Values Investing: The Indexes Are Up

Socially-responsible investing, long the domain of fine-tuned mutual funds, is drawing more attention from the stock-index world.

Major providers such as Dow Jones and FTSE are expanding their index list, giving individuals and institutions more options, and licensing more products with a social focus. Moreover, by expanding their approach to “best in class” companies, the index-related products help overcome concerns by some institutional investors who want exposure to a broader market.

Exchange-traded funds are a major beneficiary of the trend. The New York Stock Exchange in early 2005 launched Barclays Global Investors’ iShares KLD Select Social Index Fund. KLD’s index managers select stocks from the Russell 1000 and S&P 500 indexes, but give greater weight to companies with the best social and environmental performance. At the end of March, the fund had net assets of $126 million and holdings in 224 companies.

At the American Stock Exchange, Power-Shares Capital has done well with two ETFs — the WilderHill Clean Energy Portfolio and the Water Resources Portfolio — tied to specialized indexes. Scott Ebner, head of new product development at the AMEX, doesn’t view the two funds as directly socially responsible, but says their focus on a specific issue may have “a great deal of appeal for many socially responsible investors.”

Nasdaq is launching the NASDAQ Clean Edge U.S. Index, tracking the performance of clean-energy companies and is in talks to license exchange-traded funds, futures and options tied to the index.

Dow Jones got into the field in 1999, joining with SAM Group of Zurich to launch a series of sustainability indexes, since expanded into Europe and, last year, to North America. In general, the indexes comprise companies from the 2,500 largest market capitalization companies worldwide; the top-ranked 10% or 20% from particular sectors are selected for the various indexes.

FTSE4Good indexes, launched in 2001, “tries to capture a deeper number of companies,” says Will Oulton, head of responsible investment for the FTSE Group. While FTSE4Good excludes companies in the tobacco, weapons and nuclear industries, it is moving toward a performance-based model. Licensing revenues from the FTSE-4Good Indexes are donated to UNICEF. Mr. Oulton says exact numbers aren’t available, but estimates that investments using the indexes are around $3 billion, up about 25% over the last two or three years.

State Street Global Advisors manages about $85 billion in accounts concentrated on socially responsible investments, about 85% of it tied to various indexes, says Bailey Bishop, a principal.

“We’ve been seeing the introduction of many, many more dedicated socially responsible benchmarks,” he says, because investors “are feeling a little more comfort-able” with the concept.

Bishop is working on a managed account that will use “community commitment” as its benchmark, focusing on whether companies pay attention to the needs of their workforce, provide wealth-creation opportunities for lower-wage employees, and support community needs. The idea is backed by a foundation with a $10 million account but Bishop thinks “a lot of others may be interested” if the approach proves itself.

In Zurich, SAM Group has seen sharp growth in its business. The dollar value of investments it manages rose about 30% to a bit over $4 billion last year, says Alexan-der Barkawi, managing director. He cites “a growing conviction (among investors) that it is the right thing, not only from an ethical, but from a performance viewpoint.”

SAM’s methodology seeks to identify “sustainability leaders” in specific industries. Climate change, for instance, “means one thing for the insurance industry and may have different implications for the utility sector,” he says. On the other hand, governance “is an issue we believe is important in all sectors.” With growing pub-lic interest in governance issues, he notes, “governance may be an issue that doesn’t help us identify best-in-class companies as much anymore. Everybody has improved on that front.”

In January, Dow Jones and SAM started an index of 105 companies that meet both sustainability and Islamic investment criteria. (The Islamic Market Index excludes companies that do business in industries banned by Islamic law, such as alcohol, tobacco, weapons and gambling. It also excludes companies that use a lot of interest-based financing.)

By James C. Hyatt. This article first appeared in the Summer 2006 issue of Business Ethics, Volume 20, No. 2.