Why socially responsible investing affects you

The environment wasn’t the only thing to suffer with BP’s oil disaster.

Investors – including more than 1 000 institutions that owned portfolio stock in BP to the combined asset value of $2,7-trillion – took a serious hit.

BP lost more than half its market value, which fell as low as $26,75 a share by June 28, though it rallied to above $40 a share in August. Its weight in the FTSE 350 index fell from about 7,1% to 4,6% and for a time investors’ hearts were in their mouths.

Assuming BP can contain the cost of the spill in the coming months, it may be business as usual for the multinational oil company. But investors may well hesitate to put their money into BP stock, particularly as BP faces 300 federal lawsuits and has had to set aside $20-billion for a claim fund.

Institutional investors are also threatening to sue, claiming the company inflated its share price by misrepresenting its safety record. Environmental activist George Monbiot writes caustically about this on his website, monbiot.com: “They might not have been warned by BP, but they were warned repeatedly by environmental groups and ethical investment funds.”

Assessing risk
After the disaster, fund managers scrambled to gain assurances from oil-industry players that any possible future accidents could be handled so that investors would not be the losers. But can oil companies give them the assurances they need?

Deepwater offshore oil and gas drilling is notoriously risky. Quite apart from spills, deepwater drilling can throw up toxic metals from mud, which may end up in our seafood. At best, the ethics are dubious; at worst, environmental catastrophes are a very real possibility.

Of course, one might argue that, after a decade of deepwater drilling without incident, one accident is an anomaly. But the fact is, the risk remains. BP’s 2009 annual review, titled “Operating at the Energy Frontiers”, spells this out clearly: “Risk remains a key issue for every business, but at BP it is fundamental to what we do. We operate at the frontiers of the energy industry, in an environment where attitude to risk is key. We continue to show our ability to take on and manage risk, doing the difficult things that others either can’t do or choose not to do.”

Terence Craig, writing for Element Investment Managers’ quarterly newsletter, poses a crucial question – why did analysts not highlight the risks posed by BP’s drilling activities? With enough research into BP’s safety record, could they not have factored this risk into their valuations of the company? Craig points to a US government department study showing that, during the past three years, BP violated no fewer than 760 health and safety regulations. By contrast, Sunoco and ConoPhillips recorded eight violations, Citgo two and Exxon one.

“Shareholders and analysts should have been focusing more on BP’s safety standards and procedures to prevent such a disaster,” Craig suggests.

Potential claims
Prasheen Singh, head of RisCura Investment Consulting in South Africa, says that investors need to know what effect any potential claims against a company in the future might have on that company’s bottom line. “When managers assess the value of the company for investment, some of the measures that they may look at are how much free cash they have, and what their earnings growth potential is, and so on – in the case of BP, for example, the effect on earnings as a result of potential claims against the company should also be factored into the assessment of the company and understood.”

The event has highlighted something investors and analysts can no longer choose to ignore – environmental impact. Yes, analysts have taken corporate governance and social issues into account with regard to valuation, but environmental matters are increasingly a factor.

“BP’s drop in share price represented a loss of £63,2-billion in market capitalisation – in rand terms at end-June this represented a R723-billion loss of value – more than the value of Anglo American, Sasol and Standard Bank combined,” Craig said. “Given that most UK [and possibly global] pension and mutual funds will have been invested in BP, an understanding of environmental risks is clearly material for investors.”

Socially responsible investing
Socially responsible investing (SRI), also known as values-based or ethical investing, has traditionally looked at social infrastructure, development, roads, rails and so on here in South Africa.

The safety record of mining companies and the possibility of asbestosis claims are already taken into consideration by analysts. However, Singh feels that environmental issues should be top-of-mind for asset managers in today’s investment climate. “Look at the potential of a company down the line and the legacy we leave behind for future generations,” says Singh. “Responsible investing is increasingly on the agenda in South Africa, but it’s not yet mainstream. And yet asking if companies are serious about accountability is a very important question.”

Analysts are slowly starting to factor in investments that are not just secure and promise adequate financial returns, but which are also ethical. Ethical investments are inclined to focus on avoiding companies that causes illness, disease and death and which may damage or destroy the environment. Tobacco companies therefore get the cold shoulder, as do companies that pollute the environment or produce biohazardous products.

The pension-fund scenario
If your pension fund is invested in a company, it’s essential to ask some questions, as diversifying into publicly offered funds seems to be the most sensible way to structure such an investment:

  • It is not possible to predict which companies will have accidents, though some ventures are obviously riskier than others, as inherent sector risk is a fact of life. The question to ask is, how will the company I’m investing in manage any fall-out? How will the balance sheet, the share price and cash-flow be affected? Are they responsible in the management of these risks?
  • Pension funds should disclose how their responsible investment strategies are put into practice. What are the exclusions and affirmative criteria? Can your analyst explain how the shortfall risk has been minimised?
  • Does the fund have a large surplus and how does it intend to invest this?
  • A company may be heavily involved in alternative energy initiatives, but look at the bigger picture – what does its core business entail? BP is an object lesson, because about 3% of its capital spending is in renewable power: wind, solar and biofuels. So BP may have a better reputation than its peers – like ExxonMobil, for example, which invests only 1% in renewables – but does this make a difference in the face of the oil spill?
  • Singh points out that South African pension funds of companies are separate legal entities and thus the assets of members may not be used to fund claims against the company. In terms of the members’ exposures to the company assets, pension-fund regulation in terms of prudent investment guidelines stipulates general maximum limits for investment in certain asset classes, and further restricts the investment in sponsoring employer assets.

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