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«Sustainable Investment Amsterdam, 31 August 2010 Commissioned by Duisenberg School of Finance and Holland Financial Centre Sustainable Investment ...»

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Sustainable Investment

Amsterdam, 31 August 2010

Commissioned by Duisenberg School of Finance and Holland Financial Centre

Sustainable Investment

Literature Overview

Jarst Weda

Marco Kerste

Nicole Rosenboom

Roetersstraat 29 - 1018 WB Amsterdam - T (+31) 20 525 1630 - F (+31) 020 525 1686 - www.seo.nl - secretariaat@seo.nl

ABN-AMRO - Postbank 4641100. KvK Amsterdam 41197444 - BTW 800943223 B02

SEO Economic Research carries out independent applied economic research on behalf of the government and the private sector. The research of SEO contributes importantly to the decision-making processes of its clients. SEO Economic Research is connected with the Universiteit van Amsterdam, which provides the organization with invaluable insight into the newest scientific methods. Operating on a not-for-profit basis, SEO continually invests in the intellectual capital of its staff by encouraging active career planning, publication of scientific work, and participation in scientific networks and in international conferences.

SEO-report nr. 2010-67 ISBN 978-90-6733-585-0 Copyright © 2009 SEO Economic Research, Amsterdam. All rights reserved. Permission is hereby granted for third parties to use the information from this report in articles and other publications, with the provision that the source is clearly and fully reported.


Preface At Duisenberg school of finance, we are committed to providing excellent financial education in order to create the next generation of responsible financial leaders. To achieve this, leading industry practitioners and world-class academics have joined to develop a set of forward-looking financial programmes. These programmes integrate theory and practice, and encourage critical thinking and continuous reflection on the dynamic financial landscape.

The existing set of programmes at Duisenberg school of finance will soon be expanded. With the support of Holland Financial Centre, specifically the Centre for Climate & Sustainability, Duisenberg School is currently developing a Programme on Finance & Sustainability. As part of the Programme, Duisenberg School and Holland Financial Centre intend to offer top-notch education and conduct cutting edge research in the area of finance & sustainability.

While industry practitioners and policymakers around the world are facing the topic of finance & sustainability on a daily basis, academic interest in the topic is relatively recent. In designing a curriculum and a research agenda, therefore, we feel it is important to take into account not only the insights yielded by academic research but also by industry practitioners and policymakers.

Accordingly, as a preliminary step, we have asked SEO Economic Research to conduct a broad, high-level literature overview on finance & sustainability.

The survey has resulted in four reports, each providing a literature overview on one aspect of finance & sustainability: (i) financing the transition to sustainable energy; (ii) carbon trading; (iii) innovations in financing environmental and social sustainability; and (iv) sustainable investment.

The report you have before you describes the review on ‘sustainable investment’.

The survey has been conducted by SEO Economic Research; Duisenberg School has offered suggestions throughout the process. The result should be of use not only to Duisenberg in designing its curriculum and research agenda, but also, we hope, to anyone interested in the increasingly relevant subject of finance & sustainability.

Amsterdam, August 19, 2010 Prof. Noreena Hertz Chair of Globalisation, Sustainability and Finance Prof. Dirk Schoenmaker Dean, Duisenberg school of finance Sjoerd van Keulen Chairman Holland Financial Centre

–  –  –

Table of Contents Executive Summary and Further Research

1  Introduction

2  Corporate Social Responsibility

2.1  Introduction

2.2  Value Drivers and Measurement

2.3  The Business Case for CSR

2.3.1  The Value of Sustainable Companies

2.3.2  Implications for Investment and Investors

2.4  Reporting Requirements

2.5  Conclusion

3  Socially Responsible Investment

3.1  Introduction

3.2  Reasons for SRI

3.2.1  Financial Attractiveness

3.2.2  Compliance

3.2.3  Salient Information

3.3  Performance of Sustainable Funds

3.3.1  Underlying Theory

3.3.2  Mutual Fund Studies

3.3.3  Regional Differences

3.3.4  Short Run Versus Medium and Long Run Results

3.3.5  Multifactor Models

3.4  SRI Success Drivers

3.5  Conclusion


–  –  –

Appendix A.1  Socially Responsible Investment

Appendix A.2  Sustainability Reporting

–  –  –

Executive Summary and Further Research Sustainability: Profitable from a Company Perspective… Corporate Social Responsibility (CSR), or sustainability at the company level, entails incorporating ecological (environmental stakeholders) and social aspects (stakeholders other than shareholders and environmental stakeholders) when doing business.

Ethical considerations set aside, there is a financial business case for CSR as well. This review summarizes the economic ‘value drivers’ of CSR, as well as the empirical findings on the relationship between CSR and corporate performance. The former include operational efficiency opportunities, increased brand value and reputation, better risk management, attracting and retaining talented employees, and pre-empting regulatory intervention.

The financial bottom line of CSR has been analyzed empirically from many research angles, which makes the comparability of these studies challenging. Nevertheless, the outcome of the literature overview performed in this report is that empirical studies generally indicate that CSR enhances corporate financial performance. This holds true for all aspects of CSR that have been subjected to econometric analysis, which can be categorized in (i) good corporate governance; (ii) environmental performance; and (iii) stakeholder relations. In conclusion, the literature that has been discussed indicates there is consensus that corporate financial performance benefits from CSR.

