new construction.

Apart from the upside uncertainty of housing starts, the major downside risk is that US government cost-cutting may remove the 30% tax credit for geothermal home installation that is supposedly in place till 2016. Management said they feel the tax credit is relatively secure based on their lobbying contact with lawmakers.

Another upside uncertainty that would increase the financial attractiveness of geothermal is how much, if at all, natural gas prices will go up.

The acquisition of Hyper Engineering sounds like a reasonable move. Its technology for limiting the inrush current on startup of electric motors can both be integrated into its own products and continue to be sold, even expanded, as a separate business. WFI managers even said that Hyper is a profitable business right now.

Due to the removal of the federal retrofit rebate program, Canadian sales kept falling through 2010 (now under 15% of total sales) and according to WFI management, have now hit a solid bottom. Some provinces continue to support geothermal for residential.

WFI continues to fly under the radar - only two analysts, one for CIBC and another whose affiliation wasn't stated - took part in the conference call.

One of the Board directors, Thomas Dawson, even bought 100 shares in February at $25.25. There have been no sales by insiders for over 12 months so that is positive.

All in all, maybe things will get better in 2011 as WFI management expects, but at worst it is still a waiting game, perhaps another year or two before growth resumes. Other investors in the last two days seem to like the results - the stock is back up over $26. I am comfortable holding onto my WFI shares.

EDHEC Papers Burst Balloons on Cap-Weighted Indexing and SRI Funds

The EDHEC-Risk Institute, an academic institute with a practical orientation, has put out a couple of papers that knock down some investment wishful thinking.

In Does Finance Theory Make the Case for Capitalisation-Weighted Indexing?, authors Felix Goltz and Véronique Le Sourd, after reviewing the academic literature, answer that question quite categorically - "No, it does not". A cap-weighted index does not represent the market portfolio of finance theory and even if it could, it would not be efficient in a risk-return sense without making highly unrealistic assumptions. As they say, "... from a theoretical perspective, cap-weighted stock market indices seem to offer no particular advantage". It then becomes a practical problem to construct indices that offer higher return to risk trade-off (as expressed in higher Sharpe ratios). They offer their own Efficient Indices here and when they assess alternatives (Improved Beta? A Comparison of Index Weighting Schemes) like fundamental indexing, equal weight indexing, efficient indexing and minimum volatility indexing, the alternatives all beat Cap-Weighting (e.g. their US Efficient Index has outperformed the FTSE US Cap-weighted index by 2% annually since 2002 while lowering volatility). Of course, not all these better indices are investable for the average retail investor - so far only fundamental and equal-weight funds are available - and the costs of running the index fund could obviate the benefits (witness the sorry story of mutual funds in Canada) if too high (my assessment of US ETFs suggests they do preserve the benefit in real life and I've started a realistic portfolio experiment for a Canadian investor that includes Canadian ETFs).

The other foray into clarifying reality vs wishful thinking is The Performance of Socially Responsible Investment and Sustainable Development in France: An Update after the Financial Crisis by Noël Amenc and Véronique Le Sourd (again! does she like setting people straight or what?). Comparing the performance of SRI funds in France, they cannot really find any significant difference with ordinary funds in terms of risk-return efficiency. During the period of the financial crisis, SRI funds provided no better protection against the downturn. A subset of SRI, Green (environmental) funds, compared to best-in-class ordinary funds "... reveals, over the long term, higher alpha for green funds, with higher risks, including higher extreme risks." The paper's findings will give some comfort to the SRI-minded investor with its evidence that the investor need not lose out by going SRI. However, it does also remind us that SRI is no investing philosophy panacea either. I am currently reading Confessions of a Radical Industrialist by Ray Anderson and he leaves an over-the-top impression that going green is a sure-fire route to greater profitability. That may be so if you do it right but I daresay there are well run and badly run SRI and green companies, just as in any human activity (as an illustration of the principle for those with a reflective bent, I highly recommend the book Albert Speer: His Battle With Truth by Gita Sereny; it tells the story of a highly intelligent but amoral organizational genius who put his talents in the service of evil as the mastermind of Hitler's war production machine)

Geothermal Home Heating Case Study - Going Green Puts Green into Your Pocket

In the autumn of 2009, good friends of mine converted their Montreal home from oil heating to a system that uses heat from the ground. I asked them to share their experience since the new system is so impressive and unique both for its environmental benefit and its financial payback. What follows is their story.

The Need: We were facing the replacement of our existing air source heat pump as it was well past its expected life time. This would have cost us $ 6,000. An air source heat pump in Montreal provides air conditioning throughout the summer and provides some heat down to -10 C. It is not nearly as efficient as geothermal because the ground, below about 5 ft, at this latitude is a constant 8 C.

