Five Questions about SRI – Weekly Expert Interview with Dr. Tessa Hebb, Director, Carleton Centre for Community Innovation, Carleton University, Ottawa, Canada – September 7, 2012

Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.”  The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience.  The goals of Five Questions about SRI are fourfold:

  • To collect a catalogue of examples of SRI in practice in emerging markets;
  • To raise awareness about SRI in emerging markets;
  • To reflect on what SRI in emerging markets means to practitioners; and
  • To enable SRI practitioners in emerging markets to network with peers around the world.

This week’s interview is with Dr. Tessa Hebb, Director, Carleton Centre for Community Innovation, Carleton University, Ottawa, Canada.

The Carleton Centre for Community Innovation (3ci) is a university research centre based at the School of Public Policy and Administration at Carleton University, Ottawa, Canada.  Through research, education and program management, 3ci investigates, strengthens and disseminates innovation in responsible investment, non-profit and philanthropic management, social finance, community-based economic development, and local governance, on the part of geographic communities and communities of interest, in Canada and around the world.  Acting as a catalyst and convener, and linking research to practice and policy, the Centre seeks to enhance understanding and knowledge of the distinctive contributions of the non-profit, voluntary, and philanthropic sectors and local institutions to the quality of life of citizens and community vitality.  It invites community leaders, policymakers, business executives, trade unionists, non-profit managers and engaged scholars to join it in producing action-oriented knowledge that will empower communities to build better lives for their citizens.  Dr. Hebb is the Director of the Carleton Centre for Community Innovation, Carleton University, Canada.  Her research focuses on Responsible Investment and Impact Investment is funded by the Social Sciences and Humanities Research Council, Government of Canada.  The Carleton Centre for Community Innovation is a leading knowledge producer on Responsible Investing and Impact Investing tools and instruments. Dr. Hebb received her Doctorate from Oxford University. She has published many books and articles on responsible investing and social finance policies including the volumes Working Capital the Power of Labor’s Pensions; No Small Change: Pension Fund Corporate Engagement; and  The Next Generation of Responsible Investing.

Emerging Markets ESG:  How would you define socially responsible investment (SRI)?

Dr. Tessa HebbI have been researching both responsible investing and socially responsible investing for twenty years and I am often asked how I distinguish the two.  For me, responsible investing is factoring environmental, social and governance (ESG) concerns into investment decision-making.  For long-term investors this approach is about lowering long-term risk that can arise from these factors over time, and the possibility that taking this factors into consideration in addition to financial factors may lead to out-performance of the investment (alpha) over time.

Socially responsible investing (SRI) also brings a concern for ESG factors into consideration, but for me, in addition to ESG this approach also includes an ethical component that is not present in strict responsible investing (RI).  This ethical component will vary by individuals and organizations.  Like RI, SRI can be practiced through both positive (best of sector) and negative screens, and includes corporate engagement as a tool to accomplish its goals.  SRI is often associated with individual investment choice, though many institutional investors (most notably the Norwegian Pension Fund) also have an ethical dimension.

Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Dr. Tessa Hebb: Mainstream investment continues to adhere more or less to modern portfolio theory (MPT), meaning that mainstream investors believe that the market is relatively efficient and that the known and relevant information about the firm is already embedded in its market price.  If new information is critical for the firm over time, arbitragers will use this information to either drive the price up or down accordingly.  This view discounts most information that is not financial.   Recent financial crisis have spawned a critique of this narrow view of
the market and behavioral finance is providing us with a much more nuanced understanding of the irrationality of the market.

SRI in contrast suggests that the market is not efficient and that there is important information for long-term returns rooted in what is often termed the extra-financial information on the firm, in particular the environmental, social and governance standards of firm behaviour. As a result SRI investors seek raised ESG standards to both prevent future losses in their portfolio and position themselves for future positive growth.
SRI with its grounding in ethical standards is often at the forefront of broad societal change and is well positioned to take advantage of those changes as early market movers.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging
for companies in emerging markets to manage?

Dr. Tessa Hebb: I would have to say the social factors are the hardest to manage for most companies operating in emerging markets.  Governance standards are improving in most emerging markets as local stock exchanges mature and government regulation strengthens emerging market corporate governance regulation.  Similarly many companies can and do bring higher environmental standards to their  emerging market operations then in the past.  Companies which would have the greatest environmental impact in emerging markets tend to be large multi-nationals (often in the extractive sector) and directly control the operations in these countries.  Increasingly they are imposing company-wide environmental standards in their operations that exceed those required by local regulation (where environmental standards may be weak).   But human rights issues, particularly labor rights, continue to surface in many emerging market operations.  Often these issues
occur down the supply chain, but increasingly contracting companies are being held responsible for those actions, and are punished by consumers and investors alike for human rights abuses in their supply chain.  Yet controlling supply chain abuses, particularly in small operations in countries with weak human rights and labor rights standards remains a challenge.  

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most
challenging for investors in emerging market companies to analyze?

Dr. Tessa HebbFor the same reasons detailed above, I would argue that social issues remain the hardest area for investors to analyze in these markets.  Because these abuses tend to occur down the supply chain and in small and often geographically disbursed operations they are exceedingly difficult to monitor.  Non-governmental organisations (NGOs) and specialized ESG rating agencies are providing more information on ESG standards, particularly for investors in large multi-national companies operating in emerging markets.  SRI investors are able to use these ratings to develop best-of-sector approaches to their investment or to remove companies whose ESG standards are particularly egregious in their operations in emerging markets.   But monitoring companies based in and listed in emerging markets themselves is much more difficult.  Where government standards are lax, it is hard to gain sufficient information required to monitor social issues and remains a challenge for most investors in this sector.

Emerging Markets ESG:  From your perspective, what is the nexus between community-based economic development and socially responsible investment in emerging markets?

Dr. Tessa Hebb: I have a deep interest in the intersection between community-based economic development and both responsible investment and socially responsible investment.  My research work in developed countries such as Canada and the United States demonstrates that investment can be targeted for both ancillary benefits to community (such as affordable housing, clean technology, improved infrastructure and revitalized communities) and financial return. This approach is now spreading to investment in developing countries with emerging
markets.  The current term applied to this global investment approach is “impact investing.”  While it embraces investment in areas such as
micro-finance, impact investing goes well beyond.

A recent report of JP Morgan (2010) suggests there is “a significant market opportunity for impact investment over the next ten years. After analyzing selected segments of five sectors – urban affordable housing, rural access to clean water, maternal health, primary education, and microfinance – serving the population at the “base of the economic pyramid,” the authors identify a potential profit opportunity between $183 and $667 billion and a potential investment opportunity between $400 billion and $1 trillion in the next decade for just these segments of the impact investing market.”

Emerging markets will continue to grow and develop with booming populations and scant infrastructure; meeting the basic needs of these economies in the near future will provide enormous potential for RI and SRI investors.  Large scale water projects, transportation systems, sanitation, sustainable energy production – these are just a few examples of the nexus between SRI and community economic development around the world.