Socially responsible investment: Good Returns

The time has come for charities to rethink a 21-year-old piece of case law and to take a proactive approach to socially responsible investment, argues Paul Palmer.

There's nothing like a medical charity investing in tobacco or an animal rescue shelter putting money into vivisection to generate a generous number of column inches. How organisations invest their money generates a surprising level of interest.

It isn't surprising, then, that socially responsible investment (SRI) has been a recurring topic of conversation for the past few decades. Trustees are legally obliged to safeguard their organisation's finances, and existing case law has made lawyers and charities wary.

It is an uneasiness that charities are going to have to overcome: the new Sorp 2005 accounting standard requires charities to declare their "investment policy and objectives, including the extent (if any) to which social, environmental or ethical considerations are taken into account".

Much of the current scepticism stems from the 1984 court case Cowan v Scargill. Arthur Scargill, then leader of the National Union of Mineworkers, proposed that the coal workers' pension fund should exclude all overseas investment and avoid investing in any industries that competed with coal.

The fund's trustees disagreed with Scargill and, when the case went to court, so did the ruling judge, Sir Robert Megarry.

The case is reputed to have ruled out SRI on the grounds that it is inconsistent with trustees' duties to put the financial interests of their beneficiaries above all else and to diversify investments.

However, re-reading Cowan v Scargill today, it is striking how little the investment policy disallowed in that case resembled any likely modern SRI strategy. Moreover, the policy was mandated by an outside body (the NUM) and was drawn up without regard to its effect on investment performance.

The judgement was not concerned with whether taking social, environmental and ethical considerations into account might improve investment return.

That question never arose in the case.

What the case does exclude is ethical investment decisions based on the "personal interests and views" of the trustees, which cannot "be justified on broad economic grounds".

As such, the Megarry judgement should not be seen as a bar to an ethical preference policy.

As Megarry himself commented, there is a difference between a policy of preference and one of prohibition. The judgement does not stop trustees securing a non-financial benefit for some of their beneficiaries by investing in accordance with the beneficiaries' moral principles, as long as they can do so without affecting any beneficiaries' financial interests.

One of the reasons why legal misgivings still flow from the Megarry judgment is a continuing failure to distinguish SRI (which is about securing long-term increases in the value of investments by taking environmental and ethical factors into account) from ethical investment (which is concerned with non-financial criteria and negative screening).

The distinction is important - the number of ethical fund products suitable for those following an ethical invstment policy is limited, but this is less the case with SRI. Initiatives such as the FTSE4Good index have meant that there is more choice, so it is easier to diversify investments.

Many proponents of SRI believe in the stereotype of sharp-suited City fund managers with little understanding of SRI who scare off concerned 'brown shoe' trustees by expressing worries about adverse investment performance and restricted choice. But when I was researching my recent book, I found examples of best practice in both fund managers and pension fund trustees, and a clear knowledge of SRI and how it was different from ethical investment.

Unfortunately, I also encountered attitudes that played to the worst kind of prejudices. But most common were ignorance, inactivity and a desire not to rock the boat.

One finance director at a large charity failed to communicate with the staff who had begun to ask questions on SRI, or to provide any form of leadership. Most worrying were fund managers who claimed there was evidence of adverse performance but, when challenged to support this proposition, were unable to substantiate it.

Trustees and their advisers should recognise that the Megarry judgement has little relevance to contemporary SRI.

This would clear an unnecessary obstacle to the progress of SRI.

Our research shows that there is both confusion and a deeply ingrained attitude that SRI investment must come at a cost. Governance studies have discovered similar views. We conclude that a major educational initiative and a proactive campaign is required to change these perceptions.

- Paul Palmer is professor of voluntary sector management at the Centre for Charity Effectiveness at City University's Cass Business School in London, and co-author of Socially Responsible Investment: A Guide For Pension Schemes And Charities.


Passive investment policy: A charity hands over investment decisions to a fund manager

Active SRI policy: A clear declaration that the charity will seek companies with good governance practice and will not invest in, say, alcohol, tobacco, gambling, pornography or anything that breaches human rights

Ethical preference policy/ethical investment: A charity adopts strong ethics in a particular area that affects investment decisions - for example, the Salvation Army refusing to invest in alcohol.

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