The Socially Responsible Investment (SRI) market in Europe has grown from €1tr in 2005 to €2.65tr at the end of 2007. Eurosif research has divided the assets into two segments: core and broad. Core SRI consists of ethical exclusions (more than two negative criteria) in addition to positive screens such as best-in-class or SRI-themed funds. Broad SRI, which is followed mostly by institutional investors, consists of simple exclusions such as weapons screening, engagement (seeking changes in company behaviour) and integration (the explicit inclusion by asset managers of environmental, social and governance risk into traditional financial analysis).

At the European level, the SRI vehicles most often used remain discretionary mandates (82%) followed by investment funds (12%), according to Eurosif. Structured products are still marginal. Equities remain the preferred SRI asset class with 50% of SRI assets under management. For comparison, equity represents 39% on average of European mainstream assets under management. SRI bonds represent 39% of total SRI under management, which is equal to the share of mainstream bond assets in Europe.

In the last two years, fund managers have developed new methodologies allowing them to apply SRI approaches to corporate, government and supranational bonds. The French pension fund ERAPF, for example, selected a research agency in 2006 to build an SRI reference tool specific to sovereign bonds issued by states, municipalities and international organisations. An increasing number of research agencies now offer country sustainable ratings, and many SRI asset managers have developed their own set of criteria, often utilising public information from international organisations and NGOs.

Property represents 4% of total European SRI assets under management, originating mostly from the Netherlands, UK, Sweden and Denmark, according to Eurosif. Private equity stands at 1.4%, followed by hedge funds (1.3%). These last figures are driven mostly by the Netherlands where large pension funds such as ABP and PGGM are delving into new asset classes. Lastly, at the European level, SRI money market funds have started to emerge and are increasing rapidly, especially in France, Germany and Belgium. Microfinance, with its focus on providing financial services to the world poor, is also of increasing interest to SRI investors. There are about 10,000 microfinance institutions with consolidated assets of $53bn, according to Microfinance Information eXchange.

SRI returns

The Eurosif survey concludes that demand from institutional investors will be the main driver for SRI in the next three years, followed by legislative changes. Evidence of the increasing demand for SRI from institutional investors comes from the recent SRI tenders issued by European investors, among them Swedish AP7 (clean technology), Danish PKA (forestry), the British Pension Fund of Unison (equity mandate) and Dutch APG and PGGM (sustainable energy infrastructure projects, forestry).

While interest in the segment has grown, as evidenced by the sheer number of mandates, the survey begs a fundamental question in the minds most investment managers’ during a year of poor performance. How has the SRI space performed on an absolute return basis compared to broader indexes? One popular SRI index followed by managers is the Domini 400 Social Index (DS400) and its recent performance is sub-par when compared to the S&P 500. The DS400 is the first benchmark index constructed using environmental, social and governance factors.

The composition of the index includes 250 S&P 500 companies, 100 additional large and mid cap companies selected for sector diversification and 50 smaller companies with extremely social and environmental records. Industries covering tobacco, firearms, alcohol, military weapons, gambling and nuclear power are excluded. In August, the index posted a loss of almost 9%, trailing the S&P by 56bps. Year-to-date, the DS400 has trailed the S&P by 97bps and in the last five years it has underperformed by 1.54%.

VB