The geothermal system and its cost:

The installation of the whole system was approximately $ 36,000. This included the new heat pump, circulating fan, thermostat and most importantly the 2 wells drilled to a depth of 250 feet each. This last point is important since it is the most expensive line item. We had to go with a vertical implementation. If you have enough land, it can be put in horizontally. It makes a mess of your yard, but it is much cheaper. Some installations can use a nearby lake or pond for the heat source and that can reduce costs as well.

See photo showing result of drilling - pipes leading out of the hole to the house

We were able to take advantage of a grant from the government for retrofitting to geothermal. This program (the EcoEnergy program) was abruptly cancelled by our beloved Conservative government. (Note from me your blogger: some provincial governments still seem to offer a grant according to NextEnergy) The grant was worth $ 4,600.

When the heat pump is running below its maximum output, the extra heat is used to pre-heat our domestic hot water.

See photo of heat pump installed inside the basement of the house - looks a lot like a furnace)

We had to make a case for an additional $ 26,000 (i.e. approx. 36,000 - 6,000 heat pump replacement - $4,000 grant).

Financial Justification:

This house averaged 3,000 liters of oil every winter to heat the house and provide domestic hot water. This was in addition to the electricity to run the air-source heat pump which provided heating in the spring and fall.

The cost of oil was 98 cent / liter in 2008, but subsequently dropped to 75 cents / liter in 2009. I expect the price of oil to rise back to at least a dollar / liter within the next 2-3 years.

The increase in electricity costs this past winter was $ 320.

We saved 3,000 * .75 = 2250 - 320 = $1930 this year at 75 cents / liter.

I project we will save 3000 * 1.00 = 3000 - 320 = $2680 per year in the future. This assumes constant electricity rates. I also assume that oil prices will rise faster then electricity in this province.

Another important factor: the efficiency of a geothermal system is 1:4. That means each unit of electricity provides 4 units of heat. We are just moving heat, not creating it. For instance, if someone heats their house with electricity via heating coils, and the cost of electricity goes up, they will have 4 times the increase in heating costs compared to a geothermal system. This is important from the perspective of a retired person as it shields us somewhat from inflationary energy costs.

So how is my return on my investment? I save approximately $ 2,000 dollars this year with my one time incremental cost of $26,000. That is a 2000/26000 * 100% = 7.7 % return (note, even without the government grant, that's a return of 2,000/30,000 = 6.7%). And that is a non-taxable return (they haven't figured out how to tax money not spent!). I feel that my money is working well for me.

Another advantage is the increased value of our house if / when we should decide to sell it. It is hard to say what percentage of my investment we would get back. At the very least, it will make the house much easier to sell. I expect that as geothermal heating becomes more common, the advantages will become more obvious and that we may see a 70 % return from a new value perspective (70/100 * 36000 = $ 25,200).

It just feels good to be green:

I believe the IPCC findings regarding global warming. I recognize that my contributions to carbon dioxide loading of the atmosphere is a mere drop in the bucket, but you can't expect a government to make policies that you yourself will not follow.

Oil produces 2.6 kg of CO2 per liter burned. We have therefore reduced our carbon footprint by 3,000 * 2.6 = 7,800 kg of CO2. That is 7.8 tonnes of carbon!

Electricity in Quebec comes from Hydro, so the resulting $ 320 of extra electricity I consume would have a negligible carbon footprint of its own.

Another way of looking at it: my car averages 8.5 liters of gas per 100 km. I now drive about 15000 km per year and therefore consume 1275 liters of gas per year. Gasoline creates 2.5 kg of CO2 / liter. My driving therefore produces 1.5 * 1275 = 3188 kg of CO2 / year. I save the equivalent of 2.44 years of driving!

Other Options in Comparison
We looked at a couple of different options:

1. A super high efficiency air source heat pump that extracts heat as low as -30 C called the "Acadia" sold by a small Maine company called "Hallowell". Here is a link: http://www.gotohallowell.com/

This looked like a less expensive option and we seriously considered it. I had to track down the Canadian distributer of this. It is a new technology and we would have been the first installation in Montreal, the second in Quebec. There were good reviews of this product in the US, but I was concerned about being the first to put it in and the lack of experience, if not expertise, with this product in the local market. I had a quote, and this was going to cost a bit over $ 20,000. It did not qualify for the government grant.

Another concern is that it sits out in the open and would be subject to rain, snow, ice, ice build-up and any bumps by activity around it.

1.5 While we were looking, Mitsubishi came out with a competing product to the Acadia. Link: http://www.mitsubishielectric.ca/en/hvac/zuba-central/zuba_central_vs_traditional_furnaces.html

2. The brand of heat pump that we went with is the WaterFurnace "Envision" heat pump. Our installation has 4 modes: low power heat pump, high power heat pump, 10 kw electrical heating element and finally it will kick in our existing oil fired hot water system. This last option was never used and we learned to avoid the 10kw heating element by not setting the thermostat more that a couple of degrees lower at night. That runs counter to general advice, but for a geothermal heat pump, it is more efficient to maintain a (nearly) constant temperature.