…and at least as Profitable as Conventional Funds from an Investor Perspective Socially Responsible Investment (SRI) concerns sustainability at the investment, fund or portfolio level and involves screening the sustainability of companies before investing in them. Investors applying SRI ‘target’ sustainable companies.

The economic rationale for SRI has been subject of many empirical studies. For data availability reasons, empirical research generally focuses on the performance of SRI funds vis-à-vis conventional funds: do SRI funds perform better or worse than conventional funds in terms of returns? Mutual fund studies that were reviewed in this report do not offer an unequivocal answer. In general, these studies conclude that SRI funds do not perform better or worse than conventional funds as most research offers statistically insignificant results. Several authors have attempted to take into account the regional and fund lifecycle differences that exist in fund performance. However, these studies offer mixed results as well.

The lack of statistically significant differences in most mutual fund studies supports the hypothesis that investing in SRI funds enhances sustainability without necessarily negatively affecting the return on investments. This conclusion is strengthened when focusing on mutual fund studies that are based on multifactor models. These studies use more sophisticated econometric models to incorporate non-quantifiable aspects and indicate that portfolios selected based on ‘environmental, social and governance’-related variables even outperform portfolios that score low on these variables.

–  –  –

In conclusion, although they do not provide unambiguous evidence of outperformance, empirical results do indicate that sustainable investments at least perform as well as conventional investments. More research is needed in this field.

Room for Further Research This report will be used by Duisenberg school of finance which is currently designing a research agenda for its Programme on Finance & Sustainability. Box 1 hopes to contribute to the efforts of Duisenberg school of finance in this area, by summarizing blind spots in the research areas encountered during the course of writing this report. Some subjects have not been discussed in (academic) literature but are found to merit further research or updating.


SUMMARY iii Box 1 Subjects for future research Included in this box are areas for further research that were encountered when composing this literature overview. Within each area potential research questions have been defined. The list of research areas and questions is by no means comprehensive, but should offer an interesting starting point to define further research.

• Measuring the value created by CSR

• Can sustainable activities be standardized so as to better understand the relationship between sustainability on the one hand, and company performance and company value on the other?

• It may be that ‘measuring’ the sustainability impact is not possible; what does this imply for narrative reporting?

• The CSR-company performance relationship has been analyzed primarily by comparing market prices (e.g., stock prices and stock returns): what is the (isolated) impact of CSR on other corporate finance ratios (e.g., return on assets)?

• Pricing of CSR on capital markets

• How can the direction of causality between CSR and higher shareholder value be determined?

• How does CSR influence the cost of capital of firms and their investment decisions?

• Are non-sustainable firms punished by the capital markets? Do investors require an additional return for investing in these companies? How does this influence the cost of capital of these firms as well as the investment and lending decisions of financial institutions?

• How should CSR be better communicated so as to reveal more information about company risk and strategic intent?

• Assessing SRI success drivers

• What is the precise impact of investment screens on SRI fund performance?

• Can previous findings that fund performance benefits more from positive than negative portfolio screening, be generalized across sectors and countries?

• What other success drivers can be established empirically?

• Robust empirical findings across existing studies

• Current fractured evidence on (in particular) the relationship between sustainability and fund performance could benefit from techniques as meta-analysis and Influential Literature Analysis (ILA).

• Impact of SRI on financial institutions

• What is the impact of SRI on the investment and lending decisions of financial institutions?

• How can ‘outsiders’ evaluate the impact of the adoption of sustainability principles on the performance of banks and other financial institutions?

• Do financial institutions that apply sustainability principles perform better or worse than otherwise comparable financial institutions?

• Does applying sustainable principles result in higher or lower returns on financial products (e.g., project and asset finance products)?

• What is the effectiveness of sustainability principles: do they actually lead to more socially and environmentally responsible projects?

• Reconciling the seeming anomaly between CSR and SRI

• If CSR is found to enhance a firm’s value and performance: why is this not reflected in SRI?

See Orlitzky et al. (2003) and Hoepner & McMillan (2009) for a starting point on applying respectively meta-analysis and ILA on sustainability outcomes.

–  –  –

As recognized today by leading CEOs and leading thinkers, ‘sustainability’ is a key issue for business leaders to understand and manage. Whilst the term ‘sustainability’ is being used to mean different things by different parties, this paper will follow the extended WCED definition of sustainability incorporating both environmental and human rights objectives, based on the ThreeDimension Concept of the ‘Declaration of Rio on Environment and Development’. The World Commission on Environment and Development (1987) defines sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs’’. The ‘Declaration of Rio on Environment and

Development’ recognized that sustainable development is a balance of three dimensions:

environmental protection, economic growth and social development (United Nations Conference on Environment and Development, 1992).2 Research on finance & sustainability is still very much an emergent field. At the request of Duisenberg school of finance, SEO Economic Research has surveyed the literature on finance & sustainability. This has resulted in four reports,

each providing a literature overview of one aspect of finance & sustainability:

• Financing the transition to sustainable energy;

• Carbon trading;

• Innovations in financing environmental and social sustainability; and

• Sustainable investment.

Each report provides comprehensive insights on a major topic within the field of finance & sustainability. Based on our findings from (academic) literature and relevant policy discussions, key topics per subject are identified and discussed. Moreover, areas where it is felt that the literature is underdeveloped have been identified in order to contribute to Duisenberg school of finance’s overall thinking about research objectives for its Programme on Finance & Sustainability. The topics as well as the broader scope and focus points of each topic, have been defined in close cooperation with Duisenberg school of finance.

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