Here is a link with lots of useful information about heat pumps and specific information about our unit: http://www.waterfurnace.com/products.aspx?prd=Envision

3. There are other brands of heat pumps available for the geothermal system. A bigger consideration for us was the company that was going to install and support the system. We had several representatives over to our house to give us their recommendations and quotes. Here are the important considerations:

- One company was going to do the work for less, but not use the correct "filler" around the vertical wells. They were significantly cheaper, but this work would not qualify for the eco-Energy federal grant because a certified system needs to use "bentonite" which acts like a concrete to prevent pollution of the aquifer.

- We looked carefully at using our existing hot water radiators to transfer the heat from the heat pump. This can be done, but would not work as the sole source of heat since heat pumps do not warm the water up to high enough temperature. We would have required a hybrid hot water / forced air combination and would have incurred higher costs, so we did not pursue this.

- The most important consideration was the expertise of the contractor. We choose a local company called "Thermo-stat" because their representative impressed us with his thoroughness. He is also the WaterFurnace technical expert in this market. They contract out the drilling and fitting of the pipes and then install the heat pump themselves. We have been very happy with their work.

4. A final consideration was where to do the drilling! We chose to have holes drilled where our driveway is. The pavement needed replacement as it was. The location was close to the foundation so a long run of pipes was not required. It avoided any damage to existing trees or gardens.

5. Maintenance. Everything is either underground or in our basement. Geothermal systems have actually been around for over 20 years. Failures of the pipes in the ground are extremely rare. They will likely last for 100 years. The heat pump should be reliable because it is not exposed to the weather. The Waterfurnace heat pump has a 10 year labour and parts warranty. The pumps have a 5 year warranty. The heating element also has a 5 year warranty.

From the day of the drilling to the final hook-up of the heat pump was 3 weeks.

It's an all-round impressive project.

Here's a final photo of my friends drilling, turning dirt into dollars.


Update 14 Sept: The Green Building Talk forum has a lot of advice and experience from people in the USA who've done geothermal. They keep emphasizing how important the contractor doing the installation is. The equipment itself seems to be fairly close in efficiency and reliability from one manufacturer to another. Re ongoing maintenance, one post says the pumps tend to wear out and need replacement after about 5 years at a cost of $200-250US but other than that, a well installed system seems to go 15+ years without any attention whatever.

Socially Responsible Investing: another Take from the Globe and Mail

A few months ago I had posted here and here about the difficulties and quirks encountered by investors interested in investing according to what are termed socially responsible principles. The Globe and Mail has come along and published another view in its Report on Corporate Social Responsibility based on research done by Corporate Knights. The approach taken differs fairly significantly from that of Jantzi Sustainalytics. Whereas Jantzi screens out "bad" companies in gambling, armaments etc and screens in "good" companies improving the environment etc, Corporate Knights seems to simply rate all companies according to quantifiable measures of environmental performance (4 indicators for energy consumption, carbon emissions, water usage, waste production), social performance (5 indicators for CEO to lowest paid ratio, employee safety, taxes paid, presence of a DB pension plan, funding adequacy of DB pension) and corporate governance (board committee on social responsibility, diversity of board membership, executive pay linked to social responsibility).

The Globe's effort is much better in my opinion - the ratings criteria are actually published unlike the vague Jantzi "we won't tell you because it is proprietary" message, the ratings criteria are clear and quantifiable and the criteria make sense. They even allow you to download the whole table of ratings for all the TSX 60 companies. Kudos to the Globe!

The Globe comes up with different results than Jantzi too. We previously noted that George Weston failed to make the grade in the Jantzi method (but we aren't told why) but in the Globe's ranking they are right up there in number 2 spot. Unfortunately, Tim Hortons is still a bad guy but now the Globe tells us why - they don't actually disclose any of the required data on the environmental factors. It's time to fess up Timmy.

FWIW, there are nine Canadian companies in the top Global 100 Corporate Sustainability ranking by Corporate Knights, a number far above Canada's economic weight (the US has only ten companies in the list). Take a pat on the back Canada for its corporate do-gooders. That is nowhere near the best country of all, the UK with 21 companies in the top 100 (no, BP is not amongst them).

For investors who want to take their socially responsible investing decisions seriously and not take the lazy "anything labeled socially responsible will do" route, the Globe's list is still not the final answer. Take Barrick Gold for instance - our previous post noted that there is controversy about the company's activities but it is ranked quite high at 19th best out of the TSX 60. Caveat emptor as always.

Socially Responsible Investing: Tim Hortons is Out!?

Take a look at the holdings of the iShares Jantzi Social Index® Fund (symbol: XEN) and you will not find that Canadian icon of ordinary life, Tim Hortons (THI). What gives, why doesn't Timmies make the grade that iShares describes this way: "The Index is comprised of securities of Canadian issuers selected by Jantzi based on criteria for identifying companies that reflect a higher standard of environmental and social performance."?

The question is pertinent because Tim Hortons does appear in the standard TSX Index of the 60 largest Canadian companies. In the iShares S&P/TSX 60 Index Fund (XIU) that invests in the TSX 60 index, THI is in 47th spot.

When I compared the holdings of XIU and XEN, no less than 25 companies in XIU comprising about 30% of its total market cap did not make the cut in XEN. Other puzzling deletions compared to XIU - Manulife (why them while Sun Life is in?), George Weston (groceries, how bad can that be?). Unfortunately, as I wrote in yesterday's post, beyond the general statement of the principles it follows, Jantzi does not reveal any details about why specific companies are included or excluded (actually, Jantzi does not even reveal the list of companies in its index, it is only because the ETF publishes its holdings that we can even see that much).

Interestingly, XEN's replacements for those 25 companies (it also holds 60 companies like XIU) were all really small, accounting in total for only 4% of the total market cap of XEN. In other words, XEN in reality just puts a lot more weight on the biggest companies, mainly the banks (e.g. Royal Bank goes from 8.3% of XIU to 11.6% of XEN). Another stat - XEN's top 10 holdings = 62% of the holdings, XIU = 46%. XEN is a significantly more concentrated portfolio than XIU, which is a riskier investing strategy. Also, XEN's MER is 0.5% while XIU's is 0.17%.

Is Tim Horton's really not a socially responsible investment and why not? Is it that their coffee comes from exploitative producers, the litter that emanates from outlets, the food that harms people, employment practices etc? Should we in good conscience not invest and maybe just drive by to the next competitor outlet? Or was it just that Jantzi needed to make space in its index for trendy companies like Zarlink, Jean Coutu and Harry Winston Diamonds? The criteria for inclusion and exclusion of particular companies amongst those who create indexes or funds that follow socially responsible investing principles really needs to be more visible.

Socially Responsible Funds: Forcing Investors to Buy Blind

Recently, one of my kids suggested I look into Socially Responsible Investing. She doesn't want to invest in companies like Copper Mesa, which is apparently doing bad things in Guatemala to the environment and the local population near their mine.

A popular way to invest in companies that toe the SRI line is to buy one of the many mutual funds (e.g. Social Investment Organization's 2010 Guide to SRI Mutual Funds) which promise to adhere to such principles. Do you think you could actually find out whether Copper Mesa is amongst the holdings of any particular fund? Unfortunately, no. Funds seem to only publish their top ten or twenty-five holdings. An exception is the only ETF in the field in Canada, the iShares Jantzi Social Index Fund (symbol: XEN), which has a constantly updated complete list of its holdings. They are not especially noble in that since all ETFs are similarly transparent. At least one can see there is no Copper Mesa within.

Beyond the generality of statements like the following, a fund prospectus isn't a lot more explicit or detailed about its own method of stock selection.

"Positive and negative screening, such as tobacco, alcohol, environmental performance, human rights violations, community involvement and employee relations. Screening involves the application of pre-determined social or environmental values to investment selection. The aim is to screen out particular companies or sectors based on values choices, or to positively select companies considered “best of sector.”

Does Jantzi Sustainalytics, the well-established leader in SRI indexing, do any better in revealing what companies its indexes contain or the exact inclusion/exclusion criteria? Not that I could find.

To my mind, simply sticking the SRI label on a fund and asking individual investors to believe in the product is not sufficient. Most SRI investors I would guess feel strongly about specific issues or companies they wish to promote or avoid, so they need to be able to figure out if the fund is ok that way. Unlike politicians who are never to blame for anything, companies are never perfect. Indeed, as fact sheet #2 on Social Investment Organization admits, "Social investors know there are no perfect companies." SRI investors must pick their spots and be able to act on their preferences.

Copper Mesa is probably in no fund's holdings, SRI or not, given its dodgy corporate machinations and financial condition (see this post on StockHouse and the TSX delisting announcement). After all, it is investing (I doubt any SRI fund screens out companies for making too much profit, an inference I make based on the prominent presence of Canadian banks amongst top Canadian SRI fund equity holdings).

However, bigger, successful companies like Barrick Gold may be more problematic. It has attracted criticism at MiningWatch Canada. Since Barrick is a large company we are fortunately able to find Barrick among the top 25 holdings of the Acuity Social Values Canadian Equity Fund (see latest March 2010 Quarterly Portfolio Disclosure). Investors should be able to see all the holdings to decide for themselves whether the fund is acceptable or not with Barrick in it.

The SRI sector, especially given its avowed aim, needs to apply its own principles to itself and adhere to a higher standard of transparency and disclosure.